Investors looking to build their equity REIT allocations are going to want these six on their radar. These 6 operate in four different property types:
- MH Parks: SUI and ELS
- Cell Towers: AMT and CCI
- Data Centers: EQIX
- Industrial: TRNO
What do these REITs have in common?
- Massive growth in AFFO per share
- Massive growth in same-property NOI
- Lower dividend yield
What we are seeing is primarily a plunge in quality. I see this as a sector rotation where investors are trying to dump “growth” in favor of “value”. However, the “value” equity REITs aren’t really “value”. A better description for the shares that have been in favor is “low-quality over-leveraged junk”.
This is particularly interesting given the recessionary risk. If we get a recession (which we continue to see as a strong possibility), that is much worse for REITs with too much leverage and weaker properties. This is an example of the market trying to switch strategies so hard that the actual quality of the REITs is ignored.
Sun Communities (SUI) is one of our larger positions. It’s the third-largest equity REIT position. We wrote a report on SUI (subscriber link) a week ago and included more valuation charts in our recent SUI trade alert (subscriber link).
Equity LifeStyle (ELS) is great. Recent valuation pulls us towards SUI instead, but the gap isn’t huge, and both belong in the portfolio of any dividend growth investor. ELS tends to grow slower than SUI because they haven’t been aggressive about issuing above NAV and chasing acquisitions. Those acquisitions are what enabled SUI to outperform, but both of these REITs have been excellent.
AMT and CCI
American Tower (AMT) is our second-largest position and Crown Castle International (CCI) is our largest position. The difference is relatively small as each is around 11% to 12% of our total portfolio. Shares went on sale earlier this year and we kept scooping them up. After a massive recovery, many investors were sad the opportunity was gone. I was a bit sad as well. It’s nice to see the prices recovering, but I love having great opportunities to share.
Growth in AFFO per share is so strong that long-term investors don’t need any growth in the multiple. The multiple will probably increase, but even without it, the shares offer a compelling long-term return because the combination of a modest yield and massive growth is so powerful. Fundamentals continue to demand more cell towers:
Projections for data growth expect that 4,961 petabytes to turn into 17,400 petabytes in 2026:
To process that much data, carriers need to continue investing heavily in their infrastructure. Specifically, they need to keep renting space on towers and installing equipment.
Having faster access with 5G doesn’t mean the carriers can reduce their tower footprint. It means they need even more.
How can they afford to keep putting more equipment on towers?
The leasing cost per GB of mobile data has fallen every year:
That’s not a problem for the towers. The cost for data is coming down yet revenues are going up because consumers want more data. Are you reducing your data consumption? Me neither.
The carriers, including AT&T (T), Verizon (VZ), T-Mobile (TMUS) continue to spend over $33 billion per year on expanding their presence. That’s a combination of equipment for towers and spectrum for customers to use. DISH Network (DISH) will be working to build out their own network as well, which means leasing space on towers.
Moving on to Equinix (EQIX), we have the massive data center REIT:
With 99.9999% reliability, you can assume Rocket Chat isn’t on their servers.
We’ve watched EQIX for years but only began investing in them during a dip a few months ago. It’s been so hard to get an attractive entry point. However, we’ve seen excellent growth in AFFO per share. I don’t like the REIT’s definition for AFFO per share, but other metrics like their Net Operating Income per share are also demonstrating massive growth. Further, ignoring the adjustments I don’t like we would still be seeing strong growth.
EQIX also has the longest streak in the S&P 500 for consecutive quarters of revenue growth:
Not bad. That’s certainly supporting the idea that tech companies continue to want the services from EQIX so they can keep their own customers.
The dividend yield is tiny, but they should retain every available dollar of capital. The unlevered (no multiplier from using low-rate debt) AFFO yield on their investments (developments) came in at 14% for Q1 2022.
The same-property revenue growth came in at 6% for stabilized sites and 21% for expansion sites.
Debt relative to market cap is small, so the REIT isn’t relying on refinancing debt at low rates. They have $1 billion due in 2024 and nothing before that. That’s not a big challenge for EQIX and 94% of their debt is fixed rate.
Investors should expect significant growth in AFFO per share to continue (7% to 8% for 2022). When the market is done punishing “growth” REITs, we could see a big recovery in the share price.
It may not be as exciting as Netflix (NFLX) or Meta Platforms (FB) but EQIX has been a steady producer and delivers a critical service to their customers.
Terreno Realty (TRNO) is an outstanding industrial REIT. There is nothing to dislike about this REIT. They earned outstanding marks for growing net operating income, AFFO per share, NAV per share while delivering outstanding transparency.
TRNO is one of the few REITs which avoids joint ventures because of the accounting complexity. They want to ensure that investors can easily understand their results, which is refreshing. Joint venture accounting is a mess under GAAP. GAAP disallowed the most transparent form of reporting on the basis that it might confuse investors. Instead, investors get minimal information about joint ventures. They can’t be “confused” if they don’t know it’s there. It’s like how kids never ask their parents questions about quantum mechanics. If they don’t know about it, they can’t be “confused”.
Therefore, TRNO gets extra points for being intentionally transparent.
TRNO goes all out on corporate governance:
That’s important because it often allows TRNO to trade at a premium to NAV per share. They’ve used that premium share price to issue new stock and acquire new properties, which further accelerates their growth in NAV per share and AFFO per share.
TRNO is constantly reinvesting into its portfolio to drive additional growth:
To put that 6.6% cap rate in perspective, Duke Realty (DRE) had an offer that valued the company around a 3.6% implied cap rate. Duke replied by saying that they are still open to deals, but the buyout offer was insufficient. TRNO’s portfolio is superior and should trade around the bottom of the 3% range.
However, TRNO also deserves a premium to NAV due to corporate governance.
This is simply a winning strategy:
That growth isn’t just in the past. It’s still going on:
The portfolio is unique because it is located in areas where it is not economically feasible to create new industrial real estate:
Industrial real estate generally carries a much lower value per square foot. Consequently, developers attempting to maximize the value of a piece of land have an incentive to build other types of real estate. That keeps rents rising. If industrial real estate appreciates to the extent that it becomes a competitive choice, TRNO’s value would be exploding higher.
San Francisco is a great example. Industrial real estate in San Francisco is extremely desirable. It commands much higher rates than elsewhere. Yet we’ve seen a 23% decrease in supply since 1997:
During that time, we’ve seen rental rates increase dramatically because of the emphasis on rapid delivery. Every company selling online needs to compete with Amazon (AMZN) and they need the warehouse space to do it.
The Growth REIT Correlation
When I suggest that the market is blindly selling growth REITs and buying crap REITs, that might seem like an oversimplification. It couldn’t really be that simple, could it? I’ll provide the chart for you to evaluate. If you’d like a test, cover the right side of your screen with your hand so you don’t see which color represents each ticker. Then see if you can tell which line doesn’t match the rest in the $100k chart:
Pretty clear, right?
The high growth REITs surged during different periods. That makes sense since they come from four different property types. However, none of them has been remotely correlated with weak REITs. For simplicity’s sake, we used the Invesco KBW Premium Yield Equity REIT ETF (KBWY) to represent a combination of weak REITs. It’s a great tool for charting the aggregate performance of lower-quality REITs because the index picks them so effectively. If the market was not simply trading high-growth REITs together, then a REIT index would theoretically flow through the middle of them.
We can zoom in on the chart and just look at the performance since 2021 and especially in 2022:
Note: Let me know if you have any difficulty zooming the images. Seeking Alpha limits resolution, especially the pre-zoom resolution.
What we’re seeing in early 2021 and again over the last few weeks is weakness in high-growth REITs. The fundamentals remain excellent but share prices have been hit by a shift in sector allocations. You may recall that when the pandemic actually hit, KBWY got smacked dramatically harder than any of these quality REITs. When things actually got ugly, investors finally remembered that fundamentals matter even more in the tough times.
Want one more reason investors shouldn’t just buy junk?
Big investors are regularly coughing up a significant rate for the privilege of shorting it. This is the primary reason I haven’t suggested shorting some KBWY as a hedge on equity REIT exposure. Because investors have to pay out an extra 7% or so on average. Beating KBWY over long periods has been easy but needing to beat it by an extra 7% annually would put a real dent in the margin of victory.
While STORE Capital (STOR) is also at a large discount to our target buying prices, it is in a more unique situation. The triple net lease REIT has a dramatically longer lease duration which makes it more exposed to inflationary pressure and interest rates. Consequently, it can and often does trade in correlation with entirely different factors. In this article, I wanted to focus on the connection between the high-growth REITs without including the interest rate sensitivity of net lease REITs.
There are some other high-growth REITs that would’ve fit the chart perfectly. They were left out since they aren’t deep in our target buying ranges. Further, the chart already had 7 lines which makes it more difficult to read.
These great REITs are precisely the kind of positions investors should be building up for their long-term allocations. This kind of panic is a great opportunity to build those positions. I’ll be looking to add cash to my portfolio again this month to keep building my positions. Given the big positions in AMT, CCI, and SUI (which overlap with ELS), I’ll probably be looking to buy some EQIX or TRNO if they stay anywhere near this cheap.
Note: A few days after sending this alert to members of the REIT Forum we transferred in more cash and increased our position in TRNO by another 158 shares. Those 158 shares are not reflected in the allocation percentages shown below.
Ratings: Bullish on AMT, CCI, EQIX, TRNO, SUI, ELS, and STOR.
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