Look at REITs as dividend income machines

0:00Thank you.

0:30David Auerbach:It's always right before, right after a Fed meeting. It feels like that macro point is always lurking in the background or perhaps in the foreground, as the case may be. Do you want to start there? We have a Fed meeting in a couple of hours. Or I guess not even in a couple of hours, imminently. But do you want to just maybe ground us in the current moment as it pertains to the macro picture, as it pertains to REITs and how you're looking at things, thinking about things? It seems a rate hike is about to be fall, all of us. What would you say about things right now? Well, as you just said, it is very likely the Fed's going to be raising interest rates today.

1:13And REITs have been operating in a high for long environment for a long period of time now. The REITs are basically tired of waiting for the Fed to cut interest rates. And so as a result, a lot of these management teams have gotten very savvy as to knowing when to go on offense, knowing when to go on defense. They're focusing on property level fundamentals. And I think that's the key aspect here that gets overlooked in that fundamentals matter. REITs have been reporting strong net operating income growth. FFO or their earnings have been growing. The balance sheets mostly contain fixed rate debt.

2:01M &A is alive and well and very rampant in the sector. We'll be discussing that more and more. And so it's business as usual for a lot of these REITs. And, you know, the Hoya High Dividend Index in this rising environment as of the end of last week is up over 9%. And as I mentioned, the REITs are still paying dividends that are below their 20-year average. And so as a result, there's still a lot of room for these companies to grow. And as we go through it, kind of highlight the solid fundamentals that we're seeing in the sector.

2:35David Auerbach:Where do you feel like is the best place to start? I was going to say, like, when you're talking about fundamentals matter, if you could pick that apart, what would you say about that? The state of REITs going back basically to the start of the 2000s. There are certain periods that really jump out off of this chart, right? The housing crisis of 08-09, COVID, you know, you could see how things came roaring back post-COVID. But I think the key takeaway here is that net operating income and FFO continues to go up. Dividends continue to go up. All in all, the net operating income is up over 21 % going back to 2019.

3:22FFO, or the REIT earnings, are up almost 15%. And dividends are up around 7 % going back to 2019 as a whole. So as a result, it seems like this trend of growth is continuing, even as the Fed has, you know, potentially been raising rates, as the 10-year Treasury has continued to climb, You know, fundamentals remain pretty solid here. So as I mentioned, NOI up 4.1 % year over year in the second quarter. FFO up 4.5%. Dividends up 4.1 % in the second quarter. When you look at occupancy as a whole, overall occupancy is up around to 94 % approximately, which is up 80 basis points versus the first quarter.

4:14one sector that jumps out and we'll talk about is office. You know, everybody talks about the death of office, and yet office was up 180 basis points in occupancy to a sector-wide 88 % level. So right now, it seems like these REITs are in a good position, and I think one key underlying driver here is basically called supply, that a lack of new supply in a lot of these sectors, especially in retail, as an example, makes existing real estate that much more valuable. But where we stand in the current market, these higher financing costs are suppressing new construction, which helps improve the medium-term outlook for a lot of these existing landlords.

5:00So I mentioned the REITs having fixed-rate debt. This is a very important thing because a lot of people compare public to private real estate. That's always the, do I own public or do I own private or do I own both? And there's a lot of different camps that are out there. But I think the reason why everybody should own public REITs is, frankly, for the transparency. Public leads private. And as a result, when we look at the publicly traded REITs, 90 % of public REIT debt is on fixed interest rate. You're seeing these REITs have been able to raise, frankly, tens of billions of dollars of new debt this year that are locked in for three, five, 10-year, seven, 10-year increments that they don't really deal with a rising rate environment.

5:53They're okay with that. A lot of the private owners have property-level mortgages, refinancing deadlines, as well as a lot of floating rate debt. And so right now is when they'd be feeling that pinch. And by the way, that could change at the top of the hour when the Fed raises interest rates and how that trickle down continues. But there's a big gap between public and private, which makes the public REITs probably more attractive at this current point. And then the other key thing here, why REITs right now, is all about M &A. All the different REIT deals that have happened in the past couple of years, or as well as REITs that are currently in the process of exploring a sale.

6:40So the Center Space IRT deal was just announced a couple of weeks ago. It's obviously a much, much smaller transaction than the Avalon Bay equity residential apartment merger that was announced and just closed in the middle of August. That equity res Avalon Bay was kind of like a one off. It's two S &P 500 behemoths getting together. But the private guys are chasing public REITs. And so as an example, you could see a handful of the private players acquiring some of these publicly traded REITs. But management teams, again, are sick of waiting for the Fed. And their job is to find ways to add value to shareholders.

7:27And what's the easiest way to add value to a shareholder? By selling the company. And I think that's why you're seeing a lot of opportunities here, because you'll notice that the sectors, it's pretty much across all the sectors, we've seen a lot of this activity occurring. It's giving these management teams a pathway to recognize underappreciated or undervalued companies in the market current. Let's talk about sectors that we like versus, let's say, we're cautious about. I think one that doesn't really jump out on the page here that we really focus on, and I think it's getting more and more attention, is the world of healthcare REITs.

8:09Specifically, senior housing, medical office, those types of sectors. I always like to joke, Rena, we're 10 minutes older than when we started this conversation. The first baby boomers are turning 80 this year, you know, and they're finally just starting to use some of these properties. Frankly, there's just not enough supply for the amount of demand that's coming online in the world of senior housing. This chart that's on the table shows net operating income looking at cumulative since 2019. And you'll notice that manufactured housing REITs, and there's three publicly traded manufactured housing REITs, has seen NOI grow 49 % in the past several years, followed by industrial, storage, single family rental, the list goes on and on.

9:01So manufactured housing is a sector that we like. You know, there's still, with housing affordability pressures that are out there, and we see the headlines every day, we're in a 7 % mortgage environment, not enough supply for the amount of homeowners that want to buy, the list goes on and on. Manufactured housing or single family rentals is a great way to get into the residential sector. Lodging is another sector that just jumps out right now. Now, you don't necessarily see it in the performance on this table here, but every lodging player raised their guidance coming out of earnings, second quarter earnings.

9:46All facets of the lodging business have been seeing improvement, especially in the rebound of business and group travel. And I also like to joke that, you know, when you talk about terms of risk in REITs, you look at it based off of the lease term. As an example, an office lease might be five to seven years. An apartment lease is one year. But a hotel is the riskiest of them all because it's a one-night lease. That resets every single day. So there's pros and cons that go with that. But clearly, this big macro topic of inflation shows that room rates obviously have been going up, but yet the demand side of that equation is still there.

10:33And so the consumer is frankly paying that higher price, it seems, for those properties. And we're coming up to third quarter earnings. And I'm sure we're going to get a lot of commentary across all of these sectors about how inflation is impacting both, let's say, the property level, but more importantly, at the consumer level. So another sector we like is we're very selective on some of the net lease players that are out there. We're very constructive on sectors such as industrial and data centers. And we've talked about both of those sectors a lot in the past. If you're watching this on YouTube right now, you're using a data center read most likely.

11:15If you're running a query through chat GPT or something, most likely it's running through a data center read as well. So AI is clearly a story that resonates across multiple sectors, but it's also the real call of demand driver that's going to take this industry into the next several years. And we've seen a commentary from Andy Power, the CEO of Digital Realty, Mark Holliday, the CEO of SL Green, a New York office REIT, the West Coast players, the residential apartment REIT, seeing demand from these firms. AI is basically trickling in down coast to coast. And there's so many beneficiaries of that.

12:01We're very selective on sectors such as office, apartments, and single family rental. and we can get into that, I would say the one sector that we're very cautious about would be the commercial mortgage REIT sector at this point. But at the end of the day, when you look at performance, and that's what matters is performance, these numbers were as of Friday, September 11th. And what you'll see here, especially after a rough week that we had last week, frankly, coming into this week as well, five of the 20 plus subsectors, were down year to date. Four of these sectors are up 20 % or more, and half of the sectors are up 10 % or more this year.

12:48So the performance is there, broad-based. And we can go through a couple of the other sectors, the underperformance that's there. But frankly, the numbers, the performance, the fundamentals speak for themselves.

13:02David Auerbach:Can I ask you a question? You mentioned that you were down on commercial mortgage REITs. Can you spend a minute or two about why that is? Yeah, there's frankly a variety of reasons, but I would say the number, the two most important reasons, dividend coverage and credit resolutions with underlying paper, if that makes sense. If we can work out the dividend coverage issues, if we can work out the underlying credit issues, that will play itself out. So here's a couple of sentences. Loan resolutions have contained below prior reserve values in parts of this sector, with some stress being seen in office, multifamily bridge, and the life science market.

13:50The residential mortgage REIT's dividend coverage has generally improved over the last quarter, So we like to avoid treating the entire mortgage REIT universe as one trait.

14:00David Auerbach:Can I ask you a note about the data centers also? Yes. I know we all know about the crazy growth ahead for AI and its presence already in our lives and yet to be determined how much more so that will be. What would you say in your professional estimation is the growth runway for data centers for like the next year, five years and then into the future? So I'll answer your question a little bit in a different way. I always like to answer these questions in terms of baseball innings. Where are we in the game? There are some people that are out there that would say we're probably in the third or fourth inning.

14:45And there are some people that would say, we're not even at the top of the first inning yet. So I think that there's still a long way to grow with this. There's a couple of buts and ifs that go with it. The number one issue is power. Talk to any of these data center folks that are out there. It's not a question of building the property. That's easy to do. The question is, where does the power come from? And I think that's the 800-pound gorilla that overhangs the space right now. Because without power, there is no property. And I think a lot of these companies are focusing more on the power equation to grow that.

15:36But here's what we're not thinking about. I'm in Dallas, Texas. Digital Realty, one of the largest players, has a very big footprint in Dallas, Texas, or Texas as a whole. They're headquartered in Austin. Dallas also has several, let's say, private players that are potentially going public within the next couple of years focused on data centers. You have existing REITs that are out there Like Prologis, Prologis The largest industrial REIT That has a whole separate Data center business Tied to it One other thing Talking about that trickle down effect There was some great research that was published In the past couple of months From one of Blackstone's Industrial Spinoffs called Link Logistics And Link said For every new gigawatt of power that is generated, it warrants 2 million square feet of new industrial space to support it.

16:44So think about some of the numbers that were being kicked around as far as the amount of power that is going to be generated. And then think about the potential opportunity to develop new industrial warehouse space to support that data center growth. And the other side of that coin is forget domestic. Think global. We haven't even started thinking about AI opportunities in faraway markets such as Australia, Africa, India, South America. The list goes on and on. and for established players that are out there with a global footprint, like a digital realty or an Equinix, EQIX, frankly, they're already in the driver's seat.

17:36And a lot of these companies, the digitals and Equinixes of the world, are putting out press releases of, we just signed a deal in Nairobi, we just signed a deal in Turkey, we just signed a deal in this country and that country. So you're seeing this thing, what started here domestically, now standing across the globe. So that's why I think both, frankly, both sides of those camps of maybe the third, fourth inning, or we're not even out onto the field yet to start the top of the first inning, you can kind of see how both sides of that are playing out. You know, I always talk about when you buy REITs, you buy REITs for the dividend income stream.

18:17I have no control over stock prices. The companies themselves have no control over their stock price. But what they can control is the dividend. What we're looking at here is that dividend payouts as of the end of the second quarter are around 66, 67%. The 20-year average is 78%. And so REITs have gotten more conservative with how they're paying out dividends in that they can choose to push out an extra penny, two pennies to shareholders every year, every quarter, et cetera. or they can keep that money for a rainy day for value-add opportunistic situations that arise. And I think that's something that you kind of, we gloss over because it's just a dividend.

19:04But when you buy a REIT using, frankly, 20, 30-year glasses, and if you own a monthly dividend-paying REIT like an Agri, a Realty Income, an Apple, the list goes on and on, or an annualized quarterly dividend payer, you know, I always use the very simple example. Stocks trading at$20, company pays you a$2 a year dividend. In 10 years, you've already earned back the stock price, let's say,$20 of income with anything extra to happen on top of that with the stock price. So it's why when I talk to, let's say, young parents, young grandparents, You know, the greatest gift that you could give your child or grandchild is on the day that they're born, opening up a custodial account for that child or grandchild and go out and buy one of these monthly dividend paying stocks or one of these REITs that you can reinvest the dividends and basically your hands off for the next 25, 50 years.

20:07you're taking that one share that could become 10 20 50 shares over the course of that time frame where you're basically giving that child or grandchild a head start on their 401k or their ira to retire and that's the beauty of reeds is because remember a reed is just a tax structure that's all it is and the way that the tax structure works is that 90 if not all of that net taxable income is passed through to shareholders in the form of dividends. So as the REIT does well, the shareholder does well. And that's, I think, the interesting story to focus on. So 60 plus REITs have already raised their dividends this year, and that number is going to continue to grow between now and the end of the year.

20:58So look at REITs as dividend income machines. That's basically the only way that I could phrase it. The other key point here is occupancy, right? So unless I fill up my building, I'm not getting paid. Now, I know this is a busy chart, and I apologize, but I'll give you the very high level here. We look at four sectors and the industry average. And what you're seeing here is that office is bringing up the rear, but yet office is still coming way off of its lows from a couple of years ago and seeing that significant growth. Retail, very strong. Residential, strong. People may talk about the volatility with Sunbelt apartments or something like that.

21:47But looking at this chart, we're at 96 % occupied across residential, which means, think about it from a very vague example, you own 100 apartments in your property, 96 of them are occupied. So you got four open units at a given time for every 100 units that are available. It's not like we're at 50 % occupied. But the trend is occupancy continues to grow across most of these sectors. Then we look at valuation. Now, we're a little biased because of the high dividend yield index with its focus on small and mid-cap REITs. But that's where we see the opportunity. That's where the investor is going to, frankly, capture that alpha, that performance, the growth, and frankly, the dividend growth is going to be in the small and mid-cap REITs.

22:42Why? Very similar. Let's use that Prologis example as before. prologis the largest industrial reit owner in the world basically goes out and buys a 25 000 square foot property at dfw airport in dallas test slash trick question for you do you know what that transaction does to prologis's bottom line the answer is absolutely nothing the only way big companies grow is by buying other big companies or buying other companies Now, take a company that owns 25 properties And they go out and do that same transaction You can track the earnings growth So, yes, you might be sacrificing

23:36Let's say, credit strength and S &P indices And some of this other stuff by going down that cap stack But the opportunity for growth and to realize value and, frankly, dividend growth is where you're going to find that. You know, another way to look at it, those largest REITs that are in the S &P 500 only yield, you know, 2%, maybe 3%, whereas some of these mid and small cap REITs have dividend yields that could be 5%, 6%, 8%, 10%. Now, am I saying buy every single one? Not at all We're very select in those But just because something has a nine handle on the yield Doesn't mean it's junk or a going concern Hence why it's important to look at the company fundamentals Or as I like to joke, peel back the layers of the onion And look at the core of the onion to see what's going on there But I think there's what's being told by the media and in the headlines and really what's going on and what the truth is.

24:46And the truth is these REITs are trading at a discount. And that's why you're seeing the M &A machine grow because a private operator can buy some of these REITs at 50, 60, 75 cents on the dollar and own tens of thousands of units or millions of square feet of space in industrial or office or whatever at a fraction of the cost it would take for them to go out and build that size of a platform. We talked about this before, that with rising interest rates and the rising cost of capital, you've seen REITs have gotten a little bit more cautious. And so this is a great way for REITs to recognize value because they are getting more active going on on the acquisition front.

25:38They're basically always selling off non-core assets or finding opportunities to recognize top value, you know, a deal too good to pass up, that that acquisition disposition chart, you know, really kind of shows where that landscape is going. And basically what we're seeing is that that REIT M &A machine is picking back up to where it was almost pre-COVID as far as the acquisition side of things. This is one of my favorite charts that we publish. How much capital is being raised? And the answer is a lot. Just look over the past couple of years of how much has been raised in terms of debt, ATM, you know, at the market equity offerings.

26:19We're not really seeing common share offerings. If anything, you're seeing a reach to a lot of forward equity offerings. And so they are constantly out there raising capital. Farina, I think what people and you really want to focus on are what are some names that we should be looking at? What are some of the stories that we should be following? So why don't I give you a handful of names for you, if you'd like, and we can kind of talk about the why of some of those names.

26:50David Auerbach:An embarrassment of riches, as they call it. Yeah. Let's do it. Well, I got about 15 names in various different classes for you. So I came prepared. Let's talk about our best ideas to start. I'll give you three. Apple Hospitality, ticker APLE, UMH Properties, so Manufactured Housing REIT that I mentioned before. Vici, V-I-C-I. They're a gaming slash experiential offering REIT. So let's talk about the pros and the risk of each of those names. Apple. Select service hotels. This isn't your Four Seasons and your Ritz-Carlton's. This is your Courtyard by Marriott and those types of properties. These are the properties that are being used, frankly, every single day of the week.

27:41These are where if you're going to go see grandma and grandpa, you're not going to take the kids and stay at the Four Seasons. You're going to stay at the Courtyard. select service, improving business group demand, strong Q2 execution, strong balance sheet. What's the risk? It's already had a heck of a run. So some of that may already be priced in potentially. UMH, manufactured housing, affordability. That's number one why. almost 9 % same property NOI growth last quarter. Occupancy continues to grow. There's a wide gap between fundamentals and share price. As a result, UMH has an activist investor urging the company to explore a sale.

28:33So there could be something going on there behind the surface. What's the risk, the execution, and the financing side of it. And again, that's mother market overhead. Vici, the king of the Las Vegas Strip, love Vici. Long lease in place, rent escalators in place, low teen FFO valuation, very high dividend coverage. What's the concern? Tenant concentration, MGM. MGM's in play. What happens if MGM merges and what happens to VG at that point? So that's the fair and balanced of the best ideas. Let's focus on income. I'm going to give you three income names. Triple N to Netly Street, Highwoods, Sunbelt Office, HIW, Easterly.

29:27We talked about easterly before, DEA. Triple N. We think there's better value in Triple N versus buying realty income at this point. Triple N has over 99 % occupancy, attractive acquisition spreads, and 37 years of dividend growth. But interest rate sensitivity plays into that. Highwoods. Selective office recovery, improving leasing spreads an investment grade balance sheet we took some money off the table and we still own it but the key risk there is obviously office demand and that's a whole separate story but I think we've covered that office is seeing that demand Easterly the only government really the only publicly traded government lease REIT that's out there 98 % occupancy raising their guidance obviously the big risk is anything federal policy oriented.

30:28Doge, we've been through that before. All right, let's talk dividends. Here's four dividends names for you. Essential Properties, EPRT, Stag Industrial, STAG, Digital, which we've talked about, and Invitation Homes. I'm not going to talk about digital, really. We just think it's the cleanest way to own AI and that power story that's out there. But it is kind of an expensive name. And remember, data centers, AI, growth, all that has a very high CapEx number tied to it. All right, so essential, I call it ePert. ePert, high quality net lease platform, 99.6 % occupancy, growing dividend there, growing external growth economics.