Tag Archives: REIT

Steepening Yield Curve Could Yield Generational Opportunities : Michael Lebowitz on Real Vision

On July 1st, Michael Lebowitz was interviewed by Real Vision TV. In the interview he discussed our thoughts on the yield curve, corporate bonds, recession odds, the Federal Reserve, and much more. In particular, Michael pitched our recent portfolio transactions NLY and AGNC, which were both discussed in the following RIA PRO article: Profiting From a Steepening Yield Curve.

Real Vision was kind enough to allow us to share their exclusive video with RIA Pro clients. We hope you enjoy it.

To watch the Video please click HERE

Inverted Curve? Not So Fast, Says Gundlach

While many pundits have been calling for a flat or inverted yield curve – a widely acknowledged recession-predictor – DoubleLine Capital founder, Jeffrey Gundlach, recently argued not so fast. Looking at the difference in yield between the 10-Year and 2-Year U.S Treasuries, Gundlach said in his January 9th, 2018 “Just Markets” webcast, “I’ve noticed that the yield curve has stopped flattening.” Gundlach noted at the time that there are more curve-flattening bets now than at any time since 1995, and said that the crowded trade already wasn’t working.

Normally, creditors demand a higher yield to lend for a longer period of time, making for an upward sloping yield curve. But the curve can flatten or invert if creditors pile into longer term bonds, sending their yields down, if they anticipate a slowing economy and future low rates

Sure enough, after narrowing to 50 basis points on January 4, the difference in yield between the 10-year and the 2-Year has begun to rise again at least for the time being, hitting 62 basis points on February 1.

Gundlach reminded his listeners that the Fed has three rate hikes scheduled for 2018. While that could contribute to flattening or inversion, Gundlach asked listeners to consider the possibility that the long end of the yield curve could steepen. This is in contrast to other asset managers such as Morgan Stanley and T.Rowe Price, who think the Fed’s elevation of short term rates will accompany worldwide central bank balance sheet expansion, buoying demand for long-term debt and leading to a flat yield curve. According to a Bloomberg article, Morgan Stanley strategist, Matthew Hornbach, thinks the U.S. central bank’s plans to shrink its balance sheet is already priced into the market, and that the yield curve will flatten in the third quarter of this year.

Gundlach said leading indictors show no recession for the next six months. From the time of Gundlach’s webcast on January 9th through February 1st, the spread between the 10-Year and 2-year Treasuries has widened from 57 to 62 basis points.

On Friday, Gundlach tweeted about the Federal Reserve Bank of Atlanta’s GDPNow estimate of 5.4% GDP growth for Q1 2018 and average hourly earnings increases. These developments support an inflationary thesis and a steepening curve. Late Saturday, Gundlach also gave an interview to Reuters’ Jennifer Ablan arguing that it was “hard to love bonds at even 3 percent,” given recent GDP growth estimates.

Commenting on the blistering pace of rate increases on parts of the yield curve since September, Gundlach told Reuters that “this is partly caused by the manic mood and partly caused by the falling dollar and related rising commodities.”

While Gundlach doesn’t think bond yields of 3% are attractive given prospective economic growth, PIMCO’s Dan Ivascyn and Mark Kiesel say 3% yield on 10-Year Treasuries might be a signal to buy, according to another Bloomberg article. The article quotes Ivascyn saying “[T]here’ll be buyers of bonds if we back up to 3 percent,”

Not All REITs Are Equal

As an investment concept, I like REITs, and so should small investors. Real estate investment trusts give ordinary investors the ability to own office buildings, apartments, hotels, storage centers, medical facilities, industrial warehouses, malls, movie theaters, gas stations, and even data centers where large computer systems for big online retailers and Internet businesses are stationed. REITs are organized in a way so that there is no tax at the corporate level in exchange for the company distributing 90% or more of its profits as a dividend to shareholders. Dividends from REITs are not qualified, so it helps to hold them in tax-advantaged accounts.

But, as much as they afford small investors the ability to own unique properties, like any investment, REITs can get too expensive. And despite trailing the broader stock market in 2017 and posting losses so far in 2018, most REITs still aren’t priced low enough to deliver big returns in the future. In this article, we’ll show you how to assess REITs, and highlight some possibly cheap ones in an otherwise expensive sector.

Making the assessment

While many investors look at a P/E ratio to appraise a stock, that doesn’t work for REITs. That’s because accounting rules allow real estate investors, including REITs, to take a big depreciation charge every year. So a REITs earnings or “net income” almost always look tepid. Luckily for an investor, that charge doesn’t reflect economic reality well, and the real cash flow the properties inside a REIT are generating is usually significantly higher than stated earnings. That’s why, instead of looking at earnings, knowledgeable REIT investors look at another metric that all REITs publish, but is still poorly reported in the business press, called “funds from operations” or “FFO.”

Basically, FFO takes earnings or net income and adds back the depreciation charge and any profits a company may have made from selling property instead of renting it out or “operating” it, which is its main business. Now, adding back all the depreciation may be too generous because property owners must consistently pour money into properties for upkeep, and, even then, properties get old and obsolete. In other words, FFO isn’t an accurate reflection of reality either. However, FFO is a standardized metric that helps investors compare different companies that own similar or different types of property. And it’s a better starting point than net income, from which investors can subtract their own upkeep estimates.

So instead of a standard Price/Earnings Ratio, we constructed a Price/FFO Ratio for the top-25 REITs in the Vanguard REIT Index ETF (VNQ). The results show that these large REITs are trading at around 18 times FFO. That’s not a cheap price. Investors seeking to by an ETF are buying into an expensive sector. It’s true that REITs have much lower debt burdens than they did before the financial crisis, and the companies are covering their dividends with FFO instead of having to borrow money. But that doesn’t mean future returns will be high.

What looks cheap?

Vornado, a company that owns retail and office property looks like the cheapest stock on our list, with a P/FFO of around 10. But since its one-year FFO number is likely inflated due to one-time rearrangement of its property portfolio, including a spinoff, investors will have to do some digging to arrive at an estimate of “normalized” FFO.

That leaves Host Hotels and Resorts with a P/FFO of around 12. Hotels are, of course, the most economically sensitive property type, with their one-night leases that consumers and businesses slash from their budgets quickly when the economy falters. For that reason, they typically trade at lower multiples than other property types. Still, a multiple of 12 seems compelling, and Host has a good portfolio of 96 hotels with nearly 54,000 rooms encompassing upscale properties including Marriotts, Hyatts, and Westins in major U.S. cities, five Ritz-Carltons, and Le Meridien Piccadilly in London. It also has a few properties of more economy brands, and they are centrally located in cities as well.

Besides a compelling Price/FFO ratio, the next thing investors should want to know is if Host’s 4% dividend yield is safe. The firm pays a quarterly dividend is $0.20 per share, and FFO per share for Q3 2017, the last reported quarter, was $0.33 per share. A dividend soaking up less than two-thirds of FFO shouldn’t be in jeopardy. And while it is of some concern that FFO per share declined in Q3 2017 from $0.37 in Q3 2016, FFO per share held steady for the three quarters before that on a year-over-year basis.

The other stocks that have lower P/FFO ratios are either healthcare companies like Ventas (VTR) or retailers like Simon Property Group (SPG). The companies that own healthcare facilities have not grown dividends in recent years, and the retailers are under pressure from Amazon.