Author’s Note: This article was published on iREIT on Alpha in early February.
I was clear in the year of 2023 early on that I was going to overweight REITs more than I have done before – and so I have, to great results. Most of the REITs I’ve bought shares in, including many that are viewed as somewhat “riskier”, have seen great short-term returns, contributing to portfolio-wide YTD returns of almost 14.5%. Those are obviously some great numbers, and they come from stocks like Boston Properties (BXP)…
…like AvalonBay Communities (AVB)…
…and let’s not forget Digital Realty Trust (DLR).
Pretty damn good short-term RoR, right? Oh, there are better ones. In some of my Swedish/European investments, I’m actually up nearly 28%. I’m a strong advocate for an appealing international mix of diversified, undervalued equities. This has delivered alpha for me since I started investing – and it continues to do so here.
So, with that return now out there, what sort of companies are attractive at this point anymore? It’s a fair question. I myself cover a list of several hundred stocks and let me tell you that since Christmas, the investment appeal in many of those companies has gone down, or even disappeared altogether. What was perhaps a list of 70-80 attractive investments has gone down to less than 40. We’re definitely in a richer valued market today than we were 30 days back.
That doesn’t mean that there aren’t very strong investment potentials, however – and that’s what I want to focus on here.
I said early on this year that I was going to overweight REITs more – and that’s what I’ve done. What has happened won’t stop me from doing that – it’ll cause me to do it more.
The approach is simple – the indicators of a qualitative company are similar both for the REIT and non-REIT sectors. I cover qualitative companies, and I target the undervalued ones of the bunch with recurring investments. I don’t get attached to any one specific business or company, and I buy and sell based on conservative and fundamental appeal and upside (or downside) – nothing more, and nothing less. A company that I’ve held for 10 years can be “out” of my portfolio as quick as something that I bought 2 weeks ago if the circumstances are right, or wrong.
For these 3 companies I’m presenting you with today, I believe the circumstances are very much “right” for investing.
So, which are they?
Here they are.
1. Essex Property Trust (NYSE:ESS)
Yeah, Essex has seen some good growth for the past month – but not as much as AVB, and it’s better positioned here, with a higher yield, compared to AVB. If you missed out on buying ESS a few weeks back, that’s truly something to regret (I believe anyway). Take a look at how the valuations are looking here.
I believe we’ll be looking back on the valuations we saw weeks ago as something once-in-a-5-year period, or even rare, as we move forward. A quality business like ESS is unlikely to trade at such low multiples for long, and even the months we saw were, as I see it, unexpected.
I used the opportunity to buy a solid position in this, one of the premier apartment REITs in the USA.
The company is high-IG rated and has high safeties, and even if some of its portfolio areas are seeing compression, I believe it is unlikely that there is going to be a significant impact on the company’s bottom line here. Instead, I believe the drop was an overreaction. We should perhaps be somewhat more conservative in forecasting ESS – because what, after all, if the premium turns out to be “too high”? But even conservatively, you’re able to see double digits if you forecast no higher than 18x P/FFO, compared to the typical premium of close to 21x.
Essex is stellar, with a superb capital structure with 94% unencumbered NOI and $1.2B available in total liquidity as of the latest report. Net debt is down to 5.8x to adjusted EBITDAre, and there are no maturities at all worth mentioning in 2023, with only very limited in 2024 and 2025. over 60% of the total debt isn’t due until 2027 or after, with an average weighted interest rate of 3.2%.
The only risk to Essex aside from the macro risk of interest rate is the specific risk to the west coast. But this needs to be looked at from the perspective of interest rates as well. In times of higher interest rates, the cost of homeownership goes up to a point where renting from a company like ESS still is the best option for many. What’s more, in exactly this environment, people are more likely to rent, not less.
It’s also wrong to declare the west coast as “lost”. ESS expects a 2.0% rent growth in 2023. Despite some tech firms laying off, Google recently broke ground on its Downtown west campus, doubling office space in one of the company’s areas with 25,000 new jobs.
So, Essex is in no way in a precarious or difficult situation – earnings, fundamentals, and upside are very much intact. Even growth in FFO is very much intact, with 7.1% on average annually until 2025E.
I have said it before, and in this article, I’m reiterating my target for Essex – this one is a “BUY”, dear readers. I believe you may want this one in your portfolio, even if it’s not a “high yielder” as such. At iREIT, we consider Essex a “STRONG BUY” with a target of no less than $300/share. This may sound much, but it only represents 18.6x P/FFO normalized, so it’s actually quite conservative.
I second this target at this point – “BUY” and a $300 PT. I own 1.4% of ESS in my portfolio (of the total), and I’m buying more.
Despite the upswing we’ve seen, this one is a significant “BUY”.
2. Highwood Properties (NYSE:HIW)
How about one of the best Office REITS out there? 6.3% yield, investment-grade safety, no exposure to west coast geographies (which are riskier in terms of office space). Instead, Highwood focuses on the attractive southeast with exposure in areas like Nashville, Atlanta, Raleigh, Tampa, and Orlando, which together account for around 80% of the company’s overall geographic mix of properties.
This REIT is extremely focused on growing markets, and it shows in the company’s numbers. It is an Office REIT, and generally speaking, we at iREIT do recommend caution with regard to this specific subsector.
But – take it from me. I’m generally very negative on growth stocks and tech stocks overall – but even in this sector, there are undervalued Gems worth buying that I do own – such as Wise plc (OTCPK:WPLCF). Even in sectors that we generally are conservative about, there are potentials that should not be underestimated – and Highwood is one of them.
Well, the REIT was one of the few that averaged, in the office sector, rent collections of around 97-99% for every month during the otherwise significantly-impacted period of COVID-19. This showcases historical stability, as well as acumen in terms of picking its clients because there were companies that did far, far worse. ABR diversification is a big part of this. Almost 4% of Highwood’s square footage is rented to a client that will likely never default on payments – The federal government. Aside from this, we have companies like Bank of America (BAC), various universities, states, Albemarle (ALB), and others that really make up a superb mix of the top-30% of the company’s ABR with an over 8.5+ average lease on a weighted basis.
So when you know that, and see this in terms of valuation…
…that really implies to me that the market has gone much too far. And so I started buying. And bought more. And more, until I’m where I’m at today with just over 1% of my total portfolio in Highwood. Even at a relatively conservative forecast of 11-12x, this company is likely to touch close to 20% annualized RoR until 2025E, or almost 67%. Growth isn’t as impressive here, but I don’t see fundamental declines in Highwood’s near-term future, nor indications that the company is facing some massive sort of risk, aside from what we already know.
The earliest significant maturities do not come until 2026-2028, giving the company ample time and room to move. HIW works with an average weighted interest rate of 3.4%, leverage of 5.3x to annualized EBITDAre, and a 39.5% debt + pref/gross assets. Furthermore, since 2011, it’s lowered its leverage from the mid-6x range to the current low 5x range, showing a history of conservative decision-making. The people in charge do not make hasty decisions – but don’t mistake this for indecision, as the company is strongly moving into Texas, and Dallas specifically.
Highwood Properties fundamentals aren’t as solid as they were going into the pandemic, or even mid-pandemic, when the company was down below 5x in leverage with an even higher unencumbered NOI – but it’s still very much solid, as things go here.
Highwood hasn’t gone up as much as other Office REITs have, and it retains one of the higher quality metrics in the peer group – that’s what makes this one a “BUY” for me here, and I’m continuing to increase my stake in the business. There is no real fundamental risk that I can see – not to earnings, not to dividends, and certainly not to the company itself from a high level.
Disagree? Let me know why – but I’m a “BUY” here!
3. Medical Properties Trust (NYSE:MPW)
There comes a point in every company when a valuation has gone “too low”. Where justification in terms of risk no longer is “proper” in relation to what the company actually trades at, and what even a conservative upside is. That time has been reached for MPW a few times over the past few months – and that’s when I’ve bought, loading up on the company at around 6.3x P/FFO respectively every time it reached that level. The company is now around 7.1x P/FFO, but I believe this marks a level that we probably won’t go far below again under these circumstances.
Now, you could go with a REIT like AvalonBay or Digital Realty as a third pick as well. Those are far more conservative and with perhaps a safer overall upside. But I want to show you, dear readers, that I am very much capable, and clear when I see undervaluation even in stocks that others have described as perhaps being a tad “riskier”.
MPW is without a doubt a bit riskier. I doubt you could have been following the articles and missed out on what’s happening with Steward. I doubt, however, that you could have also missed the fact that 90%+ of all contributors, including us here at iREIT, are incredibly positive on Medical Properties’ Trust and its 9%+ yield.
Why is that?
Well, valuation reasons first. MPW trades at a material discount to any fair-value book, and it’s working hard to lighten the operator-related hardships it’s currently experiencing. With almost 20 years under its belt, MPW is no stranger or inexperienced when it comes to handling difficult circumstances.
It owns 434 properties in 10 countries (not just the US), which comes to a total number of 44,000 beds. MPW uses a net-lease model, and it’s about 80.6% attractive hospitals, with the rest in a mix of behavioral care, urgent care, and a mix of “others”. Steward has been oft-discussed when it comes to MPW, and with good reason. The company makes up almost 30% of the REIT’s annual revenues. The argument that they underwrite the actual real estate is only so-so in terms of making this safer. This argument would have probably made investors feel safer if it wasn’t as much as ~30% on the line, should this particular tenant face trouble.
While MPW would theoretically be able to attract new operators to mission-critical infrastructure, I believe the market has some credence with its worries with regard to MPW.
However, it’s gone too far.
There’s also the simple fact that head of 4Q22, the problems with Steward have materially improved – with volume metrics up, a better quality mix, better EBITDAR, a decrease in labor expense, and outperformance for several months.
So while I will say I believe it is likely for MPW to remain flat here in terms of operating cash flow growth for the next few years, I still believe the levels of where that cash flow is valued are far too low.
Now, a real table-pounding, bonkers-sort of buy would be a single-digit share price. But even at $12.9/share, this company is far below where I would consider it valid. At iREIT, we give the company a $17/share price. S&P Global price target trends are lower than that – 13 analysts average ranges of $10/share on the low side to $18/share on the high side with an average of $15.5/share. So you’ll see that most analysts are more or less in agreement about where the company “should” be. That $10/share is dirt-cheap, and that $17-$19/share is about as high as the company “should” be here.
Out of those 13 analysts, 8 are at “BUY” or “outperform” here. For that PT, we’re forecasting the company at around 9-10x P/FFO, which brings the conservative upside to around 17-20% annually here, or 60% in total until 2025E.
I don’t think many of you will argue with me that 9-10x P/FFO is conservative for this company. While things could happen that throw us for another loop here and could potentially push earnings down, I have a hard time seeing, given the latest communication that things would materially worsen. it’s not as though MPW is unaware that its Steward exposure is problematic – it was the reason it dropped nearly 5% due to a potential rating downgrade.
This one is a riskier play than the first two – and I do suggest that you check out other names, but I believe ignoring MPW at this valuation would be folly, and that the risk/reward ratio is extremely favorable.
This marks the three REITs I’m currently buying more of. While I invest in a basket of attractive REITs on a relatively consistent basis, the weightings of these investments depend entirely on their respective valuation, and where I see the most upside.
That’s really all I’m about, in the end. Conservative upside – the higher wins.
Once the company in question hits those high notes and can be considered expensive, I’m not one to linger – and this is somewhat of a change given how I invested in the past. I would often keep around companies far after their “high notes” have been reached, and the result of this is capital inefficiency. When it comes to European stocks and REITs, I consider myself decently knowledgeable to a degree to which I can tell when something is cheap or not – reflected by the outperformance I’ve seen in my portfolio for the past 5-6 years.
I will continue to invest in this fashion – and this is the latest specification in how I do so for the REITs.
Let me know!