Tag Archives: REITs

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.

REITs: Slightly Better Than Broad U.S. Market, But Still Not Cheap

When I wrote an article on REITs for the Wall Street Journal in early 2017, I used a research report from Research Affiliates in Newport Beach, CA to argue that the asset class was overpriced and poised to deliver 0%-2% or so real returns for the next decade.

My article sparked a lot of mail and controversy. One reader reply underneath my article on the WSJ website said “Among equity REITs traded on stock exchanges there has literally never been a 10-year period in the history of REIT investing when real total returns averaged 0% per year (or worse) as [John Coumarianos’s] approach predicts.”

Another letter, which the Journal published as a reply to my article, from Brad Case of the National Association of Real Estate Investment Trusts (NAREIT) strangely had the exact same language about REITs never producing such a poor 10-year return as the letter written by someone of another name under the column on the website. Case’s formal, published letter went on to say, “The current REIT stock price discount to net asset value suggests that returns over the next 10 years may exceed inflation by around 8.15 percentage points per year on average.”

The decade isn’t up, but now, two years in, let’s see how things are going for REITs. Also, what’s the forecast today? Have things improved? After we assess recent returns, let’s go through the forecast again to see if things look any better now.

Not A Great Two Years For REITs

In 2017, two major REIT index funds – the Vanguard REIT Index fund and the iShares Cohen & Steers REIT Index ETF — produced a nearly 5% return each.  Considering that the CPI (consumer price index) was up 2.1% in 2017, that’s about a 3% real or inflation-adjusted return.

In 2018, the iShares fund delivered a 5.29% return through October, while the Vanguard fund delivered a 2.03% return through October. So far inflation is running at an estimated 2.2% for the year, according to the Minneapolis Fed. That means REIT real returns for 2018 are in the 0%-3% range, depending on which index you use. For both 2017 and 2018, we are a far cry from Case’s 8.15% real return forecast.

Start With Dividend Yield

The analysis advocated by Research Affiliates was simple. First, start with “net operating income” (NOI) or rent minus basic expenses. NOI a good indication of the cash flow a property or a collection of properties are delivering. Investors take this number and divide by the price of a property to determine what they call a “capitalization rate.” In effect, that resembles an earnings yield (earnings divided by price) of a stock. Mutual fund investors can substitute dividend yield of a REIT-dedicated fund.

For my original article, the dividend yield of most REIT index funds and ETFs was around 4%. Now it’s closer to 3%. The iShares Cohen & Steers REIT ETF yields less than 3.2% right now, while the Vanguard REIT Index fund lists a current effective yield of 3.23% and a yield adjusted for return of capital and capital gain distributions over the past two years at 2.13%.


The second component of a return forecast is a property upkeep component. Real estate requires capital – not only for the initial purchase, but also for maintaining the property. Things are always breaking and obsolescence always threatens landlords who must update kitchens, bathrooms, and other aspects of their properties. It’s true that with some property types, tenants are responsible for some upkeep and improvement, but that isn’t always the case. Research Affiliates figures 2% of the cost of the property per year, is a decent round number to use in a return forecast. Unfortunately, that wipes out most of the 3% dividend yield investors are currently pocketing.

So far, we are running at a 0 or 1% real annualized return for the next decade.

Price Change

The last component of real estate valuation and return forecasting is the most speculative. Where will properties trade in a decade? Nobody knows for sure, but Research Affiliates estimated in early 2017 that commercial property was priced 20% above its long term trend. If prices remained at that level, investors would capture the 4% yield minus the 2% annual upkeep or 2% overall. If prices reverted to trend, investors would have to subtract enough from net operating income adjusted for upkeep to bring future returns down to 1.4%.

Currently on the Research Affiliates website, the firm forecasts REITs to deliver a 2% annualized real return for the next decade. That’s about where the forecast stood at the beginning of 2017. It’s worth noting that although that’s a low return, it’s actually a better forecast than the firm has for U.S. stocks, which it thinks won’t deliver any return over inflation for the next decade.

Gut Check

It’s often useful to take multiple stabs at valuation. So, in the spirit of providing a gut check, I supplemented this dividend-upkeep-price analysis with a simple Price/FFO (funds from operations) analysis. REITs have large, unrealistic depreciation charges, rendering net income a mostly useless metric. FFO, which adjusts net income for property sales and depreciation is a more accurate cash flow metric. FFO isn’t perfect either because it doesn’t account for different debt loads of different companies and because it doesn’t account for maintenance costs, but it’s a uniform metric that almost all REITs publish.

Of the top-20 holdings of the Vanguard Real Estate Index fund VGSIX, Weyerhaeuser and CBRE didn’t publish FFO metrics. The average of the other 18 companies was 20. That’s a pretty high multiple for REITs, which are slow growth stocks.

Three Opportunities In The Retail Wasteland

It’s no secret that malls are under pressure from e-commerce and Amazon. Even strip malls anchored by supermarkets and stores like Target and WalMart are struggling as shoppers buy more necessities and staples online. But some shopping center REITs’ stocks have declined so much that they’re worth a look from investors. Three of the largest – Brixmor, KIMCO, and Weingarten are yielding 5.70% or more.

Covering Dividends & Interest Payments

First, all three companies can cover their dividends with funds from operations (FFO). FFO is an important REIT cash flow metric that’s useful for understanding dividend coverage. It adjusts net income for property sales and depreciation, the latter of which can be an unrealistic charge in real estate. It’s not perfect because some capital is required to maintain property every year, but it’s a decent start to see if companies can maintain their current dividends. Our three  companies are producing FFO that’s at least 38% higher than their current dividend payouts.

Second, none of our companies is carrying a dangerous amount of debt. Their fixed charge (bonds and preferreds) coverage ratios are all over 3x. The typical cash flow metric used to calculate coverage is EBITDA or earnings before interest, taxes, depreciation and amortization. Again, that’s imperfect because it doesn’t include maintenance capital expenditures, but at 3x or more it’s fair to say our companies don’t have unreasonable amounts of debt.

Same Property NOI Growth & Property Quality

Another important metric in real estate is if companies are experiencing same-property rent and net operating income (NOI) growth. Our companies are. Brixmor, however generated the lowest same property NOI growth for the second quarter of 2018 (the most recent available), and that may be why its stock is trading at the lowest FFO multiple and delivering the highest current yield.

One possible reason for Brixmor lagging in this category is that its sprawling property portfolio includes malls in less upscale areas. When looking at the amount of annualized base rent (ABR) each firm had from each city or metropolitan area, and Brixmor had only 24% of its rent come from Los Angeles, Houston, metropolitan New York City, Chicago, Miami, Washington, D.C., and San Francisco. By contrast, Weingarten had 34% of its rent come from those locations and KIMCO had nearly 39% of its rent come from those locations.

Additionally, Brixmor may have the least desirable top tenants. Weingarten and KIMCO count Home Depot and WholeFoods as top-10 tenants, but Brixmor doesn’t. Brixmor has more discount stores in its top-10, including Burlington and Dollar Tree.

Overall, all three companies are healthy, but KIMCO and Weingarten have a more attractive tenant lineup that make paying up for them worth it. Incidentally, this exercise also shows why investors need to be wary of advisors who say to them “I can get  you x% yield.” Higher yield usually comes with higher risks or, in this case, inferior real estate and tenants. You can have any yield you want, but you have to be cognizant of the risk associated with each yield.

Q3-Market Performance Review

Yesterday was the first day of the Fourth Quarter of 2018, so it’s a good time to assess where markets are for the year. Nobody should change their portfolios radically based on recent market moves, and, to the extent that anybody does, the long term bias should be gently adding what has dropped and trimming what has surged, keeping in mind that catching absolute tops and bottoms is difficult. But, from time to time, it can be useful to observe recent trends.

The first thing to notice about market returns through the first three quarters of 2018 is that U.S. stocks are up again. The S&P 500 Index closed the Third Quarter up 10.58% for the year, including dividends. Mid-cap stocks were up too, though less dramatically. The Russell Midcap Index gained 7.45% for the year through the Third Quarter. Small-cap stocks have gained about as much as the S&P 500, with the Russell 2000 Index up 11.51% for the year. And the Russell Megacap 50 Index also has a similar gain for the year of 11.69%.

Two Discrepancies

If U.S. stocks are having a good year, international stocks aren’t. The MSCI EAFE Index, which tracks stocks from developed countries, lost 1.43% for the year through the end of the Third Quarter. The MSCI Emerging Markets Index (MSCI EM NR) has done ever worse, shedding 7.68% for the year through the end of the quarter. Much of those losses are attributable to the dollar’s surge against foreign currencies, especially those of emerging markets. When U.S investors buy foreign stocks or a foreign stock fund, they typically get two sources of return, the stock’s return in its own market and the foreign currency’s return versus the U.S. dollar. That second return has hurt U.S. investors in foreign stocks this year, as the dollar has surged. A dollar surge also puts emerging markets under a cloud because emerging markets countries and companies borrow in U.S. dollars, making a dollar surge especially burdensome for them.

A second discrepancy is the difference in value and growth stocks. Value stocks tend to trade with lower price-earnings and price/book ratios, while growth stocks tend to trade with higher ratios precisely because of their anticipated growth in earnings and/or book value. The Russell 1000 Value Index rose a tepid 3.92% for the year, while the Russell 1000 Growth Index surged by 17.09%. the top-5 holding of the Russell 1000 Growth Index are Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Facebook (FB), and Alphabet (GOOG). The only one of the so-called “FAANG”s that it’s missing is Netflix, and the FAANG stocks have gained more than the overall market.

Bonds and REITs

Bonds, represented by the Bloomberg Barclays U.S. Aggregate Index dropped 1.6% for the year through the end of the Third Quarter. Interest rates have been rising in fits and starts. The yield on the 10-year U.S. Treasury has spiked up above 3% (where it rests now) during the year, but also fallen back at times. Bond yields move in the opposite directions of prices.

Volatility in the bond market has also likely influenced REIT returns. REITs pay out 90% of their net income as dividends in exchange for having tax-free status at the corporate level. The high dividend yield, low-growth companies often trade with some correlation to bonds. REITs (MSCI US REIT Index) tumbled in January and February of this year, the soared in March, May, and June. But in September they shed more than 2% to give them a roughly 2% year-to-date gain. That’s not terrible, but it lags the broader market’s return considerably. Large REIT companies that have declined for the year include paper and forest products company, Weyerhaeuser (WY), office landlord Boston Properties (BXP), and medical space REIT Ventas (VTR).

Judging Your Portfolio

If you have a lot of REIT exposure, that has probably been a drag on your portfolio. That’s why gunning after the highest yielding stocks is sometimes not a good idea. Additionally, if you have a lot of international stock exposure, that’s also been a drag. The discrepancy, for example between the year-to-date returns of the Vanguard Balanced Index Fund (5.6%) and an index consisting of 60% MSCI ACWI (All Country World Index) and 40% U.S. bonds (1.7%) is large.

That doesn’t mean you should exit all your international stock positions. What does badly one year can do better the next. In 2017, for example, international stocks outpaced domestic stocks, and emerging markets stocks, the dogs of this year, gained 37% versus the 22% gain of the S&P 500. Picking a single year’s winners isn’t easy.

Overall, investors should know that domestic stocks are considerably overpriced by any valuation metric one chooses to use. That doesn’t mean they can’t get more expensive, but nobody should be anticipating robust long-term returns from U.S. stocks.

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.

REITs Paying 6% Or More — The Good, Bad, And Ugly

Unscrupulous stockbrokers and advisers are always dangling yield in front of unsuspecting clients. “I can get you (fill in the blank with a percentage),” they say to yield-starved investors. But capturing current yield is one thing; buying shares of a firm that can sustain a dividend beyond the next quarter or two is something else.

I ran a screen on REITs using two factors – enterprise value/EBIT of 25 or less and a dividend yield of 6% or higher. I got 12 companies back. And EV/EBIT of 25 is quite high, which tells you something about how REITs are priced right now. Also, the screen was just the beginning of the process. The fun part is examining each company to see if dividends were sustainable and if it had any other warts such as a high debt load, a declining business, competition from Amazon, etc…

Here’s the list of the original screen followed by comments on some of the companies.

The Good

After compiling the names from the screen, I included FFO or Funds from Operations, a REIT cash flow metric, and calculated Price/FFO, a common, though imperfect, REIT valuation metric. Funds from operations or FFO is a measure of REIT cash flow calculated by adjusting net income for property sales and depreciation. A big depreciation charge runs through a REIT income statement, and it usually doesn’t correspond to economic reality. FFO isn’t perfect because some depreciation should be calculated for any property, but FFO is uniform and allows for some comparison between companies.

FFO is also useful for understanding dividend coverage. For every company on our list except for two (Gaming and Leisure Properties and The GEO Group) FFO covers the dividend. When FFO is less than the dividend it can be a sign of a dividend cut coming. Companies not covering the dividend with FFO have to hope for FFO-per-share growth or borrow to pay the dividend. Still, all the Price/FFO metrics were reasonable or downright cheap in some cases. None of the stocks on this list is outrageously expensive in my opinion.

Also, despite some tightness on dividend coverage, the companies on this list are surprisingly healthy in terms of their debt levels. None of them is in financial distress or unable to pay its interest and preferred dividends in my opinion.

The Bad And Ugly

Despite being financially stable and not inordinately expensive, the companies on this list don’t have what anyone would call outstanding, irreplaceable real estate. Buying shares in them arguably violates the old “location, location, location” rule of real estate investing with the exception of a few properties in the hotel portfolios. None of the companies own trophy office buildings in New York or San Francisco, Rodeo Drive retail space (which had some vacancies the last time I was there), or upscale apartments on the coasts where it’s hard to build. Instead the list is filled with strip mall retail space under attack from Amazon (KIMCO, Brixmor, and Tanger) hotel companies that are economically sensitive and always trade with lower valuation multiples than other property types (Hospitality Properties Trust and Sotherly), casinos under pressure from states allowing their proliferation (Gaming and Leisure Properties),  medical facilities including nursing homes (Medical Properties Trust and Sabra), and prisons (The GEO Group and CoreCivic). In other words, these are cheap, high-yielding REITs because they arguably deserve to be based on the quality of their property.


Although these companies don’t own the best property, their stocks are reasonably priced, and in most cases their dividends are sustainable. Investors who understand that REITs are stocks, not bonds, in terms of risk and volatility can own a basket from this list as a small part of an income-generating portfolio. Nobody should bet the ranch on any of these stocks or on a basket of these stocks. Investors should also understand that monitoring that basket is required – not just in terms of how the stocks are performing, but also in terms of how the businesses are performing, including debt levels, occupancy, natural disasters potentially damaging the assets, management decisions, and many other things.

We at Clarity Financial LLC, a registered investment adviser, specialize in preserving and growing investor wealth. If you are concerned about your financial future, click here to ask me a question and find out more.

Disclosure: We are long SKT in some portfolios.

Q1 2018 Review: The Virtues of Cash

A Bloomberg review of the quarter asked “Is Nowhere Safe?” The headline had a point. Both stocks and bonds declines for the First Quarter of 2018 with higher interest rates weighing on both asset classes.

The S&P 500 Index dropped 0.76% after surging around 10% from the 2017 close in January. February and March brought turbulence that eliminated early gains. Still, damage was minimal, and investors still have the opportunity to reevaluate their asset allocations without having to do so under the stress of losses.

Developed country stocks also dropped with the MSCI EAFE Index losing 1.53% for the quarter in dollar terms. Emerging markets stocks were the bright spot with the MSCI EM Index gaining 1.42% for the quarter.

Among the global sectors, information technology led the way. The sector posted a nearly 4% gain. Telecom Services and consumer staples were the losers, each posting losses of around 5%. Consumer staples usually hold up in market downturns, and it’s surprising to see them down so much. Their decline may reflect their overvaluation, as investors have piled into dividend-paying stocks that have traditionally been less volatile.

Low beta or low volatility ETFs that often hold these stocks have also captured large amounts of cash as investors have sought yield from stocks and have sought to gain stock exposure in what has traditionally been the least painful way. Investors may have pushed the prices of these stocks up so high that they are leading the downturn.

Bonds also dropped in the first quarter. The Bloomberg Barclays US Aggregate Index closed down 1.64%. The yield on the 10-Year US Treasury went from less than 2.45% to more than 2.7%, and spent considerable time in the 2.8%-2.9% range. The yield on the 2-year US Treasury went from 1.9% to more than 2.2%. So rates are rising at the same time the yield curve or difference in yield between the 2-year and 10-Year Tresuries is flattening. Rates increase typically result from bullishness on the economy, while a flat curve indicates bearishness.

Corporate bonds also declined. The iShares Investment Grade Corporate Bond ETF (LQD) lost 2.90%, as investors sought higher yields for accepting credit risk. The yield spread on A-rated corporate bonds increased from less than 75 basis points to more than 95 basis points during the quarter.

High yield spreads also increased, but less dramatically, from less than 3.6 percentage points to more than 3.7 percentage points.

However, one of the largest floating rate bond fund, the $11 billion Fidelity Floating Rate High Income Fund (FFRHX), posted a 1.17% gain. Floating rate loans or bank loans are first lien loans of corporations whose credit is generally rated below investment grade. Investors in them are first in line in case of trouble, and they offer coupons that float with Libor (London Interbank Offer Rate), so they provide a measure of inflation protection. They often do well in rising rate environment, but excessively rising rates can spell trouble for them, as the companies behind them have limits on what they can pay.

The bond market is also sending some mixed signals. Rates are rising, and investors anticipate hikes by the Federal Reserve, but the yield curve is also flattening. And a flat or inverted curve has a good record of forecasting recession.

Impending recession or not, volatility has returned after a long absence in 2017 when every month saw a gain in stocks (the first time in history that happened). Perhaps a time of reevaluation has arrived for investors, as they rediscover the virtues of holding some cash in an environment where almost everything else is down.