The State of REITs: October 2020 Edition

Micro cap (-9.97%) and small cap REITs (-4.78%) saw the biggest losses in September. Large caps (-2.41%) and mid caps (-3.68%) outperformed their smaller peers in September. Year to date there has been a very strong correlation between total return and market cap size. Large cap REITs (-6.75%) have thus far in 2020 outperformed micro caps (-39.35%) by more than 3200 basis points.

4 out of 20 Property Types Yielded Positive Total Returns in September

20% of REIT property types averaged a positive total return in September, with a 16.43% total return spread between the best and worst performing property types. Casino (+3.03%) and Student Housing (+3.01%) had the strongest average returns. All 3 casino REITs saw gains in September, led by VICI Properties (VICI). Due to continued 100% rent collection throughout this pandemic, VICI was able to raise their dividend 10.9% in September. Although the gaming industry is hurting badly due to reduced travel, VICI has performed well thanks to their triple net contracts with tenants that have very strong balance sheets.

Malls (-13.4%) was the worst performing property type in September, weighed down by the -49.65% collapse of Pennsylvania REIT (PEI). Due to the plummeting share price (and thus market capitalization), PEI was removed from the SmallCap 600 in September. This magnified the selloff, because funds and ETFs that follow the SmallCap 600 exited their positions in PEI on this news.

The REIT sector as a whole saw the average P/FFO (2020) fall 0.6 turns during September (from 13.8x down to 13.2x). The average FFO multiples declined for 75% of property types and rose for 25% in September. Land (26.1x) overtook Manufactured Housing (25.6x) as the property type trading at the highest average multiple. Hotels (-4.5x) are trading at a negative FFO multiple as the hotel sector continues to struggle to recover amid the ongoing Covid-19 pandemic. Malls (4.8x), Corrections (5.4x), and Shopping Centers (8.4x) are the only property types trading at a positive single digit multiple.

Performance of Individual Securities

Mall REIT Pennsylvania REIT (PEI) had the lowest total return (-49.65%) of all REITs in September and the 2^nd worst performance YTD (-88.57%). Only severely over-leveraged hotel REIT Ashford Hospitality Trust (AHT) has fallen further in 2020 (-94.09%). PEI spent the month of September negotiating with lenders to try to waive covenants and recapitalize the company, but was unable to reach an agreement until October 14^th. This agreement, however, will not be valid until support for the agreement is secured from the remaining 20% of lenders as well.

Land REIT Safehold (SAFE) was the best performing REIT in September with a solid +12.24% return. This marks a continuance of the strong steady share price gains for SAFE that the REIT has seen since the beginning of 2019. SAFE is up 55.94% thus far in 2020 and 239.91% since the beginning of 2019. This massive share price increase has been fueled almost entirely by multiple expansion, now trading at a price/FFO of 44x.

18.89% of REITs had a positive return in September and only 19.89% are in the black year to date. During the first nine months of last year, the average REIT had a strong +26.88% return, whereas this year the average REIT has seen a disappointing total return of -24.93%.

Dividend Yield

Dividend yield is an important component of a REIT’s total return. The particularly high dividend yields of the REIT sector are, for many investors, the primary reason for investment in this sector. As many REITs are currently trading at share prices well below their NAV, yields are currently quite high for many REITs within the sector. Although a particularly high yield for a REIT may sometimes reflect a disproportionately high risk, there exist opportunities in some cases to capitalize on dividend yields that are sufficiently attractive to justify the underlying risks of the investment. I have included below a table ranking equity REITs from highest dividend yield (as of 09/30/2020) to lowest dividend yield.

REIT Premium/Discount to NAV by Property Type

Below is a downloadable data table, which ranks REITs within each property type from the largest discount to the largest premium to NAV. The consensus NAV used for this table is the average of analyst NAV estimates for each REIT. Both the NAV and the share price will change over time, so I will continue to include this table in upcoming issues of The State of REITs with updated consensus NAV estimates for each REIT for which such an estimate is available. A statistical anomaly arose in the data this month and is reflected in this table. The NAV discount of PEI at the end of September was -162.94%, which is mathematically accurate when applying the traditional NAV premium/discount formula, but actually reflects a substantial premium given that PEI now has a negative consensus NAV and positive share price.

Takeaway

The large cap REIT premium (relative to small cap REITs) significantly increased during 2019 and has further expanded during the first three quarters of 2020. Investors are now paying on average over 3 times as much for each dollar of 2020 FFO/share to buy large cap REITs than small cap REITs (22.1x/7.3x – 1 = 202.7%). Excluding hotels, whose earnings have been decimated by both the government-imposed economic shutdown as well as fears of the coronavirus, the small cap REIT average FFO multiple is 10.6x and the large cap REIT premium is 108.5% (22.1X/10.6X – 1 = 108.5%). As can be seen in the table below, there is presently a strong, positive correlation between market cap and FFO multiple.

The table below shows the average premium/discount of REITs of each market cap bucket. This data, much like the data for price/FFO, shows a strong, positive correlation between market cap and Price/NAV. The average Large cap REIT (+0.10%) trades very close to consensus NAV. Mid cap REITs (-8.32%) are trading at a modest discount to NAV. Small cap REITs (-19.53%) trade at a moderate average discount, whereas micro caps on average trade at less than half of their respective NAVs (-50.36%).

5 of the 25 best performing REITs in Q3 were Self storage REITs. Although Land and Data Centers are two of the best performing property types YTD, neither had a single REIT in the top 25 in Q3. However, there were 3 Hotel REITs and 1 Mall REIT among the top performers, despite the fact that both property types have been far more negatively impacted by the pandemic and are severely underperforming this year. Despite those strong Q3 gains, these REITs remain 34% – 67.7% lower than where they began the year.

This highlights that it is very important to consider a multitude of factors when selecting investments. Some property types are clearly outperforming fundamentally in the current environment, but many of the securities within these property types are fully priced or even richly priced. If an opportunity arises to buy a well-managed REIT at an attractive multiple in a sector with great fundamentals, it may be a great opportunity. However, it’s important for potential investors in such companies to determine at what multiple too much expected growth has already been priced in.

Among the property types that have been most badly beaten down, some REITs may not remain solvent whereas others will recover and experience enormous gains as share prices return toward NAV. Investors who can correctly identify which of these REITs will recover and which will not have the potential to achieve substantial alpha. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.