Tag Archives: dividend investing

Pssst. Want To Own The Empire State Building?

I know what you’re thinking when you read my title – that you should run away from anyone trying to sell you a famous bridge or building. But real estate investment trusts (REITs) sometimes own landmark structures, and you can too if you decide to buy their shares. One such REIT is Empire State Realty Trust (ESRT), named after the most famous building in its portfolio, the Empire State Building, and its shares look reasonably priced.

Empire State Realty Trust owns 14 office and 6 retail properties in and around New York City totaling 10.1 million rentable square feet. Suburban properties are in Westchester County, NY and Fairfield County, CT. Occupancy for the entire portfolio runs nearly 88.8%, down from just under 90% from a year ago. Greater New York office is at 87.6% from 91.25 a year ago, while standalone retail is at 94.4% from 99.4% a year ago. The landlord’s largest retail-related tenants are Global Brands, Coty, PVH Corp., and Sephora. Other large tenants include LinkedIn, Li & Fung, HNTB Corporation, and Legg Mason. No tenant accounts for more than 6.7% of the firm’s annualized rent.

Over the past four quarters, the firm has collected around $730 million in rent. This includes a whopping $131 million in revenues from the Empire State Building Observatory, up from $111.5 million in 2014. More than 3 million people visit the observatory every year, though the number of visitors declined by 4%-5% over the past three quarters compared to the same quarters from last year. Around $500 million of the rent is from the Manhattan office portfolio.

Over the past four quarters, the $730 million in revenue has resulted in $282 in funds from operations. The latter is a real estate cash flow metric that adjusts net income for property sales and depreciation. That’s just under $1 per the roughly 297 million shares outstanding. At its current price between $15 and $16 per share that means that stock trades at a Price/FFO multiple of around 16. Some publicly traded REITs, especially the larger apartments with coastal property, are trading closer to 20. Empire State Realty Trust’s competitor in NYC office space, SL Green, is trading at around a 14 Price/FFO multiple.

The firm’s cash flow is easily enough to cover its dividends. The firm has paid out $0.10 per quarter in dividends recently, and its FFO has been between $0.19 and $0.29 per quarter over the past four quarters. However, it seems as if the firm is conserving cash in order to redevelop some of its property. Some analysts classify the firm’s property as between class-A and class-B, and a glance at the tenant roster shows an absence of high-powered New York financial and law firms. The good news is the firm has the luxury of being able to spend the money required for redevelopment. Its financial condition is strong, as it’s able to cover interest payments by nearly 6x with cash flow.

Despite a reasonable valuation and a strong financial position, passive investors in Class A shares – the ones most investors would be purchasing — have much less control over the company than investors might like. The Class B common stock, when accompanied by 49 operating partnership units, entitles an investor to 50 votes on all matters on which Class A common stockholders are entitled to vote, including the election of directors. REITs often have structures unfriendly to shareholders, most frequently poison pills that make a takeover or change of ownership difficult because of the automatic issuance of new stock when a shareholder accumulates a concentrated position. This separate share class arrangement is an extra problem for ordinary shareholders.

Owning Empire State Realty Trust isn’t a slam-dunk investment. But you’re getting paid nearly 3% to own the Empire State Building and other New York City-area properties, while you wait for the firm to redevelop its other Manhattan buildings. There are worse places to allocate capital right now.

Big Apartment REITs Aren’t Yielding Enough

The seven largest publicly traded apartment REITs are now paying dividend yields of less than 3.5%. The two largest — AvalonBay Communities and Equity Residential — are paying around 3.2%. Essex Property Trust, whose apartment buildings are all in California, is paying barely over 3%, roughly the equivalent of the 10-year U.S. Treasury Note. Historically, REITs have paid one full percentage point more of yield than the 10-year Note, and that means investors in apartments could be in for trouble if the yield on the 10-year Note doesn’t decline and/or the apartment landlords don’t increase their dividends.

Recent History of Apartment REITs

Among the different property types in real estate, apartments (sometimes called the “multifamily” sector) have done particularly well since the financial crisis. That makes some sense since homeownership went from the low 60% range to above 68% during the bubble period of 2003-2007, and the collapsed again to the low 60% range. Families that couldn’t stay in homes after the crisis went back to renting. Also multifamily new development stagnated, and a continued influx of educated people into big cities with limited apartment stock contributed to increasing rents.

At around the beginning of 2011, companies like AvalonBay Communities and Equity Residential, the two largest multifamily REITs, and their competitors began raising rents, and haven’t stopped since. In the early years of the recovery, those rent increases were sometimes more than 6% on a year-over-year basis. After a dip in the rate of increase in 2013-2014 to the high 3% range, rent increases moved up to nearly 6% again in late 2015 and 2016.

 

After declining down to 2%, rent growth has picked up for the past few quarters again. But publicly traded multifamily companies are increasing rent in the 2%-3% range on a year-over-year basis instead of the 6% range. The pattern for Avalon Bay is similar to those of its competitors.

This declining growth would make it difficult for Avalon Bay to increase its dividend despite its current comfortable coverage. Avalon Bay pays around $800 million in dividends annually, and generates around $1.2 billion in funds from operations. That’s  a difference of around $300 million But funds from operations doesn’t take long-term property upkeep and improvements into consideration. One percent of the stated value of the firm’s property — a modest annual upkeep charge — would be around $200 million. Some real estate analysts think 2% is a more reasonable annual charge for upkeep and maintenance. That would be around $400 million or more than Avalon Bay can afford while paying its current dividend.

Perhaps 2% is draconian for annual long-term capital expenditures, but it seems clear that Avalon Bay doesn’t have the ability to pay a dramatically higher dividend if it doesn’t experience more robust rent growth. This is also true for its large publicly traded competitors. Perhaps they could all boost their dividends by an amount that would equate to 4% at current stock prices, putting their yields a full percentage point above that of the 10-year Note, but not much more. And if the large public apartment REITs can’t boost dividends significantly at this point, it makes little sense to own them when their yield advantage over a 10-year U.S Treasury Note is so minimal — unless you think rates are going back down significantly.