In a recent Market Update, we explain that we are adjusting our accumulation strategy after the recent surge in valuations.
We will continue to make steady weekly additions as long as prices remain opportunistic. However, we are becoming increasingly selective to position our portfolio for maximum reward in the recovery:
Some investments will recover faster and stronger than others. Right now, we invest on average in only one company out of 10 analyzed opportunities.
We are particularly bullish on the REIT sector which currently presents great value in comparison to traditional stocks and bonds. Below we highlight two REITs that we are buying before the anticipated recovery:
STORE Capital: 5.5% Yield and 50% Upside Potential
Recently, as the author “CashFlow Capitalist” joined our team at High Yield Landlord, he laid out the macroeconomic case for Net Lease REITs in 2020.
In short, we believe that the new 0% interest rate environment is very bullish for REITs that own properties with long lease terms. They are the most comparable to bonds and they are set for significant appreciation as yield-starved investors return to the REIT market:
Bruce Flatt, CEO of Brookfield (BAM), recently shared similar thoughts in a conference call:
“Today across all major markets in the world, interest rates are 0% or negative. This will have a drastic effect in a positive way on asset values going forward. The fact that interest rates went to 0% everywhere has not yet been filtered into the market given the short term chaos.”
All net lease REITs are expected to benefit from this, but some are better positioned than others.
Out of all net lease REITs, we believe that STORE Capital (STOR) currently offers the best mix of quality and value. It trades as if it was one of the weakest net lease REITs, when in reality, we believe that it’s one of the strongest in its peer group.
It may suffer a little more right now in the short run, but as we get to other side of this crisis, it’s better positioned to continue outperforming in the long run:
- Longest Leases: STOR has some of the longest leases in its peer group with 14 years remaining and very limited maturities in the coming years.
- Profitable Assets: These properties are highly profitable during regular market conditions and enjoy a ~2.5x rent coverage ratio.
- No Rent Abatements: STOR expects nearly all missed payments to be collected at a later date. Its leases do not include any “Force Majeur” clauses and rents remain due. It positions STOR for abnormally large cash flow in the aftermath of the crisis.
- Growth Advantage: STOR has historically been able to grow faster than its peers thanks to its unique strategy that results in sector-leading investment spreads.
- Superior Management: Led by Chris Volk, and backed by Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), STOR is very well managed. Chris Volk is a pioneer in net lease investing, and his track record speaks for itself:
Right now, STOR is priced at just 12x FFO and a 10% discount to NAV, which is materially cheaper than most of its closest peers.
But the most important metrics here are the dividend yield and yield spreads. STOR traded at a ~3% dividend yield prior to the crisis when the 10-year treasury yielded 2%.
Today, the dividend yield is 5.5% even as the 10-year Treasury yield has dropped to 0.6%. As a result, the yield spread has expanded from ~100 basis points to nearly 500 basis points:
That’s a massive expansion. The yield spread is nearly five times larger than prior to the crisis even as investors are starved for yield in a 0% interest rate world.
As we put this crisis behind and things return to more or less normal, we expect STOR to reprice at a ~3.5% dividend yield, which would lead to over 50% upside. Meanwhile, the 5.5% dividend yield is expected to remain sustainable and helps us to remain patient.
Medical properties Trust: 5.8% Yield 50% Upside Potential
In addition to net lease REITs, we also are very bullish on healthcare REITs right now at High Yield landlord.
Healthcare REITs own properties that are essential to our society whether the economy is booming or collapsing. The demand is less sensitive to the economy, and more so to the rapidly aging population:
In the coming 10 years, the population over 80-years-old is expected to rise by ~50%!
Moreover, most healthcare REITs enjoy long leases, which result in highly predictable cash flow.
However, not all healthcare REITs are created equal. As an example, senior housing is oversupplied right now and rents are on the decline. Skilled nursing facilities are equally challenged as operators struggle to make a profit and may not afford their rent payments in the long run.
On the other hand, hospitals and medical office buildings are much more resilient. They enjoy long leases, high rent coverage, and as a result, these REITs have become “Safe Havens” in today’s crisis.
One of our favorite opportunities among healthcare REITs is Medical Properties Trust (MPW), which is a pure-play hospital REIT.
MPW is one of the few REITs to not have been heavily impacted by the COVID-19 crisis. In fact, it has managed to collect >95% of its rents in March, April, May, June, July and these strong collection rates are expected to continue. The impact has been so little that MPW was able to reaffirm its full-year guidance for 2020.
The management also noted that it is very bullish on not only long term growth prospects, but also near term growth prospects. This is a big statement because MPW has historically been able to grow its cash flow at 5-10% per year and significantly outperformed the rest of the REIT market:
Put simply, MPW is more resilient and has better growth prospects than average. The business of owning and renting hospitals is recession proof and MPW is well positioned to quickly recover as we put this crisis behind us.
You would think that the market would reward this resilience and growth with a rich valuation. Yet, MPW has dropped in association with other REITs and now trades at just 11x FFO and a 5.8% dividend yield.
Its price is currently at $18 per share, and we believe that its fair value is closer to $25-$30 per share, which would price it at a 3%-4% yield. That would still be a very attractive yield for a resilient company, growing at >5% per year, in a 0% interest rate world.
As we put this crisis behind us, and yield-starved investors return to the REIT sector, MPW has >50% upside potential. Investors who buy today can lock in a near 6% dividend yield that is sustainable.
Our Real Estate Portfolio
STOR and MPW are exactly the type of REITs that we target at High Yield Landlord:
- They pay a 5-8% dividend yield.
- They have >5% annual long term growth prospects.
- They have >50% upside potential.
They allow us to generate high and steady income while we wait patiently for them to return to fair value. In a 0% interest rate world, we believe that it’s only a question of time before yield-starved investors return and bid up share prices of such REITs.
The last time REITs were this cheap, they nearly tripled in value in the following two years:
A lot of people will tell you: “don’t buy just yet. Prices are going lower!”
I respectfully disagree because you cannot time the market.
Most individual investors do so poorly because they think that the best time to invest is when everything is sunshine and rainbows. In reality, the best opportunities emerge when there’s blood in the street and it looks like the world is coming to an end.
Today, there exists historic buying opportunities in the REIT market and we are buying more, week after week, at High Yield Landlord. We expect this courage to pay off handsomely in the coming years.
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Disclosure: I am/we are long STOR; MPW; BAM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.