"Do you feel lucky, punk?"
Well, before you get angry (for calling you out as a punk), let me remind you that I am referring to the famous line from Inspector Callahan (Clint Eastwood) in the classic movie, Dirty Harry.
In case you missed it (or forgot), Inspector Callahan was tracking a bank robber and the two were confronted with Callahan pointing a 44 Magnum at the crook. Callahan calmly says, 'Do I feel lucky?' Well, do you, punk?
O.K. Now that I have your attention, I want to provide you with some actionable information that should help you with your New Year’s resolutions. Keep in mind, I have already provided my full New Year’s Resolution, and I can assure you that I was not trying to offend you by calling you out as a punk, my resolution #3,
Be nicer. This might be hard, as I’m already nice. Perhaps this actually means, be tougher when it’s called for, and be able to quickly shift gears, as needed, knowing that others mean well (when they do).”
Most of you know that my objectives as a writer on Seeking Alpha are very clear, and I made that my #7 resolution,
Be more courageous in “calling out” the ugly ducklings – and I mean the ones that never, ever turn into SWANs. These are those REITs that might look good with super high “sucker yields,” but that are not operating with the investor in mind. Curious business practices, slippery dealings, unsettling aspects in the balance sheets, the prospect - or reality - of decreasing dividends, and the like. Stand strongly by a most-cogent analysis.”
You can read my entire REIT resolutions here, so I won't bore you with the details. Instead, I want to begin a series of lists this week (my kids are out of school, so lists are perfect this time of year), starting with these "7 lucky REITs that yield 7%+."
And on Thursday I will provide you with the “REITs that yield 8%+” and on Friday I will finish the series with a list of “the REITs that scream double-digit” (and we rate as spec buy). So now, let’s get back to business, and in the words of Inspector Callahan, "Do You Feel Lucky, Punk?"
7 Lucky REITs That Yield 7% Plus
Brookfield Property Partners (BPY) is managed by Brookfield Asset Management (BAM) – see latest article here – and the company is not a traditional REIT, instead it is structured as a limited partnership or LP, with BAM as its general partner and sponsor. This means that Brookfield Property is similar to an MLP in that it uses a K-1 tax form and pays distributions (a tax-deferred form of dividend). But unlike most MLPs, Brookfield Property is structured as an LP whose assets are themselves LPs, meaning it generates no unrelated business taxable income or UBTI. That means it’s safe to own in retirement accounts like IRAs and 401Ks.
Brookfield Property has grown via several major acquisitions to bring most of holdings under one umbrella. As a result, Brookfield Property has not just tripled in size, but it’s become diversified into 10 different REIT industries. As a result of this mega-growth, BPY now owns some of the world’s most famous properties, including London’s Canary Wharf and the Fashion Show convention center in Las Vegas.
Brookfield Property has grown earnings by an average of 6% per year and in doing so the company has brought the payout ratio down from 90% at IPO to 81%, which is in line with management’s long-term goal of maintaining an 80% payout ratio while growing the payout 5% to 8% per year. That’s not just one of the highest payout growth rates in REITdom, but more importantly, the LP has proven it can deliver on that guidance safely.
Brookfield Property has underperformed in 2018 (-27.2%), but that has created a wider margin of safety, and that’s precisely what makes this 7.8% yielder a sweet treat. By 2022, Brookfield Property expects the payout ratio to fall to 78%, despite its industry-leading payout growth rate. That will allow it to invest $500 million per year in retained cash flow into further growth, which it plans to augment with an estimated $600 million average in profits on its real estate investments. We have this one on our Strong Buy list.
Brixmor Property Group (BRX) is a shopping center REIT that owns 470 properties spanning coast to coast. Brixmor has one of the largest "pure play," wholly owned, grocery-anchored platforms in the U.S. (average shopping center size is 170,000 sq.ft.), around 70% of the properties are grocery-anchored, and ~76% have an additional anchor.
Brixmor focuses on non-discretionary and value-oriented retail tenants (10 of the company's largest tenants account for only 17.1% of ABR) with a strong service component, well-suited for today’s consumer environment. It covers 200+ national and regional open-air retailers, with plans to open ~13,000 net new stores.
Brixmor’s pipeline of reinvestment activity is largely funded by free cash flow and a moderate level of capital recycling. The company is essentially self-funded and does not rely upon an ATM or the capital markets. Because the business plan is funded through internally generated cash flows and opportunistic asset sales, the company’s focus (from a balance sheet perspective) is on continuing to extend its weighted average debt and opportunistically accessing the unsecured markets to drive EBITDA growth.
Brixmor has also underperformed in 2018 (-15.3% in 2018) and that’s precisely why the 7.6% yield is so tasty. Since 2014 the company has increased its dividend by an average of 7% per year and is likely to continue with that trend. Brixmor also has one of the lowest payout ratios in the shopping center sector (around 54%). We maintain a Buy.
Spirit Realty Capital (SRC) is a net lease REIT that spun off its Shopko properties, as well as the collateralized Master Trust, to form Spirit MTA REIT (NYSE:SMTA), which is essentially a “liquidation vehicle” likely to be dissolved before the initial 3-year (management agreement) term.
Spirit provides SMTA with property management, special servicing and asset management services, for approximately $27.7 million in total annual fees (make sure to back that out of AFFO for SRC). Although we aren’t big fans of SRC’s conflicts of interest (managing two portfolios) we’re attracted to the “new Spirit” that has improved its investment grade equivalent from 36% to 42% (the top 5 tenants' weighted average investment grade rating is BBB). This is comparable to Realty Income (O), yet much cheaper to own.
Also, Spirit’s leverage and liquidity are solid - the company’s adjusted debt to annualized adjusted EBITDA was 5.2x at Q3-18. The company had $636.5 million in available liquidity, and in mid-August, S&P upgraded their credit outlook (for Spirit), from neutral to positive, representing the third credit outlook upgrade received since the spin-off of SMTA.
Spirit has also underperformed in 2018 (-10.7%), and we find the discounted share price compelling, however, we recently downgraded shares based on Shopko concerns. "There are better alternatives in the net lease REIT sector (such as WPC and VER) that aren’t wresting with conflicting management arrangements. I’m glad I didn’t recommend Spirit pre-spin, and now, it’s time for me to maintain discipline and hit the brakes." Shares now yield 7.1%.
VEREIT Inc. (VER) is also a net lease REIT (like SRC) that is poised to profit. More recently VEREIT sold Cole Capital, its non-traded REIT business, to an affiliate of CIM Group. This is significant because it eliminates some of the complexity overhang surrounding the company’s competing businesses. By selling Cole, VEREIT has simplified its core business model and focus on its large, diversified single-tenant real estate portfolio.
But there’s another cloud that VEREIT is wrestling with and it has to do with ongoing lawsuits. But one way to insure against the “uncertainty” is to buy shares today, with such a wide margin of safety. There is some clarity – Vanguard has settled – and VER has substantial liquidity that can be used to reduce debt and settle the lawsuits.
From a valuation perspective, we like VEREIT because shares trade substantially below the bellwether peers, Realty Income and National Retail Properties (NNN) and even lower than W.P. Carey (WPC). VEREIT's dividend is well-covered by AFFO (76% payout ratio), and now that Cole is gone, the company doesn't have the conflicts of interest it once had. The only remaining cloud is the litigation which is dissipating, and in the interim, the 7.7% dividend yield is solid. We maintain a BUY.
Iron Mountain (IRM) is an industry leader in storage and information management services, serving 230,000 customers in 53 countries on six continents (with over 24,000 employees worldwide). According to the company's website, it serves organizations in every major industry and of all sizes, including more than 95% of the Fortune 1000, which rely on Iron Mountain as their information management partner.
One of the reasons that we like this REIT is because of its low turnover rate (Iron Mountain has only 2% customer turnover in a given year); this means 50% of the boxes that were stored 15 years ago still remain. I know of no other REIT that has such exceptional "shelf life." The company’s records management business continues to deliver steady organic revenue growth and strong margin expansion, while at the same time achieving meaningful scale and faster-growing adjacent businesses.
But we also like Iron Mountain’s evolution into the data center sector and the more recent transactions with Credit Suisse (NYSE:CS) and new partnership with Google (NASDAQ:GOOG) (NASDAQ:GOOGL), examples of how Iron Mountain is seeking to enhance investment returns while also supporting customers’ storage and information needs across a broad range of formats and asset types.
But it’s not just the company’s diversification efforts, we also like the fundamentals, including the recently announced 4% dividend increase, supported by year-to-date AFFO growth of 13.7%. For the full year, Iron Mountain’s AFFO payout ratio is expected to be sub-80% versus the original guidance midpoint of 81% (even after increasing the dividend). Iron Mountain yields 7.5% and the company returned -7.8% in 2018. We maintain a STRONG BUY.
Blackstone Mortgage (BXMT) is a ‘pure play’ commercial mortgage REIT that primarily originates and purchases senior mortgage loans collateralized by properties in the U.S. and Europe. The company is managed by Blackstone (BX), a world leader in alternative investments with nearly $367 billion of assets under management (or AUM).
We like Blackstone Mortgage because the company’s short-term floating rate assets benefit from rising short-term interest rates, as their current yields increase with these rates. REIT investors tend to fear rising rates, particularly investors in residential mortgage REITs, where many of the assets are fixed rate, but the liabilities float - but Blackstone Mortgage is different (around 92% of loans are floating rate and earnings benefit from increased short-term rates).
The credit quality of Blackstone Mortgage’s portfolio remains strong, the average loan to value is ~63% and the company focuses on coastal markets with dynamic demand in high barriers to entry, where the entire Blackstone real estate platform has had great success. As part of that focus, Blackstone Mortgage expanded its California regional office to better address West Coast lending opportunities.
In 2019, we plan to release an all-new commercial mortgage REIT index and Blackstone Mortgage will be a participant. In 2018, Blackstone Mortgage returned +6.8% and the current dividend yield is 7.8%. We maintain a Buy.
Kimco Realty (KIM) rounds out the “lucky 7” list. I wrote on Kimco a few days ago and in that article I explained that “the biggest risk for Kimco…has to do with "execution risk". In order for the company to generate impressive returns, it must prove that it can continue to evolve and manage its capital wisely.”
Since its "2020 plan" was commenced, Kimco has delivered on its promises, which includes recycling capital into more productive assets and fortifying its balance sheet. Kimco has no unsecured debt maturing until May of 2021, and only $120 million of mortgage debt maturing during the same time frame. It has over $2 billion available on its unsecured revolving credit facility, which provides a significant liquidity for any opportunistic funding refinements.
A strong balance sheet is the foundation that will support Kimco's future growth initiatives, and the company's 2018 efforts have been nothing short of impressive. Its consolidated weighted average debt maturity profile is now 10.7 years, one of the longest in the REIT industry.
Kimco's goal long-term is "to be the best shopping center REIT in the entire sector," and the company believes that in order to do that, it will "have to have same site NOI growth that's really north of 2.5% on a long-term run rate and an FFO growth rate that's in that 4% to 5% or higher.” Although the company has underperformed in 2018 (-13.1%), we believe management can move the needle, and we are maintaining a Strong Buy (Kimco yields 7.6%).
...ask yourself if you feel lucky…and if you do, these lucky 7 REITs could be just what the doctor ordered.