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What A Real Blue-Chip REIT Looks Like Might Surprise You

Summary

  • In his book Investing in REITs, the late and great Ralph L. Block called blue-chip REITs the “king of the jungle."
  • Blue-chip REITs have already established impressive track records, which are out there and open for everyone to see.
  • So, you’d better believe management wants to keep that legacy going.
  • These proverbial kings jealously guard their kingdoms, from what goes into them to what comes out. This makes blue-chip REITs worth talking about, including the ones below.

Too often, the non-"one percenters" seem to have a grossly inaccurate idea of what the other side does with its days. We see them sitting in high-backed leather office chairs, giving orders for a few hours (while eating bonbons) before jet-setting off to exotic locations and exclusive country clubs to hobnob with their own.

Surely, that's how all those Fortune 500 CEOs exist. How else would they?

In reality, though, most of them work very, very hard - harder than many of us would be willing to contemplate, much less put into action. As Forbes reported just last year, these financial elites don't have much in the way of personal time on weekends, much less on business days.

They put in intense hours, getting up early, staying late, and even working an average of 2.4 hours per vacation day. In the words of Forbes contributor Roger Trapp, "the CEO's job is relentless."

They live like proverbial kings, yes, but proverbial kings who know how quickly they could lose their kingdoms if they're not hyper-vigilant and constantly aware.

Summed up succinctly, there's a whole lot less glamour and a whole lot more hard work involved in most long-term success stories than meets the common eye.

"The little guy" has been grossly misinformed.

The Truth About Blue-Chip REITs

It's human nature to put some people, places, and concepts up on a pedestal. We hear them mentioned and automatically form a glamorous idea in our heads.

In the investing realm, that might very well include the term "blue-chip." As in blue-chip stocks or blue-chip REITs.

This isn't entirely our fault considering the term's actual definition.

When you look it up on Dictionary.com, for instance, you'll find it listed as an adjective that means "having outstanding or exemplary qualities within a specified category; leading." And switching over to Thesaurus.com, it includes synonyms such as "excellent," "elite," "exclusive," "privileged" and "first-class."

Those are all accurate, mind you, but they once again come with connotations that can be misleading. When it comes to blue-chip stocks or blue-chip REITs, it's easy to think of perfect investment entities. They never falter, never fail, and lead to sitting in high-backed leather office chairs, giving orders for a few hours (while eating bonbons) before jet-setting off to exotic locations and exclusive country clubs.

If that's your perception, adjust it now. The truth is a lot more down to earth than that.

The King of the Jungle…

In his book Investing in REITs, the late and great Ralph L. Block called blue-chip REITs the "king of the jungle." Here's how they look to him:

"Blue-chip REITs take you safely through the ups and downs in the sector's cycles and deliver consistent, rising, long-term growth in FFO and dividends. Because they are financially strong and widely respected, they will always have access to the additional equity and debt capital that fuels the growth engine. They will not always provide the highest dividend yields or even, in many years, the best total returns. Nor can you buy them at bargain prices. But they should provide years of double-digit returns with a high degree of safety. These are the REITs least likely to shock investors with major earnings disappointments and will provide very satisfying total returns."

If that sounds a bit boring, it's understandable. But boring can be downright gorgeous when it leads to secure, enjoyable retirements - perhaps even ones that involve a little jet-setting.

… Works Hard for His Dinner

In his aforementioned book, Block identified seven important qualities that every blue-chip REIT features:

  • Outstanding proven management
  • Access to capital to fund growth
  • Balance sheet strength
  • Sector and geographical focus
  • Substantial insider ownership
  • Low payout ratio
  • Absence of conflicts of interest

Of those must-haves, he singled out the first - outstanding proven management - as being of utmost value. This only makes sense when you think about it.

As kings of their respective castle, these people understand the value of what they're holding onto better than anyone else. They know the REIT's ins and outs on an intimate level, studying detailed reports, analyzing each piece of property and assessing the markets involved on a regular, if not daily, basis.

They have to, since it's their reputations on the line. Blue-chip REITs have already established impressive track records, which are out there and open for everyone to see. So, you'd better believe management wants to keep that legacy going.

What highly competitive, success-driven individual wants to fail?

By its very nature, "outstanding proven management" will make sure the REIT it oversees has sufficient access to capital. And, this almost automatically requires maintaining a low payout ratio.

It will be fully focused on keeping its balance sheet strong, operating well-placed properties and buying up complimentary assets. Everything it does is geared toward maintaining its blue-chip REIT status.

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It's running something it can be proud of, not only because of what it's producing in the moment but also where it's headed in the future. Therefore, of course, it wants to invest back into its own work.

It's a solid play with solid results.

These proverbial kings jealously guard their kingdoms, from what goes into them to what comes out. This makes blue-chip REITs worth talking about, including the ones below.

5 Blue-Chip Buys (Including a Few Bargains)

Federal Realty (FRT) has scheduled the Q4-18 earnings call on February 14th at 10:00 am ET. Referring to the latest Q3-18 results, the company generated $1.58 per share in FFO ($.07 above expectations). Federal Realty has a long history of generating consistent earnings growth evidenced by the fact the company is the ONLY publicly-traded shopping center REIT to grow NAREIT FFO per share every year since 2010. Federal Realty and Simon Property Group (NYSE:SPG) are the only two out of 24 publicly traded retail REITs to grow NAREIT FFO per share every year since 2010.

Federal Realty is also one of 25 'dividend kings' (50+ years of annual dividend growth) and one of only 12 companies with an S&P rating of A- or better. Fitch has recognized the company for its "blue-chip" credentials, last October 2018, Federal Realty affirmed its unsecured revolving credit facility, senior unsecured term loan and senior unsecured note ratings at A-, and its redeemable preferred share rating at BBB. The balance sheet continues to improve and is very well positioned from a capital perspective as they head into the next phases of new development in the coming years.

Federal Realty is "cycle-tested", which means that the stalwart REIT has maintained a best-in-class track record of delivering consistent dividend growth - a whopping 51 years in a row. While some would argue that the 3.0% dividend is puny, the blue-chip REIT investor will recognize that the shares are underpriced (P/FFO is 21.9x), representing a significant margin of safety. Furthermore, Federal has become a much stronger REIT as a result of the company's experience at integrating uses such as retail, residential, office, and hotels. Since our last article, we have downgraded Federal Realty from a Strong Buy to a Buy, reflecting 12%+ price appreciation since January 1st.

Simon Property Group has announced Q4-18 and 2018 Full-Year earnings, and this Strong Buy pick turned in some solid numbers, including Full-Year 2018 FFO per diluted share of $12.13, an increase of 8.2% year over year (over the last four years, Simon has grown FFO per share on a compound annual basis of 8%) and retail sales per square foot (for the mall and outlets) of $661, a record compared to $628 in the prior year period, an increase of 5.3%. Also, Simon announced the dividend of $2.05 per share for this quarter, a year-over-year increase of 5.1%.

Simon's "blue-chip" credentials are also rooted in the strong balance sheet: Debt/EBITDA of 5.4 (sector average 5.8), interest coverage of 6.9 (sector average of 3.4), average interest of 3.5%, and credit rating of A. Today, REITs as a sector have the lowest debt/market cap in their history, and Simon has pound-for-pound one of the best overall balance sheets in town. Which is why it's one of just two REITs in the country with an A credit rating (three have A- ratings).

While Simon's long-term thesis is strong, in the short term, it might have to deal with cyclical industry issues as well as natural economic variability. However, that is the quintessential opportunity for investors - with its enormous shadow growth backlog and access to a mountain of low-cost capital. Simon has an attractive value proposition supported by a very safe and growing dividend (yield is now 4.5%) and cheap valuation (P/FFO is 15.2x). Reviewing the "seven important blue-chip qualities" referenced in the above-mentioned book (Investing in REITs), Simon is a textbook example of a blue-chip.

Digital Realty (DLR) has announced Q4-18 and year-end earnings results that include FFO per share of $1.54 (in Q4-18), compared to $1.48 (in Q4-17) and FFO per share of $6.37 (for the full year of 2018) compared to $5.65 in 2017. For the full-year 2018, the company delivered core FFO per share of $6.60, a 7% increase from $6.14 per share in 2017. Management's long-term guidance is for 7% to 9% FFO/share growth, which analysts think will come in at 8%. This means that Digital Realty is one of the fastest growing blue-chip REITs you can buy, and makes for an excellent SWAN stock in any dividend portfolio.

Digital Realty's dividend may not be high (3.6%) by REIT standards, but it's still about double that of the S&P 500. More importantly, that dividend is very safe, thanks to a low payout ratio and a strong balance sheet that includes Net Debt/Adjusted EBITDA of 5.2 (sector average 5.8), Interest Coverage Ratio of 5.0 (sector average 3.5), Average Interest Rate of 3.6%, and S&P Credit Rating of BBB. This balance sheet ensures Digital Realty can borrow long-term bonds at rates that are three times below its returns on invested capital and makes it easier to grow AFFO/share more quickly.

If management can deliver on its long-term guidance, Digital Realty shareholders are likely to see double-digit total returns, which are far above the market's historical 9.2% CAGR total return or the 3% to 9% most analysts expect from the S&P 500 over the coming years. This blue-chip isn't a screaming buy (due to trading roughly at fair value and is facing far slower growth in 2019), but the strong data demands should propel this battle-tested REIT to solid double-digit returns (we are maintaining a Buy).

Kimco Realty (KIM) has generated solid Q4-18 and year-end earnings results that include Q4-18 FFO per diluted share of $0.35, and full-Year 2018 FFO per share of $1.47 (was $1.55 per share in 2017). The primary driver of the decrease was a reduction of $22 million in NOI from the sale of over $900 million of assets during 2018, offset by a $6 million reduction in financing costs due to lower debt. Kimco's pro-rata occupancy for 2018 was 95.8%, with anchor occupancy at 97.4% and small-shop occupancy at 91.1%, the highest level of small-shop occupancy ever reported (anchor occupancy was impacted by the Toys"R"Us and Sears bankruptcies during the year).

In 2018, Kimco was busy recycling non-core assets, and the proceeds from the sales were used to fund development and redevelopment investment of $420 million, reduce outstanding debt by $400 million, and buy back $75 million of common stock at a weighted average price of $14.72 a share. The portfolio has been strategically pruned, and that has resulted into a much higher quality business model in which around 80% of ABR (annual base rent) is generated from major metro markets (76% are coastal and sunbelt markets) with population growth of 6.3 million projected in these 20 markets within the next 5 years.

Kimco's balance sheet is also in great shape, arguably the best shape ever, as the company finished 2018 with consolidated net debt to recurring EBITDA of 6x and 7.5x, which includes the pro-rata share of JV debt and perpetual preferred issuances. The total consolidated debt stands at $4.87 billion, which is $605 million lower than the amount at the end of 2017. The company's liquidity position is in excellent shape with over $2.1 billion of availability from the revolving credit facility and cash on hand.

Kimco's goal long-term is "to be the best shopping center REIT in the entire sector," and the company believes, 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." Our Strong Buy thesis is predicated on Kimco's commitment to deliver on value, and the simplification efforts should drive the needle in 2019 and 2020, in which we are forecasting returns of 25% plus. Kimco is now yielding 6.3% with a P/FFO multiple of 17.0x.

Tanger Factory Outlet Centers (SKT) is the last of the five blue-chip REITs on my list and of course, I saved the best for last. The company has scheduled the Q4-18 earnings call for February 14th at 8:30 am ET. While I'm anxious to see how the company has performed in Q4-18, I have already provided you with a few valuable clues to set the stage for the upcoming earnings call: (1) Simon and Kimco delivered solid earnings in Q4-18 such as strong occupancy and leasing results. (2) Many retailers have reported Q4 results and thus far, there were no substantial blow ups. (3) Public optimism in their personal economy has hit a 16-year high (69% told Gallup that they expect their personal finances to be even better next year, just shy of the record 71% when the internet boom was raging under former President Bill Clinton).

Also, as I have monitored Tanger's Q1-18, Q2-18, and Q3-18 results, it's becoming clear that the retail cycle is improving, and the outlet sector continues to thrive. Remembering that there are no department store tenants in outlets - Tanger is not immune to re-tenanting risks - but on an NOI weighted basis, sales for the consolidated portfolio have improved (were $409 per square foot in the trailing 12 months), up a 2.3% from the prior year period (in Q3-17). Tanger's same center tenant sales for the overall portfolio increased 1.1% in Q3-18, and the company believes "that the level of bankruptcies and restructurings that it saw in recent years in our portfolio is tapering." Plus, based on a slightly better than expected third quarter and further visibility into the remainder of the year, Tanger raised the midpoint of its guidance range of FFO per share for 2018 to between $2.43 and $2.46.

Dividend Sensei recognizes that management is critical to the blue-chip recipe, as he explained recently, "but a top-shelf management team is worthless without a good turnaround plan, which I think Tanger has". That's obvious to see because "Tanger was one of the few REITs to grow its dividend during the Great Recession (when 78 of 90 REITs cut or suspended their payouts)". The company's capital markets discipline is evident: 88% of debt is long-term (6.4-year average maturity) fixed rate, and the REIT has been refinancing its loans at lower rates (average interest rate of 3.5%). It has no major debt maturing until 2022 and has $391 million in liquidity to add its substantial retained cash flow of $83 million per year.

That kind of smart capital allocation is why Tanger has proven to be such a great dividend growth stock over time (increased the dividend by over 24 years in a row). Yet, shares remain cheap, and arguably, this "pure play" outlet REIT is the bluest of all of our blue-chips (P/FFO 9.2x; dividend yield 6.3%). We are maintaining a Strong Buy, and we believe eventually this Carolina-based REIT will be recognized for its premium platform. Heck, Warren Buffet owned Tanger around 19 years ago, where is he now?

Dedication: I want to dedicate this article to Ralph Block. He was not only a friend and a mentor to me but also one of the most intelligent REIT investors I have ever met. He is greatly missed by many, and he will be forever recognized for his contributions to REIT-dom.

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