The State of REITs: October 2022 Edition
- The REIT sector has endured declines in 7 of the first 9 months of 2022, including a particularly brutal -13.66% total return in September.
- REITs of all sizes faced double-digit percentage declines during September’s sharp market selloff. Micro cap (-18.27%) and small cap REITs (-15.01%) saw the steepest declines. Large caps (-11.44%) and mid caps (-11.75%) endured the selloff somewhat better with low double-digit declines.
- Only 3.03% of REIT securities had a positive total return in September.
- Single Family Housing (-7.10%) and Casino (-7.71%) REITs saw the smallest declines of all property types in September. Infrastructure (-22.78%) and Land (-21.68%) REITs suffered the most severe average price collapse.
- The average REIT NAV discount widened from -20.28% to 30.96% during September. The median NAV discount also widened from -20.04% to -29.61%.
Although 2022 had already been a rough year for the market, September was particularly painful. REITs significantly underperformed the broader market with a much lower average return than the Dow Jones Industrial Average (-8.76%), S&P 500 (-9.21%) and NASDAQ (-10.4%). The market cap weighted Vanguard Real Estate ETF (VNQ) achieved a higher total return than the average REIT in September (-12.8% vs. -13.66%), but remains deeper in the red YTD (-29.31% vs. -26.68%). The spread between the 2022 FFO multiples of large cap REITs (17.4x) and small cap REITs (11.3x) narrowed in September as multiples decreased by 2.6 turns for large caps and 2.1 turns for small caps. However, the large cap premium widened on a percentage basis as investors now need to pay 54% more (up from +49.3%) for each dollar of FFO from large cap REITs relative to small cap REITs. In this monthly publication, I will provide REIT data on numerous metrics to help readers identify which property types and individual securities currently offer the best opportunities to achieve their investment goals.
0 out of 18 Property Types Yielded Positive Total Returns in September
100 percent of REIT property types averaged a negative total return in September, with a 15.68% total return spread between the best and worst performing property types. Infrastructure (-22.78%) and Land (-21.68%) REITs had the worst average total returns in September. All Infrastructure REITs saw double-digit negative total returns in September, with Power REIT (PW) enduring the most severe decline of -37.24%. This brings Power REIT’s YTD share price decline to -84.51%, worse than any other REIT.
Single Family Housing (-7.10%) and Casino (-7.71%) REITs weathered the September selloff better than other REIT property types. Factors driving this outperformance are the resilient pricing and rents of single family homes and the stability of cash flows to Casino landlords. The strength of Casino REIT rental contracts was on full display during the government-imposed lockdowns of 2020 and 2021, during which Casino operators’ cash flow suffered, but Casino REIT landlords continued to collect 100% of rent.
Performance of Individual Securities
CatchMark Timber Trust (CTT) was acquired by PotlatchDeltic (PCH) on September 14th. CTT shareholders received 0.23 shares of PCH for every share of CTT they held. This acquisition expanded PotlatchDeltic’s portfolio to nearly 2.2M acres of timberland. PotlatchDeltic’s board expanded to 10 directors with the addition of James DeCosmo, who is joining from CatchMark’s board.
Store Capital (STOR) (+17.64%) was the only REIT to achieve a double-digit percent increase in September. STOR soared on the announcement that it would be acquired and taken private by GIC and Oak Street. STOR shareholders will receive $32.25 per share, which is 20.4% above STOR’s share price at the time the acquisition was announced.
Presidio Property Trust (SQFT) (-59.98%) went into freefall after announcing on September 2nd that the high yield dividend would be switched to a variable quarterly dividend, the first of which was declared at only $0.02/share. While a dividend cut was a necessary step in the efforts to turn around the struggling REIT, it also eliminated the primary reason many investors held the stock leading to an exodus of shareholders seeking high yield. After a brutal September, SQFT now has the 7th lowest total return thus far in 2022.
Only 3.03% of REITs had a positive return in September, with 9.71% in the black year to date. During the first nine months of last year the average REIT had a +25.73% return, whereas this year the average REIT has seen a -26.68% total return.
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 09/30/2022) to lowest dividend yield.
Although a REIT’s decision regarding whether to pay a quarterly dividend or a monthly dividend does not reflect on the quality of the company’s fundamentals or operations, a monthly dividend allows for a smoother cash flow to the investor. Below is a list of equity REITs that pay monthly dividends ranked from highest yield to lowest 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.
The large cap REIT premium (relative to small cap REITs) widened in September and investors are now paying on average about 54% more for each dollar of 2022 FFO/share to buy large cap REITs than small cap REITs (17.4x/11.3x – 1 = 54.0%). 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 (-19.06%) trades at a double-digit discount to NAV, while mid cap REITs (-28.28%) trade at less than ¾ of NAV and small cap REITs (-36.66%) trade at less than 2/3 of NAV. Micro caps on average trade at approximately half of their respective NAVs (-50.12%).
Since the beginning of this century there has been a trend of cap rate compression, particularly for industrial and residential properties. That trend has often been reflected in the implied cap rates at which REITs trade. Industrial REIT implied cap rates have been more than cut in half over the past 22 years. Other REIT property types have seen cap rate compression as well, albeit by a smaller degree.
This implied cap rate trend has sharply reversed since the start of 2022 as runaway inflation has led the Federal Reserve to rapidly hike interest rates. The resulting rise in the risk-free rate has raised investors’ required rate of return on all asset classes including real estate. This has driven cap rate expansion at the property level and implied cap rate expansion for publicly traded REITs.
As can be seen in the graph above, Hotel REITs traded at a shockingly low implied cap rate in Q2 2021 due to temporarily diminished earnings from covid-related government imposed lockdowns. With the economy fully re-opened in Q2 2022, Hotel REIT implied cap rates have normalized. Even after the market selloff in the first half of 2022 largely reversed the market gains in the 2nd half of 2021, most REIT property types trade at a lower implied cap rate than they did the year prior. The REIT sector as a whole traded at the same 6.3% implied cap rate at the end of Q2 2022 that it did one year earlier.
The 2022 market selloff did not hit all REITs evenly and pushed some high quality REITs to very elevated implied cap rates. Even a large cap, profitable REIT in an attractive sector such as Iron Mountain (IRM) saw implied cap rate expansion up to 15%. Timber REITs such as PotchlatchDeltic (PCH) and Weyerhaeuser (WY) have reached even higher implied cap rates of 17.6% and 15.9% respectively. The REIT trading at the highest implied cap rate, however, is OUTFRONT Media (OUT) at 18.5%.
Although inflation is ravaging the economy and the market selloff continues, REIT dividends remain resilient with 8 more REITs hiking their dividend in September. While REIT share prices have been in freefall throughout 2022, both the rents that REITs collect from their tenants and the dividends they pay out to shareholders have continued to improve. There are now a litany of high quality REITs with excellent balance sheets that offer a high (and growing) yield.
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Through October 2021, The State of REITs was published exclusively on Seeking Alpha by Simon Bowler, Sector Analyst at 2nd Market Capital Services Corporation (2MCSC). Editions subsequent to October 2021 will be published on this website in addition to other platforms that may include Seeking Alpha. 2MCSC was formed in 1989 and provides investment research and consulting services to the financial services industry and the financial media. 2MCSC does not provide investment advice. 2MCSC is a separate entity but related under common ownership to 2nd Market Capital Advisory (2MCAC), a Wisconsin registered investment advisor. Simon Bowler is an investment advisor representative of 2MCAC. Any positive comments made by others should not be construed as an endorsement of the author's abilities to act as an investment advisor.
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