REITs are boring and boring is good

0:10David Auerbach:David Auerbach.

0:30David Auerbach:A crazy environment indeed. And you're referring, of course, to our investing summit, which was a fantastically informative time back in June of last year. So bring us up to date. We've seen a lot of underperformance in previous years from the REIT space. There's some promise of some higher performing stocks. When we look at that space, what are you thinking about looking at and maybe bring us up to date about how investors should be thinking contextually about the REIT space? There's a lot to spend right there in that one question. We could probably spend an hour just on that alone. Let's just take a step back here.

1:06If you look back to when the Fed started hiking interest rates back in March of 2022, the REITs have underperformed the S &P by about 70%. So to say that that's a massive sell-off is an understatement. If you go back to the global financial crisis underperformance, that was around 20%. So as a result, REITs are no doubt very cheap, but it does constrain them because it means that there could be high costs of capital. So external growth is somewhat difficult to come by. However, if you peel back the layers of the onion, what you'll see is that by and large, fundamentals are very solid across the board.

1:49If you take the whole REIT asset classes, I like to say in conversations, the REIT sector is like your graduating class of high school. You have the top 10 percent, the REITs that are in the S &P 500, the valedictorian, the salutatorian of your class. Then you have the other side of the curve, the bottom of 10 percent, the bullies, the troublemakers, the REITs that cut their dividends or the REITs that are over levered. But what we like to do is focus on that middle part of the curve, 150 students that go under the radar that don't cause, draw attention, cause conflicts or anything. And that's really in the small and mid cap REITs.

2:27That's where you're going to see some of these opportunities, especially when you look towards more yielding income oriented investments where we do see those opportunities. One additional point to note here is that this volatility provides opportunity. And if you take a step back, looking outside of REITs and figure out, pick your favorite stock. We could use buzzworthy stocks like NVIDIA or Apple, Microsoft, whatever stocks that you're looking at. The end investor wants a company to do four things at the end of the day, really four things. Grow revenues, grow profits, grow dividends, and grow annual guidance.

3:12If a company is able to do those four things, regardless of what macroeconomic headlines are being thrown their way, you would assume that that company is on solid footing. Now, like every other sector that's out there, sure, there's a couple of bad apples as part of this entire bunch. But the broad entire scope of the universe, most of those four things are happening on a quarter after quarter basis. Here's how to look at this. We just wrapped up third quarter earnings, and I know we're going to get into it. But of the companies that provide 2025 earnings guidance, more than two thirds have raised their guidance.

3:55More than a third of these REITs have raised their dividends this year. and more than 60 % of the companies raised their net operating income guidance for this year. And this is in the wake of tariffs, rising or high interest rates, a 10-year treasury that continues to remain elevated, treasury rate that remains elevated. All of these macro factors are being thrown at the company. At the end of the day, an investor wants a management team, whether it's Jensen Huang at NVIDIA, Tim Cook at Apple, or David Simon at Simon Property Group, they want that management team to put the blinders on and focus on ways on how they can grow revenues while cutting expenses in the hopes of maximizing profit or net income that is passed through to shareholders in the form of dividends.

4:46David Auerbach:I want to get to the dividends in a second. I'm curious, though, because of this rate environment. And by the way, for a deeper dive into the question of how the rate environment is affecting REITs on December 9th at 2 p.m. Eastern, David will be part of a webinar with Daniel Snyder hosting. Look for that. We'll leave a link to that in our show notes. But in this interest rate conversation where there's the promise of lowered interest rates after a couple of years of higher interest rates, how does that figure in and how does that play into the general kind of strategizing, looking at REITs in general?

5:22David Auerbach:And then how does it affect dividends specifically? Sure. It's a great question. And from a very high level, I want to start out by saying there's this misconception that I like to say that REITs are interest rate sensitive. Going back to what you learned in your finance class, we were always taught that REITs are kind of like that contra beta to the market, as in when the market is up, REITs are down. When the market is down, REITs are up. And now coming out of COVID for the past few years, it seems like everything trades in lockstep with each other. Number two, when they say that REITs are interest rate sensitive, I call BS on that because really when I think about REITs, I think about the end consumers that use these REIT-owned properties every single day.

6:08Case in point, we're recording this session right now that's going to be posted to the cloud or viewed on YouTube or various different sites. For the end user to watch that, they're going to be utilizing a data center REIT to get that content. Is that user thinking about where the 10-year treasury rate is, what the Fed is doing with interest rates today as they're watching this interview down the road? And the answer is, of course not. If a REIT is out there actively developing a property, they're in the market for a construction loan, they're in the market to take down debt from Goldman Sachs or JP Morgan, then yes, obviously the current market impacts the interest rate on the note that they're taking down.

6:55But I think one other key piece that is kind of getting overlooked is that many of these REITs have investment grade ratings from a lot of the ratings agencies, Moody's, S &P, Fitch. So they know what the borrowing environment looks like. In a given day, the CFO knows what the lending environment looks like. And can I borrow five-year paper today at five, 5.05, 5.1? It's not like that window moves very much on a day-to-day basis. Again, it's in those times of volatility where you see those big jumps. But let's get back to your question. We know that there is going to be a more, we'll say, dovish incoming Fed chairperson next year.

7:47We don't know who yet, but we know that the goal is to bring in somebody that's going to be much more favorable and, let's say, aggressive in cutting interest rates. Therefore, those tailwinds should benefit the REIT sector as that happens. But it's more than that. REITs are compared to fixed income, thus why REIT yields are always closely scrutinized versus the 10-year treasury, because they kind of trade in lockstep with each other. So if the average REIT dividend yield is around 4 % right now, while the 10-year treasury trades north of 4%, that would technically make fixed income a more attractive investment vehicle.

8:37But there's a couple of different ways to look at this. That 4 % number that I'm giving you is basically a market cap weighted number. So the biggest of the biggest REITs, the American Towers of the world, the Prologists of the world, frankly, aren't yielding that much, which is why here at Hoya, again, we find the value in the small and mid-cap REITs moving down that ladder. So if you equal cap weight all of those REITs, that yield goes towards around 6 % or so. And thus, again, on an equal basis, REITs would be more attractive than fixed income. And as Fed cuts rates, one would hope the 10-year Treasury number goes lower as well.

9:25And thus, that spread between REIT dividends and fixed income would continue to widen.

9:29David Auerbach:Speaking of dividends, we saw a bunch of dividend hikes in October that we just got that report out recently. What would you say to your point about dividends and that there should be improved reasons to be bullish on REITs? What would you say contextually about the dividend hikes that we've seen? I want to bring in dividends with other things that a lot of the REITs have been doing to unlock value. If we go back to the start of 2022, when the Fed started hiking interest rates, we've seen 36 different companies that have basically gone away, merged, liquidated, explored options trying to unlock value.

10:03In the past quarter alone, we've seen 10 different REITs go through that same process. While going back to 2022, we've only seen 10 new REITs come to market. So at this point, management teams are trying to figure out ways to unlock value for shareholders since most of these REITs are trading at discounts to net asset value. But to answer your question about dividends, that's why this kind of plays hand in hand with what I was just explaining. Because if you go back to pre-COVID, right before COVID started, again, and I know we're talking about something from five years ago, but a lot of these sectors are still compared about how are they performing versus pre-COVID.

10:44And the way to say about the REITs was, before COVID, the REITs were basically at the top of the market. Leasing wasn't an all time high. Rental rates were an all time high. Dividends were at an all time high. The REIT sector was just firing on all cylinders. COVID hits, REIT sector goes in the tank for a variety of reasons. Fed starts hiking interest rates. REITs are out of favor. But let's go to the fundamental side of the equation. Here we are five years later. The REITs are putting up fundamentals that surpass what they were doing at their COVID peak, their earnings, their growth, but their dividends have not caught up to where they were pre-COVID for a variety of reasons.

11:36But I would say one of the specific reasons as to why a lot of the REITs have not gotten so aggressive on hiking is because I feel like some of them are retaining cash for a rainy day. Is it better to raise my dividend by a penny or two pennies across, again, millions of shares of stock, or is it better to retain that capital to find the right opportunity that comes along? So these companies are, let me rephrase that, most, if not almost every single one of these companies, their earnings that they're making are dramatically covering their dividend payment versus a handful of options where, excuse me, a handful of companies where the dividend is not being covered by earnings.

12:30So the takeaway here is that the REITs that continue to grow still have ample capacity to continue to raise their dividends.

12:41David Auerbach:And what names would you put to that? What names would you put in that column and what names would you put in the other column? It's kind of hard to forecast who will continue and all that type of stuff. It's very hard to kind of gauge. But a couple of that would stand out, a good example would be like Simon Property Group. Simon just raised their dividend. I believe it's for the 11th time coming out of COVID. That's one example. You have companies like Welltower that have grown their market cap by over 5x in the past half decade. And they're one of the very, very few REIT stocks that's actually trading at a premium right now.

13:21So I think it's really on a case-by-case, sector-by-sector basis. Another company that stands out as far as dividend growth is a small cap health care REIT called Strawberry Fields. Strawberry Fields is a company that's more than double the size of their portfolio. And frankly, their dividend has doubled in size as well. I think a good way to look at dividend growth is looking towards the companies and the fundamentals and seeing how they are growing. Meaning, if we have gone out and acquired, I'm just throwing random numbers out there. If we've increased our portfolio revenue by 25, 50%, dot, dot, dot, one would assume that the dividend is going to go up by a corresponding amount as well.

14:08So really look towards the internal and external growth of these companies and their earnings to kind of get a gauge on what's being pushed through. Then there's other companies that pay consistent monthly dividends, realty income, agri-realty. You know the list of the companies that are out there, but it's slow and steady, tried and true. You know, I interviewed the CEO of AGNC Mortgage, a mortgage REIT just a couple of months ago, you know, and he was very transparent saying, look, David, we're a mortgage REIT. Mortgage REITs go under the radar. They're always kind of under the gun. And guess what?

14:45We've never cut our dividend. We have maintained our monthly dividend through COVID and beyond. We're plotting a lawn because our customers are Fannie and Freddie and government backed securities. And so we're able to continue to do business as usual. So I think we can play this on a case-by-case, company-by-company level. I will say, again, to be fair and balanced, one company to keep an eye on that might cut their dividend, and they're kind of implying as much, would be Alexandria, A-R-E. They had a very disappointing third quarter earnings report, and they are kind of guiding towards a 2026 dividend cut if you read through some of the materials they've published here in the past few weeks.

15:28David Auerbach:What would you say from earnings season? What left you surprised? What were you expecting? And anything else that you feel would be valuable takeaways from earnings season for investors to hear? Sure. I would say, obviously, that Alexandria report was probably the biggest surprise of all of the REITs that reported during earning during earning season period. We could put a bow on that. As far as sectors looking sectors on a case by case basis, you know, one sector that continues to jump out is senior housing. Senior housing is a sector that is going to continue to do very, very well. It's obviously still coming out of the COVID cycle when, you know, senior living was very much underappreciated because of what was going on.

16:14But we're seeing very limited new supply with a sector that's seeing robust rent growth. So that's one sector that jumps out. Obviously, you know, there's this two-letter phrase that's kicked around a billion times a day called AI. And so AI beneficiaries would clearly be data centers. That's a sector that's continuing to hum along. In fact, we just saw this recent IPO of Fermi, F-R-M-I, and it'll be a great walking case study to see how much does the data center REIT buzz continue to burn into 26. um retail another good sector that's been standing out i point to guys like tanger i also mentioned simon earlier you know some of these players are seeing you know double digit rent spreads double digit rent spreads frankly because we haven't seen much new development uh in a while you know another name that came out during um the earning cycle uh came from a non-REIT it was Berkshire Hathaway.

17:22As we know, Warren Buffett is leaving, retiring, and in one of their last quarterly earnings reports, they mentioned taking a stake in Lamar Advertising Company, LAMR, a billboard REIT. So what does Buffett know about billboards? And that's, again, a new type of industry where you don't see a lot of new supply. You don't see really many new billboards, Again, huge freestanding billboards being placed on the ground. And then again, one other sector we thought that was pretty good was mortgage rates, as I mentioned. We're not really seeing much issue on the residential credit side. The commercial credit continues to remain status quo.

18:06And any of those delinquency situations that might be happening, those are getting worked out. If you go to the other side of the coin, sectors that probably didn't perform as well, as I I mentioned lab space. That would be the Alexandria story. Cold storage being impacted, obviously, by tariffs. There's a competition situation there. We might be seeing a little bit of some oversupply. So that's a sector that's going to continue to get a lot of focus. You know, we're seeing on the cell tower side some consolidation with DISH and Echostar. Plus, there's this thing called Starlink that's out there, obviously, which may impact some of the cell tower REITs.

18:47apartments have had some very mixed results. We're seeing, you know, three-year flat apartment rent growth. There are signs we might be seeing a lift into next year, but obviously it's still too soon to tell. And then, you know, some of those that straddle the fence from good sides, some bad sides, some of those sectors include office, industrial, hotels is a sector that's especially worth a conversation, gaming REITs, and then like manufactured housing. And I would say, obviously, a lot of that earnings season volatility, especially stuff like hotels, gaming, and manufactured housing could be attributed to the travel slowdown, the government shutdown, Canada, lack of international tourism, things like that.

19:40So there's a lot, again, earning season really, though, by and large, was relatively mute. As I mentioned, again, more than two-thirds raised their annual guidance this year. A lot of them raised their net operating income guidance. And again, that's what you're kind of looking for. It's pretty much on par with one or two out-of-the-ordinary results. Again, Alexandria. One other REIT would be Office Properties Income Trust OPI, which basically is exploring bankruptcy.

20:13David Auerbach:What would you say when it comes to the retail REITs, what would you say about the economy, how it's developing, how it's not developing, and how much that is putting or how much that is having an effect on other REITs? That's a great question. And so there's a couple of different ways to look at this. Because when you talk about retail, there's, frankly, many different sectors of retail, right? You've got malls. You've got strip centers. You've also got some of those net lease assets that are retail focused. So you can kind of take it from across three different ways. um look when it comes to the world of retail when i think of grocery anchored shopping centers they're still always going to be they're going to command a premium because we're going to the grocery store every single week to buy groceries obviously tariffs inflation that stuff plays into it as well but we're still going to the grocery store to get down take down groceries on the the, let's say, mall and retail component of it, the high end is outweighing the low end.

21:27The luxury properties continue to do well. The best-in-class operators, the Simons of the world, you know, continue to hum along. They're seeing opportunities. I think there's interesting stories out there to follow when you look at, like, the resurgence of CBL properties, a REIT that was in bankruptcy a couple of years ago that is coming out again on the other side. Mastrich in the process of a turnaround situation in itself. But I think the key, when you look at it, at least on the mall and retail side, and I turned to Tanger, Steven Yaloff, their CEO, just go into Google, type in Steven Yaloff, Tanger, and you will see, I'm not exaggerating, every single week he's either on Bloomberg, on CNBC, or on some news channel highlighting what's going on at their properties.

22:19Where I'm going with this is that when you look towards a lot of these companies, they really are focusing on the experiential offering side of the equation. We don't want to get showroomed. A good example here in Dallas at one of our most famous mall properties, Netflix is opening an entertainment concept here. any day now. And so it's a way to drive foot traffic to the property, especially a family. How do we bring the family to the mall for several hours and capture them, whether it's through a movie, through American Girl, or Build-A-Bear, or Netflix, or Crayola, or Meow Wolf, or whatever it is.

23:02The goal is to try to find ways to draw families to the property, but more importantly, so that we don't really showroom that product. Why do I need to go to JCPenney when I can look, you know, go to JCPenney, look at the item of clothing and then go buy it online at home or something like that. You look at this shift. I was just talking about like Warby Parker with somebody last week when I was in New York. And, you know, Warby Parker as an online retailer shifting to a bricks and mortar concept. Look at Tesla. Tesla with a bricks and mortar concept, though you still can pretty much, I think, only order the car online, though I don't own a Tesla.

23:43So I think it's this interesting hybrid mix of looking at tried and true retailers that resonate with families while offering experiential offerings that can't be beat. Go look at a Tanger property and all the different concepts that are around in terms of food, beverage, retail, experience, rides, et cetera, so that that family is able to go hang out those properties. And then on the net lease side, you know, that's an interesting angle to look at, at least on the net lease retail side, because there's so many different moving parts with that. Look at all the retail players that make up that sector.

24:24Obviously, gas stations, convenience stores, Subway, Starbucks, the list goes on and on. And I think you can kind of look towards some of those earnings reports from some of those various retailers to see the strength of really what's going on there. I think one thing that kind of gets lost in the shuffle, many investors look at day-to-day performance of REITs. And I think that's a bad idea because with the exception of hotels, which is technically a one-night lease, the minimum lease term in place is an apartment lease, which is one year. But an office lease, a retail lease, et cetera, is five years, 10 years or more, all the way up to go out and buy safe hold, which focuses on ground leases, and that could be a 99 -year lease.

25:23So when I talk to people about the REIT industry, I always say, ignore the stock price story of this equation and focus on, again, this income side of it, this long-term lease that's in place with X company with a set rent bump in place every single year. Here's this year's rent next year, the year after, the year after, the year after we revisit it here and renegotiate. So because of that steady rent bump growth, that's kind of trying to build in some of that growth of that dividend. Part two. Talking about REITs, you focus on the dividend income machine, that compounding of dividends. Look at realty income.

26:10If you bought one share of realty income five, 10, 25 years ago, reinvesting your dividends that get paid, every single month and what you would have today versus where you started out when you bought that one share a few years ago. When I talked about this with investors, I always say you have to look at this sector with 25 to 50-year glasses. How much income are you going to earn by owning realty income over the course of the next 25 years as they consistently continue to grow that dividend. So ignore the day-to-day volatility of the market and focus on that dividend check that you're getting every month, quarter, year, et cetera, from these companies.

26:53And any upside that you get on stock price, that's basically the extra cherry on top of the sundae.

27:00David Auerbach:I'm curious, you mentioned senior living as a theme to look at after COVID. What about the office space REITs? Has that seen an uptick or evolution since the end of the COVID time? Frankly, the answer is both. You are seeing an au tip. You are seeing an evolution. Return to office is here in some form, but work from home is also still here. You know, New York City will never go back, as far as I know, to a five days a week in the office unless you're in a couple of different sectors, let's say. You know, you can go out and buy the most famous office building in the world, the Empire State Building, for$7 a share right now.

27:43I don't know anything, but something tells me that if you add up all the assets that Empire State Realty Trust owns, my gut tells me it's worth more than$7 a share. The best of the best assets that are out there, especially when you look at some of the really trophy-type names, the SL Greens of the world, the BXPs, the Highwoods, HIW, the Cousins, some of these, again, these operators that own the best assets at the best intersections, the best markets, they're going to weather the storm and they're going to be A-OK. I'm more concerned about the smaller cap over levered REIT in an undesirable suburban office that's 35 percent occupied.