If you’ve ever heard someone talk about “blue-chip REITs,” you probably have Ralph L. Block to thank. He was a friend, mentor, and an extraordinary REIT expert who did a lot for the industry.
I’m not saying he came up with the concept of “blue-chip REITs.” And he definitely didn’t coin the “blue-chip stock” concept behind it. But he definitely did popularize them, including through his book, Investing Intelligently With REITs.”
Here’s the segment where he first explores the topic (p. 180):
Now I’ll introduce the stalwarts of REITdom – the blue-chip REITs. But first, a caveat: There's no objective or commonly accepted definition of ‘blue-chip REIT.’ So you will have to accept mine until you develop your own.
Blue-chip REITs are, like all REITs, subject to the ups and downs of their sector’s cycles, but should, over reasonably long time periods, deliver consistent, rising, long-term growth in FFO, dividends, and asset value. Because they are financially strong and widely respected, they will, in most periods, have access to the additional equity and debt capital that can fuel above-average growth.
They will rarely provide the highest dividend yields or even, in many years, the best total returns. Nor can we frequently buy them at bargain prices. But they should provide years of (seven to eight) percent total returns, on average, with only modest risk.
He goes on to mention that management makes an enormous difference in separating blue-chip REITs from non-blue-chip REITs. And I can’t agree with him more.
Actually, I can’t agree with him more on most topics he covered. Ralph Block was a truly great mind and a phenomenal mentor I’m proud to have known.
When he spoke, I made sure to listen, and pass along that wisdom along as I could.
Some Ralph Block, Blue-Chip REIT Wisdom
The thing about superior management is that it affects every aspect of a company, REIT or not. And why not, considering what it means?
Superior management entails a leadership structure filled with people who are not only very good at what they do, they also genuinely care about what they do and how those efforts turn out.
As such, they’re going to understand their businesses inside and out, forward and backward. In good times and bad times, sickness and health, they’re on top of what it takes to build better futures.
For instance – as everyone from John F. Kennedy to Ralph Block to Warren Buffett to me myself have noted – a rising tide lifts all ships. In other words, any company (or at least most) can do well enough for itself when the economy is booming.
For proof of that, look no further back than the dot.com boom. Some of the online-only companies that existed at the time were downright absurd. Yet they made lots and lots – and lots – of money up until the subsequent, inevitable crash.
Those executives might have understood their opportunities in the moment. But they obviously weren’t thinking too far into the future. Otherwise, they wouldn’t have built their businesses up so quickly without the benefit of a safety net.
Blue-chip REIT types are going to keep their eyes open for opportunity, to be sure. They want to grow, and they do grow.
As such, they’re going to have their fingers on their particular real estate pulse, whatever that focus is. Whether it’s apartment buildings or offices, arable land or shopping space, they’re willing to buy when the price is right.
But the price has to be right. And so do a whole host of other factors.
Profitable Places to Be
The price has to be right. The place has to be right. The timing has to be right. And they have to be right for that particular REIT in its particular set of circ*mstances.
Stellar management analyzes every detail possible – not just its pet-project ones – and comes to solid conclusions from there. Admittedly, this might lead to slower growth at times.
But the growth is still there. Moreover, it’s growth that builds up the kind of reliable track records that are well worth investing in.
I’m not going to say that, once you find a true blue-chip REIT, you never let go. You need to be every bit as analytical as the executive teams you’re buying into. After all, they can’t do all the work for you.
However, they are supposed to make your job significantly easier – and your sleep significantly deeper – as you rest in exceptionally high chances that they’re going to do business as usual.
And that’s a profitable place to be.
3 Blue Chips To Buy…
Ventas Inc. (VTR) is a healthcare REIT that has come a long over the last decade. Back in 1999 when Debra Cafaro took over as the CEO, the company had a market capitalization of around $200 million and just one tenant, Vencor Inc., which primarily operated nursing homes and long-term acute care hospitals.
Vencor was spiraling due to fundamentals and eventually declared bankruptcy and reorganized as Kindred Healthcare Inc. Cafaro took over and was able to turn the small-cap REIT into a dominant S&P 500 business. She took on the additional responsibility of chairman of the board in 2003.
Today Ventas has made approximately $22 billion in strategic investments, with a portfolio of best-in-class operators. The company now has more than 1,200 senior living, medical office building, and life science properties across North America and the U.K.
Source; FAST Graphs
In order to grow the platform to its dominating size, Ventas has focused on maintaining a disciplined and efficient capital structure: 5.9v leverage (vs 6.2 industry average), 4.3x interest coverage (vs. 3.1 industry average) and 51% debt to capital (vs 60% safe for this industry). The company is rated BBB+ stable by S&P.
In fact, Ventas’ balance sheet is tied for the best in the industry and recently sold 11-year bonds at 3% to refinance already low-cost 4.25% debt. Its global diversification also helps because on Nov. 5 Ventas sold five-year Canadian bonds at just 2.8% interest rates. Thus, the scale and cost of capital advantages are what makes this blue chip REIT a terrific buy.
Why so cheap?
On the latest earnings call (Q3-10) Mr. Market was a bit spooked after Ventas announced a disappointing earnings report in which its SHOP (senior housing operating properties) segment saw -5% SS NOI declines. Keep in mind, the company did report positive SS NOI growth overall, courtesy of strong results in triple-net lease senior housing and medical offices, mid-line guidance for 2019 declined to -6% FFO growth and flat for 2020.
Hence the reason Ventas shares have declined by ~20% in 90 days.
We expect to see Ventas rebound in 2020 as the company operates a superior portfolio, leased to strong industry operators and a skilled management team that can adapt to challenging market conditions. Ventas has exactly such a management team and the deepest pockets to finance the necessary adjustments required to wait out today's troubled Senior housing environment until a strong demographic wave finally arrives in the 2020s.
Shares are priced at $59.47 with a P/FFO multiple of 15.6x (10-year average is 15.7x). The company is expected to report earnings on Feb. 14 and analysts are forecasting negative growth of -3% in 2020 and modest (1%) growth in 2021. While this growth forecast is not what I would call “blue chip,” we expect it to return to over 5% in 2025 based upon the powerful demographic demand. In our view, shares are mispriced and we are maintain a Buy.
Source: FAST Graphs
Our next blue-chip buy is W.P. Carey (WPC), a net lease REIT that also has seen shares pull back around 10% in the last 90 days. We consider the company to be a blue-chip pick based on its powerful scale advantage that includes the highly diversified portfolio by geography, tenant, asset type and tenant industry. As of Q3-19 the company owned 1,204 net lease properties (138 million sq. ft.) with more than $1.1 billion of annual base rent (or ABR). The portfolio is primarily industrial, warehouse, office, retail and self-storage (net lease).
We are attracted to the company’s international reach that includes 33% of revenue being generated from Europe. A few days ago the company announced it acquired a 726K-square-foot class A, cross-docked logistics facility in the U.K. for $112M (£85M) in an off-market transaction. The mission-critical facility is net leased to the U.K. operating subsidiary Dixons Carphone plc, a publicly-listed multinational electronics and telecom retailer and services company.
Source: FAST Graphs
The U.S. and European portfolio has 324 tenants and the top 10 tenants represent 22.6% of ABR. Around 99% of leases have contractual rent increases, including 62% linked to CPI (consumer price index).
W.P. Carey also has a strong balance sheet highlighted by the established $1.85 billion credit facility (providing ample liquidity) and investment grade ratings from Moody’s and S&P (Baa2/stable rating from Moody’s and BBB/positive rating from S&P).
Finally, W.P. Carey has a blue-chip dividend growth record of increasing its dividend every year since going public in 1998. The company maintains a conservative and stable payout ratio (82% based on AFFO) since conversion to a REIT in September 2012. The company has maintained stable occupancy during the credit crisis and economic downturn and we view the company’s exit from its non-traded retail fundraising business to be a big positive.
Share are now trading at $84.29 with a P/FFO multiple of 19.1x. While we don’t consider this a bargain, we recently moved the company to our buy watch list, meaning that the recent pullback has put shares closer to our buy target range. The dividend yield is now 4.9% and we would begin to “nibble” again when the yield is closer to 5%. Although for investors seeking defensive income, we consider W.P. Carey a good candidate for dependable income. Maintain Buy Watch.
Source: FAST Graphs
You guessed it, our last blue chip Buy is Tanger Outlets (SKT), the battleground REIT that has seen shares ramp up by more than 12% in the last 30 days. Of course, the catalyst for the price momentum is largely due to a combination of moving into the SmallCap 600 (from the MidCap 400) and rebalancing within the ETF sector.
While we have no insight into whether more gains are coming for Tanger, it’s clear that there’s substantial short interest in the stock that could most likely lead to another 10%-plus pop, especially if the upcoming earnings results are better than expected.
Source: FAST Graphs
Of course in retail, the winds blow daily, and Express announced yesterday it was closing 100 stores by 2022 in a “strategy to save $80 million in costs annually over the next three years.” As Lauren Thomas (disclosure: my daughter) at CNBC explains,
“The store closures add to the malaise that U.S. shopping malls have been hit with in recent years. A record of more than 9,000 store closures was announced by retailers — ranging from Gap to Forever 21 to Sears — in 2019. The apparel category within retail has been under pressure especially with more shoppers either pulling back their spending on clothing, or turning to subscription and rental services like Stitch Fix and Rent the Runway.”
In the face of this adversity, we are one of the few analysts with a “strong buy” Tanger rating, and our confidence in the pure-play outlet REIT are rooted in blue chip fundamentals. Case in point:
- Consolidated portfolio occupancy rate was 95.9% in Q3-19, compared to 96% in Q2-19 and 96.4% in Q3-18.
- Average consolidated portfolio tenant sales productivity was $395 per square foot(in Q3-19) for the 12 months ended Sept. 30.
- Investment grade rated (S&P BBB and Moody’s Baa1) balance sheet with just $16 million of floating rate debt (1% of total debt) and an unused $600 million unsecured credit facility.
- Strong leverage metrics such as 4.3x interest coverage and 5.8x net debt-to-EBITDA with no significant debt maturities until 2023.
- Raised FFO guidance (in Q3-19) modestly at the lower end in the latest quarter from $2.25-2.32 to $2.37-2.31.
- Has increased its dividend each year and paid an all-cash dividend every quarter since its IPO (in 1993).
Tanger shares are now trading at $15.93 with a P/FFO multiple of 7.1x. The dividend is well covered with a current yield of 8.9%. Although analysts forecast -4% growth in 2020 and +1% in 2021, we believe there’s ample room for shares to appreciate (as the shorts unwind). Maintain Strong Buy.
Source: FAST Graphs
In conclusion, the common thread to all three of the above-referenced blue-chip REITs is the fact that they have maintained steady discipline in their risk management practices. They recognize that the key to outperformance is to allocate capital wisely in order to generate steady and predictable profit margins.
When and if the company experiences a cyclical downturn (i.e. senior housing and retail store closures) it’s positioned to weather the storms and continue to grow its dividend. As Ralph Block explained, “Because they are financially strong and widely respected, they will, in most periods, have access to the additional equity and debt capital that can fuel above-average growth.”
Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
Join the Dividend Coalition…
The Dividend Kings and iREIT on Alpha now have over 2,000 combined subscribers on Seeking Alpha!
We are humbled by that growth and excited to accelerate our growth plans for 2020 and beyond. Our team of experienced analysts have decades of experience, and we would like for you to be part of our success.
Keep in mind that you can lock in last year's rates by acting now and subscribing for our 2-week free trial.
For more information about iREIT on Alpha, please visit our LANDING PAGE (where you can activate your 2-week free trial).
