For today’s look into REITs, we’ll uncover the meaning and benefit of a “moat” surrounding a given investment. I’ll also offer my list of the 12 most “moat-worthy” REITs.
Let’s start upstream.
In a Harvard Review article, Martin Reeves and Mike Deimler explain, “The goal of most strategies is to build an enduring competitive advantage by establishing clever market positioning (dominant scale or an attractive niche) or assembling the right capabilities and competencies for making or delivering an offering (doing what the company does well).”
Another article – by James Allen, with Bain & Co., says “sometimes the largest companies lead an industry, but in many cases, the leaders that create exceptional value don’t rely on scale alone. They use other skills to move into pole position.”
Allen explains Bain & Co. defines profit as “economic profit minus the cost of capital from the reported earnings before interest and taxes of each company. That produced the earnings of companies above their cost of capital.”
Reading the Allen article, I agree that “the classic strategic imperative for challengers – build scale or get out – is only one of several options… In most markets, one or two companies make all the money while others either struggle to return their cost of capital or destroy value. Scale can help, but companies that consistently outperform their competition build competitive advantage beyond scale.”
In my extensive approach to analytics, I consistently see how REITs uniquely grow their moats to give their company a competitive advantage, by using both valuable levers – of scale and cost of capital.
And the greatest moat-worthy REITs – those with exceptional long-term performance, have greatly capitalized on both.
I also see four important aspects for a REIT to find its way onto this vaunted dozen list: namely, their approach to acquisitions, dividend safety, earnings growth, and valuation.
While we’ve not sufficient chance here to review each aspect for these 12 moat-worthy REITs, all were screened for those elements mentioned, and their durability and scalability attributes. It cannot be overstated: scale and the cost of capital are the most important drivers for a REIT’s success. And may I remind, regardless of the size of the moat, valuation is paramount – investors should always pay close attention to the price being paid. As Warren Buffett remarked (speaking about his longtime mentor and author of The Intelligent Investor), “Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’”
I’ll close with this colorful notion (also attributed to Buffett): “A good business is like a strong castle with a deep moat around it. I want sharks in the moat. I want it untouchable.”
Now, 12 of the greatest moat-worthy REITs:
Public Storage (PSA) has four principal businesses: U.S. self-storage under the Public Storage brand, European self-storage under the Shurgard brand, commercial properties under the PS Business Parks, Inc. (PSB) brand and ancillary businesses, primarily reinsurance of policies sold to self-storage customers conducted under the Orange Door brand. The self-storage REIT has enjoyed a steady stream of dividend growth, funds from operation-based payout ratio based of 76.1%, shares trading at $211.71 and a dividend yield of 3.8% (as of Q2-18), driving me to maintain PSA as a BUY.
Healthcare Trust of America (HTA) – the largest medical office building (MOB) owner – proved it could deliver growth by scale last year when it added the Duke Realty (DRE) MOB portfolio to its more than 24.2 million square-foot portfolio in a $2.8 billion deal. The REIT is an attractive STRONG BUY because it has been successful at growing its dividend, its FFO payout ratio is 74.5%, and its shares trade at $27.76, as of Q2-2018.
Given the continued strength and visibility in the investment pipeline and the current market environment, Realty Income (O) increased 2018 acquisition guidance to approximately $1.75 billion from the prior range of $1 billion to $1.5 billion. I maintain that Realty Income, which has an AFFO-based payout ratio of 83% and shares trading at $58.35, is a BUY because it is well-positioned to flex its balance sheet (now rated A- by S&P) to continue consolidating high-quality stand-alone properties.
In June, W.P. Carey (WPC) merged CPA:17 with a subsidiary of WPC in a $6 billion transaction and completed a $187 million purchase of 14 logistics assets in the corporate headquarters of Danske Fragtmaend, a Danish business freight provider. WPC’s international exposure (and limited U.S. retail exposure) provides the company, which has a payout ratio of 84.6% and shares trading at $65.54, with a distinct advantage in maintaining occupancy.
Prologis (PLD) validated its tremendous scale and cost of capital advantages and capabilities after its $8.5 billion acquisition of DCT Industrial Trust, which boosted its 2018 core FFO guidance to $3.00-3.04 per share. Prologis has a payout ratio of 63.7%, a strong record of dividend growth and a share of cash same-store NOI growth at 7%. However, there is no margin of safety, so I will maintain a HOLD.
Last year, Mid-America (MAA) closed on the $4 billion Post Properties acquisition, wrapped up the final systems conversion work and completed the consolidation of the legacy MAA and legacy Post operations into one management and reporting platform. The REIT has a strong dividend record and shares trading a $104.01, increased its net income and balanced the growth with a conservative payout ratio of 11.1% based on FFO, but investors should not overpay.
Simon Property Group’s (SPG) portfolio is well-diversified from a geographic, tenant and revenue by real estate sector perspective with ownership interests in more than 230 North American and Asian retail properties, a 21.1% interest in French mall operator Klepierre (OTCPK:KLPEF) and a joint venture with European designer outlet operator McArthurGlen. Simon has an impressive dividend growth history with a well-protected dividend, a payout ratio of 65.6%, FFO at $1.06 billion and shares trading at $182.09.
Given Federal Realty’s (FRT) powerful balance sheet management (rated A- by S&P) and scale advantage, I consider this REIT a blue-chip STRONG BUY. Federal Realty, which reported FFO per share of $1.55 and an 8% rental increase in Q2-18, closed on a portfolio of retail assets referred to as Primestor to expand its 7-property portfolio in Los Angeles.
I maintain a BUY on Regency Centers (REG) shares because the REIT continually enhances quality and growth of the portfolio by astutely allocating capital into higher-quality developments, redevelopments and acquisitions with superior growth opportunities and compelling margins. Regency has one of the strongest dividend growth forecasts in the shopping center REIT sector (+5% in 2018) along with a sound payout ratio of 58.7% (based on FFO) and shares trading at $65.68.
American Tower (AMT) deployed nearly $1 billion of capital in Q2-17, including approximately $79 million for acquisitions and more than $400 million for stock repurchases. Although AMT has raised its dividend in every year since 2012 by about 23% in each year and has a payout ratio of 47.2%, I cannot buy a REIT that yields 2.1%.
Healthcare REIT Ventas, Inc. (VTR) is a STRONG BUY because it has deliberately constructed a portfolio of more than 1,200 high-quality assets leased to best-in-class operators and more recently, has focused on the defensive life science sector. The company now generates $134 million in annualized NOI from life science assets, has increased its dividend since 2000 (except for 2009) by around 5% annually, has a payout ratio of 78%, and FFO at an all-time high exceeding $400 million.
The non-traditional mall REIT Tanger Outlets (SKT) is a STRONG BUY because it has a platform that offers a more compelling risk/return thesis, as the company has ZERO exposure to malls. Tanger, whose shares trade at $23.17, raised its dividend by 2.2% on an annualized basis to $1.40 per share in April and expects FFO to exceed the dividend by more than $100 million in 2018 with an expected FFO payout ratio under 60%.
(Excerpts of this article previously appeared on Seeking Alpha.)
Disclosure: I am long HTA, O, WPC, SPG, FRT, REG, VTR, SKT.
