Showing posts with label REIT. Show all posts
Showing posts with label REIT. Show all posts

Tuesday, May 21, 2013

Are we in a REIT bubble?

Low rates have made investors hungry for yield. As a result, traditional higher yielding investments such as utilities and real estate investment trusts are getting bid up by investors. If this madness continues, the possibility that many investors will get burned down the road increases exponentially.

Real estate investment trusts (REIT) are required by law to distribute at least 90% of their taxable income to shareholders. The REITs I own typically distribute somewhere close to 80 – 90% of their Funds From Operations (FFO) to shareholders. FFO is a commonly accepted tool to measure profitability for REITs, and is a more accurate indicator than earnings per share. FFO adds back for certain non-cash items such as depreciation, in order to determine the amount of profits that are available. Most REITs that I follow tend to have a FFO payout ratio between 80% - 90%. I own shares of Realty Income (O), Omega Healthcare Investors (OHI), Digital Realty Trust (DLR) and American Realty Capital Properties (ARCP).

As a result, I find it safe to assume that for REITs a low yield usually shows a stock that is overvalued, whereas a higher yield usually shows an attractively valued stock. I define a low yielding REIT in the current environment as a REITs that yields somewhere close to 4% or lower. A higher yielding REIT is one that yields at least 5%. This generalization only includes REITs whose primary business is to own physical real estate.

Some investors believe that current lower than historical yields on REITs are justified by record low interest rates. For example, yields on US 30 year Treasuries are close to 3%. These investors believe that today is the new normal, as low interest rates justify REIT valuations. The mentality that the this time it’s different might be costly to your portfolio.

Investors who purchase a REIT yielding 3% are generally receiving 80 – 90% of cashflows. In contrast, an investor in a typical dividend champion such as Procter & Gamble (PG) or Johnson & Johnson (JNJ) who gets a 3% yield today also gets a 5%- 6% earnings yield.


Even in the current environment however, there are reasonably priced opportunities for investors who are on the lookout for bargains. I have been able to use the weakness in Digital Realty Trust (DLR) to acquire a decent position in the stock. In addition, the following low yielding REITs seem to have very low FFO payout ratios:


Low yields could be justified by the expectation for higher distribution growth down the road. If your REIT slashed distributions to the bone during the 2007 – 2009 recession, they could not yield much today, but could have the potential to yield twice as much in a few years. In addition, REITs in different sectors have different yields. A healthcare REIT that might be overvalued at a yield of 4%, even though a 4% yield would be considered fair for other types of REITs.

Many REITs are able to sell ten year bonds at yields as low as 3-4%. They have particularly benefited from falling interest rates in the past five years. If you re-finance debt that used to cost 6%-7% with debt that costs half of that, the FFO bottom line will be instantly improved. However, the problem that REITs might get to in a decade is if interest rates are substantially higher than interest rates today. Many investors believe that rates will go up, which could be costly to real estate trusts that want to refinance debt a decade from now.

Another risk that we might see is if REITs bid up assets they purchase to yield below 6-7 percent. If the low cost of capital drives REITs to compete aggressively for new assets to purchase, without any regards to quality or future possibilities, this could spell disaster for REIT investors. If rates increase over next decade, this could result in reductions in FFO. This could mean trouble for REIT investors one decade down the road - low property returns relative to high interest rates in 10 years. The mitigating factor here is that interest rates might increase gradually, once they start increasing in 2- 3 years. As a result, REITs will have plenty of time to adjust their debt costs. In addition, many REITs would be able to raise rents if inflation increases alongside with interest rates.

In my personal portfolio, I have replaced National Retail Properties (NNN) with American Realty Capital Properties (ARCP). Check my analysis of National Retail Properties.  I used the fact that investors pushed yields on National Retail Properties below 4% to exit my position. I did not like the slow growth in FFO/share, as well as the slow growth in distributions. The slow growth over the past decade did not justify current valuations. Buying National Retail Properties was justified up until 2010, after which I simply held on and cashed the dividends along the way. In all reality, this REIT could probably go as high as yielding 3%, which translates to $52/share.

Based on FFO/share of $1.77 and annualized dividend of $1.58/share, the forward FFO payout for National Retail Properties comes out to roughly 89%, which is rather high. For American Realty Capital Properties, FFO is expected to be in the range of 91 - 95 cents/share in 2013, and $1.06 - $1.10 share by 2014. The annual dividend is 91 cents/share, which could make up for a forward FFO Payout of 95.80 - 100% in 2013. It looks high, but in reality the company just recently completed the acquisition of American Realty Capital Trust III, which will probably distort how financials look like this year.

I liked the fact that American Realty Capital Properties (ARCP) is a REIT that is trying to make strategic accretive acquisitions in order to expand and increase FFO/share. I view ARCP as a company that could potentially become the next Realty Income (O). Since this REIT has only been publicly traded for less than 2 years, it trades at a premium to more established REITs such as Realty Income (O) and National Retail Properties (NNN).

I also put Realty Income (O) on my watchlist for potential trimming of my position there. I believe that Realty Income is a fine buy at 43/share, which translates to a 5% yield. However, if it trades above 54 it is richly valued. At current valuations, I will consider selling some at the $62-$72/share zone. This is equivalent to a yield of 3% - 3.50%. In the meantime, I will be sitting tight and reinvesting my dividends in other stocks.

I do like the fact that the REIT has managed to maintain and grow distributions. I also like the diversified nature of the tenant base, and stability and quality of cash flows. I believe that Realty Income is the Coca-Cola of REITs, but at yields below 4% it looks overvalued. At yields below 3.50% I am going to start trimming my position in it. My last purchase was in 2011, when my entry yield of 5% made me afraid that I am purchasing at the top. The REIT has managed to boost FFO substantially since then, which is why a valuation in the low 40s is fair.

Full Disclosure: Long O, DLR, ARCP, OHI

Relevant Articles:

National Retail Properties (NNN) Dividend Stock Analysis
Five Things to Look For in a Real Estate Investment Trusts
The Case for owning Digital Realty Trust (DLR): When Hedge Funds Don't Know What They Are Talking About
Realty Income (O) – The Monthly Dividend Company

Monday, May 13, 2013

The Case for owning Digital Realty Trust (DLR): When Hedge Funds Don’t Know What they are talking about

On Thursday, shares of Digital Realty Trust (DLR) fell sharply after hedge fund manager Jon Jacobson discussed their short opinion on the company at an Ira Sohn Conference. I did not attend the conference, and all of my information about the short thesis is derived from outside third-party sources. I have already analyzed Digital Realty Trust (DLR) a few weeks ago, and liked the growth in FFO/share to purchase some shares in the Real Estate Investment Trust (REIT). In this article I will try to rebuff the arguments from the short seller. I am going to use publicly available information in the company’s most recently posted Annual Report for 2012 available on the SEC website. If hedge funds learned about this secret weapon available only to retail investors, they would probably make a killing in the markets.

The thesis behind the short is as followed:

1) The company taps into the capital markets to fund its dividend

This is the point where I realized that this short seller does not know what he is talking about. A real estate investment trust is required by law to distribute over 90% of its earnings to shareholders. In order for REITs to grow, they issue shares and bonds in the markets. I discussed this in my article on the five things to look for in a REIT.

In 2012, the company invested 1.56 billion in properties. The company also put $845 million in Improvements to and advances for investments in real estate.


The company borrowed almost $1 billion and raised $1.04 billion by issuing stock. Given the low cost of dividends at 4.5% - 5% and the low cost of debt at less than 4.50%, these acquisitions should be accretive to existing shareholders almost immediately I also like the conservative capital structure of Digital Realty, where almost two-thirds of investing activity has been financed by equity. That way, when interest rates increase in the future and the real estate investment trust has to refinance those obligations, they would not suffer as much as other companies.
When I look at the income statement of Digital Realty Trust, I see a profit of $171.662 million in 2012. There is a charge of $380 million for maintenance, and also $382 million for depreciation and amortization. These are separate charges. The REIT paid $373 million in dividends.


When you add back depreciation expense and a few minor adjustments, one can see where the Funds from Operation (FFO) is calculated. One can see that the REIT has ample room to pay the dividend. If nothing else, they also have room to increase it over time.

2) Annual cost of maintenance Capex is 40% of revenues

Please refer to last paragraph, that showed a breakdown of revenues and expenses, as well as net income to FFO reconciliation. Digital Realty manages to earn $171 million after subtracting regular depreciation and regular maintenance of approximately $380 million each. In calculating FFO, the REIT adds back only depreciation, to come up with FFO of over $550 million. This makes annual distributions of $373 million paid in 2012 very sustainable. I am not even sure why the hedge fund manager would even bring maintenance expenses, other than as a tactic to scare the weak hands holding Digital Realty Trust stock. Smart dividend investors however know that a high yield dividend growth stock should not be sold, especially when fundamentals are great and business is growing. There are few companies that both yield a lot, and also manage to grow distributions quickly. These are the types of stocks to hold on to.

3) There are no barriers to entry in the business and there is increased competitions

This is a subjective evaluation, that is often prone to investor biases. When a bullish investor who has not done a lot of research on a company tries to justify their position in a stock, they typically claim that a stock has solid competitive advantages. (Of course some investors are right for the likes of Coca-Cola (KO) for example). Similarly, an investor who has not done a lot of original research when making a short sale simply claims that a company does not have any competitive advantages.

I am simply going to put the advantages identified by Digital Realty in their latest 10-K report:

  • High-Quality Portfolio that is Difficult to Replicate.
  • Presence in Key Markets
  • Proven Experience Executing New Leases
  • Demonstrated Acquisition Capability.
  • Flexible Datacenter Solutions.
  • Differentiating Development Advantages
  • Diverse Tenant Base Across a Variety of Industry Sectors
  • Experienced and Committed Management Team and Organization.

You can read more about those advantages in the 10-K report on page 3.

If only the hedge fund manager had taken the time to read this report through page three, I would not have had to spend my Sunday writing articles, instead of enjoying the nice weather.

The only factor that I found interesting in the short case is the fact about competition. I think that this is the only item that would make me lose sleep at night as an investor. If technology companies decide to buy and operate their own data centers, Digital Realty would lose out. The REIT could also lose out from competitors stealing away business. I find it difficult to believe that a large organization would move their servers every year, simply to save on rent. Anything that involves information technology change in most organization usually is resisted because of the hidden costs of transferring important corporate information. Luckily, the REIT signs long-term leases with its tenants. As of December 31, 2012, their original average lease term was approximately 14 years, with an average of approximately seven years remaining.

If everyone moves to the cloud, Digital Realty might not lose too much, since the cloud is still housed on servers somewhere. Interestingly, one of the companies that was cited as a competitor to Digital Realty, Amazon.com (AMZN) is actually a tenant of the REIT. Digital Realty Trust earns $14 million/year from this tenant.

4)The stock price should be $20/share

I am not in the business of forecasting stock prices. A stock price can fall by 50% or rise by 50% easily from here. If the economy experiences another event like the 2007 – 2009 financial crisis, shares of this REIT could easily fall 50% from here. However, as long as the fundamentals are sound, a stock should be a hold, with additions to existing positions made at attractive valuations. I believe that Digital Realty Trust has been wisely allocating new capital, and as a result has been able to grow FFO/share and the dividend per share nicely over the past seven years. Investing in stocks is risky, and those who cannot sit through a 50% decline in share prices should invest in CD’s instead. If Digital Realty can fall to $62.40/share, which is equivalent to a 5% yield, I would add to my position in the REIT.

Selling a stock short is very expensive. When someone is short a stock, they need to borrow it from a broker, and have to pay an interest rate to the individual who they borrowed the stock from. If a stock is difficult to borrow, a short seller might end up paying a double digit interest rate. In the case of Groupon in 2011, a short seller had to pay an annual interest amount equivalent to 100%. That meant that even if the company went bankrupt in one year, a short seller would still lose money. In addition, when you are short a stock, you are also charged an amount equal to the dividend payment for the security. If we assume a short interest rate of 5%, and a dividend yield of 5% , this would means that this short position is really expensive for the Hedge Fund manager. In addition, the danger behind short selling is that theoretically their risk is unlimited. For example, if Digital Realty fell to zero, all I am going to lose is the money I invested. However, if Digital Realty increased by more than 100%, a short seller would lose more than the money they invested initially.

Because selling stock short is so expensive, the short call by this hedge fund manager looks more like a last attempt to cover their position at a minimum loss. This cry for help from the Hedge Fund manager makes me very bullish on Digital Realty. If it drops to $62.40/share, I would be adding to my position in the stock.

Full Disclosure: Long DLR, KO

Relevant Articles:

High Dividend Growth REITs: Digital Realty Trust (DLR)
Five Things to Look For in a Real Estate Investment Trust
Spring Cleaning My Income Portfolio, Part II
Four High Yield REITs for current income


Monday, April 8, 2013

Five Things to Look For in a Real Estate Investment Trust (REIT)

Real estate investment trusts (REITS) represent a unique opportunity for dividend growth investors. They provide exposure to real estate, without the hassle of direct ownership. REITs are structured as trusts for tax reasons, and as a result, they do not pay federal income taxes at the entity level. The dividends they pay to shareholders are typically treated as ordinary income, and do not qualify for the preferential rate on qualified dividends. However, because income is taxed only at the shareholder level, there is more money for distributions to shareholders. In addition, a portion of your typical REIT distributions is non-taxable and it is treated as return of capital for tax purposes. This decreases shareholder's basis in the stock. The return of capital portion is caused by depreciation expense. By law, Real Estate Investment Trusts have to distribute at least 90% of income to shareholders, in order to maintain their preferential tax status.

There are five factors I analyze at a REIT, before putting my money to work in the sector. I used three REITs I own in this exercise - Realty Income (O), Digital Realty Trust (DLR) and Omega Healthcare Investors (OHI):

Funds from Operations (FFO)

Earnings per share are not an adequate way to look at REITs. Instead, analysts use Funds from Operations (FFO). FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items. I like to look at the trends in Funds from Operations per share over the past five or ten years, in order to see if there is any fuel for dividend growth. The slow growth in FFO led me to sell my position in Universal Healthcare Realty Trust (UHT) in March.

I usually prefer to see growth in FFO/share over the past five and ten years. REITs are pass-through entities, which means they return almost all of their free cashflow to shareholders. As a result, they sell shares and bonds each year in order to fund their expansion projects. These projects usually cause an increase in total revenues and FFO, but because of the dilution to existing shareholders, I want to see growth in FFO/share. This shows me that new projects are accretive to the FFO for all the shareholders. In the table below, I have placed the trends in FFO/share for three REITs I own:


FFO Payout

For REITs, I use FFO Payout Ratio, which is calculated by dividing the dividend payment over the FFO/share. I usually prefer to see a REIT whose payout ratio is below 90%. While REIT revenues are typically stable, I want to have some margin of safety in the form of a lower FFO Payout Ratio. Ideally, it would be flat or trending down over time. An FFO ratio above 90% couple with slow growth in FFO/share could jeopardize distribution growth. In the table below, I have summarized the FFO payout trends in three REITs I own:

Occupancy and Tenant Diversification

Diversification is an important thing to have in any portfolio, as it offers some level of protection to the company when something unexpected happens. I usually scan through the list of top tenants, and make sure that they do not account for an extremely large portion of revenues. I define extremely large as somewhere above the range of 50% - 66% of revenues. In addition, I also want to see stable and hopefully growing occupancy percentages over time. The occupancy ratios vary somewhat for different REITs. For example, Realty Income has an occupancy ratio of 97%, Digital Realty Trust has an occupancy of almost 94%, whereas Omega Healthcare Investors has an occupancy rate of 84%. The top ten tenants account for 64% of Omega Healthcare Investors revenues, but 35% for Digital Realty's revenues. The top ten tenants of Realty Income account for 37% of revenues.

Plans for growth

The fuel behind future distributions growth is growth in FFO/share. The growth in FFO/share is one of the factors that will determine whether distributions grow above the rate of inflation, stay flat or even worse - get cut or eliminated. I usually like to see a company that can manage to deploy capital raised in the public markets into projects that have attractive rates of return, have signed long-term leases and have escalation clauses that would allow them to charge higher rents over time. In terms of growth, Digital Realty Trust, Omega Healthcare and Realty Income all rely on strategic acquisitions of quality properties. Realty Income went one step further in 2012, when in completed the acquisition of American Realty Capital Trust. As a result, it was able to boost monthly distributions by 19.20%.

Debt, Cost of Capital and Risks

Understanding leverage is an important part of understanding REITs and risks behind REITs. Most Real Estate Investment Trusts pay for new projects either by issuing stock or issuing debt. If they issue too much debt and the projects do not work out as expected, the interest costs might eat into the profit. If it is difficult to renew the debt, or it gets more expensive, this could eat into the profit as well. This is why it is important to review the maturity schedules for the REITs you are interested in analyzing. Currently, issuing debt is very cheap, which should bode well for various projects. When the debt has to be refinanced in ten years however, it would likely cost much more to renew it. Realty Income, Digital Realty Trust and Omega Healthcare Investors do not seem to have problem accessing capital markets, nor do they have steep amounts of debt maturing soon. Omega Healthcare sold 12 year bonds in 2012 at 5.875%, while Realty Income managed to sell $450 million notes maturing in 10 years at 3.25%. Realty Income also sold 5 year notes, which yielded 2%. Digital Realty Trust sold 12 year, 400 million British Pound notes at 4.25%. Digital Realty, also managed to sell 300 million in ten year notes at 3.625%.

Dividend Growth

The table below shows the dividend growth for Realty Income, Digital Realty Trust and Omega Healthcare Investors.

I prefer to look for consistent dividend growth over time. A long streak of dividend increases for at least ten years is important. A company that manages to maximize existing investment opportunities for the benefit of growing distributions to shareholders is the right company for my money. Although dividend cuts in the past cause a red flag, if the company has managed to build a ten year streak of dividend increases, and has FFO growth coupled with adequate levels of debt, I would take a chance on it.

Relevant Articles:

- High Dividend Growth REITs: Digital Realty Trust (DLR)
- Realty Income (O) – The Monthly Dividend Company
- Three High Yielding Dividend Machines Boosting Distributions
- Four High Yield REITs for current income
- National Retail Properties (NNN) Dividend Stock Analysis
- Spring Cleaning My Income Portfolio, Part II

Thursday, April 4, 2013

High Dividend Growth REITs: Digital Realty Trust (DLR)

Digital Realty Trust, Inc. (DLR), a real estate investment trust (REIT), through its controlling interest in Digital Realty Trust, L.P., engages in the ownership, acquisition, development, redevelopment, and management of technology-related real estate. It focuses on strategically located properties containing applications and operations critical to the day-to-day operations of technology industry tenants and corporate enterprise data center users, including the information technology departments of Fortune 1000 companies, and financial services companies. I recently initiated a position in Digital Realty Trust, after selling my position in United Healthcare Realty Trust (UHT).

Digital Realty Trust went public in 2004 and has been increasing dividends for eight consecutive years. In less than two years, the company will be able to join the list of dividend achievers.

The company’s top ten tenants account for 35% of revenues. The largest tenant is CenturyLink (CTL), at 9%. Tenant diversification is important; in order to reduce the impact on revenues if they broke the lease and the property had to be leased to a new prospective client. The REIT has an average original lease term of 13.60 years, and usually has an annual 2.50% - 3% cash rent increase on existing leases. Furthermore tenants are usually the ones responsible for power costs.

The industries that Digital Realty serves include IT and Telecom Providers, as well as Financial and Corporate Service. In addition, this real estate investment trust also derives a good amount of revenues from European and Asia-Pacific operations, which together account for 21% of rents.

Approximately 39% of gross rent is under Triple Net Leases, where the tenant spends a considerable amount of capital in data center infrastructure. This reduces the risk of breaking the lease by the customer. The beauty of triple net leases is that the tenant is the one who maintains the building.

Approximately half of the revenues are derived from modified gross leases, where the REIT makes the capital investment in infrastructure. These offer a fully commissioned, flexible data center solution with dedicated electrical and mechanical infrastructure. Given the fact that technology changes fast, the risk with this revenue stream is that the company might have to make substantial capital investment to meet the power and cooling requirements of today’s advanced data centers, or may no longer be suitable for this use.

One key metric for real estate investment trusts is their occupancy ratio. An asset that is not leased is not generating any money and is costing capital and maintenance. Generally, it is important that companies are as close to maximum occupancy as possible. Digital Realty has managed to maintain occupancy between 94 and 95% over the past five years, which is impressive because it made a large amount of property acquisitions over the period, without sacrificing quality. In addition, the company has been able to renew 82% to 90% of leases that expired in 2012.

Since 2009 however, cap rates have been declining and are reaching 7.60%, which is still not bad. If the company makes large acquisitions at decreasing cap rates however, future growth might not be as robust. However, with record low interest rates, the company has been able to tap debt markets at 3.625% to 4.25% for 10 and 12 year notes.

Digital Realty Trust has managed to increase FFO from $1.37/share in 2005 to $4.46/share by 2012.


At the same time, distributions have grown from $1/share in 2005 to $2.92 in 2012.

The company’s policy is to pay at least 100% of taxable income but no more than 90% of FFO. I find that there is adequate margin of safety in distributions, as seen through the trends in the FFO/payout ratio.

Future FFO growth would be fueled by acquisitions made at attractive cap rates, while maintaining portfolio occupancy levels. The trust tends to obtain capital mostly through common share offerings. The low interest rates could offer a cheaper way to obtain capital for further expansion, that could be more beneficial to current shareholders. Given the current conservative capital structure, I see room for increasing leverage at fixed rates.

Currently I find Digital Realty Trust to be attractively priced an 15 times FFO and yielding a very safe 4.70%.

Full Disclosure: Long DLR

Relevant Articles:

Spring Cleaning My Income Portfolio, Part II
Margin of Safety in Dividends
Four High Yield REITs for current income
National Retail Properties (NNN) Dividend Stock Analysis
Dividend Achievers Offer Income Growth and Capital Appreciation Potential



Thursday, March 28, 2013

Spring Cleaning My Income Portfolio, Part II

As part of my dividend strategy, I invest in companies that grow distributions every year. I do like to see companies whose dividend growth at least matches the rate of inflation. For such companies, the yield better be much higher than my minimum requirement of 2.50% however. Otherwise, allocating funds to these securities might not be the most optimal allocation of my money. I do follow a tiered approach to portfolio management, where I own shares in companies with different yield and growth characteristics, which together fusion into a portfolio whose annual dividend growth is expected to be around 6%.

A few months ago, I started reassessing several of the holdings I held in my portfolio. In general, companies that slowed down on their distributions increases since the time of my purchase looked like excellent candidates for review. Currently, there is a very high amount of yield chasing going on by income starved retirees. In addition general stock prices are nearing all-time-highs. It looks like now is the perfect time to dispose of companies with high yields and very slow distributions growth.

One company whose stock I recently sold was Universal Health Realty Income Trust (UHT). This REIT invests in health care and human service related facilities, including acute care hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers, and medical office buildings. Universal Health Realty Income Trust is also a dividend champion, which has managed to boost distributions for 26 years in a row. The distributions were not growing very quickly however, but the stock had increased from my purchase price in the mid 30’s from several years ago. In my previous analysis of the stock, I mentioned that half of the company’s revenues are generated from a related party, which is a little concerning. With current yields around 4.30%, the REIT looked overvalued relative to other REITs. The five year dividend growth was 1.40%/annually. I researched a few REITs, and decided to equally reinvest the sale proceeds in two other trusts: Digital Realty (DLR) and Omega Healthcare (OHI).

Digital Realty Trust (DLR) engages in the ownership, acquisition, development, redevelopment, and management of technology-related real estate. I liked the fact that the company was focused on growing FFO, and also growing dividends to shareholders. The company is in expansionary mode, which should bode well for FFO/share over time, particularly given low interest rate costs on intermediate-term bonds. I also liked the fact that there is tenant diversification, which also spans across several continents. The top 10 tenants are responsible for 35% of revenues. The occupancy rate ranged between 94% and 95%, which is pretty impressive. This REIT went public in 2005, and has raised distributions every year since that event. The five year dividend growth is 20.60%/annually. Digital Realty Trust currently yields 4.70%.

Omega Healthcare Investors (OHI) invests in healthcare facilities, principally long-term healthcare facilities in the United States. The company had managed to boost distributions since 2003, and will soon join the ranks of dividend achievers. Over the past five years FFO/share has increased from $1.30 in 2008 to $2.06 in 2012. I also liked the company’s plans to expand FFO/share through new investments. One thing that worried me about Omega Healthcare Investors was the dividend cut and subsequent elimination in 2000 – 2001. The dividend was not reinstated until 2003. It takes a lot to reduce my fears of dividend cuts, especially if it has happened before. After reviewing occupancy trends, FFO payout of 87.40%, planned and past investments in properties, in addition to the debt profile of the REIT, I do not think that distributions are at risk. Occupancy is around 84%, which is an increase over the 80% occupancy in 2001. The top ten tenants generate 64% of revenues. And there isn’t any significant debt maturing until 2020, although there is $102 million in debt that needs to be paid in 2015. The five year dividend growth is 9.40%/annually. Omega Healthcare Investors currently yields 6.20%.

I have already analyzed Omega Healthcare Investors and Digital Realty Trust prior to my transactions. I plan to post these more detailed analyzes for readers to enjoy in a few weeks.

Full Disclosure: Long OHI and DLR

Relevant Articles:

Universal Health Realty Income Trust (UHT) Dividend Stock Analysis
Four High Yield REITs for current income
Dividend Champions - The Best List for Dividend Investors
My Dividend Retirement Plan
Three Dividend Strategies to pick from

Friday, July 8, 2011

Realty Income (O) Dividend Stock Analysis

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The company leases its retail properties primarily to regional and national retail chain store operators. Realty Income is a real estate investment trust widely known among its investors as the monthly dividend company. The company is a dividend achiever, which has increased its dividend for 16 years in a row by raising its monthly distributions several times per year.

Over the past decade this dividend growth stock has delivered a total return of 15% per annum to its shareholders.

Realty Income owned 2496 retail properties at the end of 2010. The company’s properties which are leased by 122 retail and other consumer businesses in 32 industries are located in 49 states. Most new properties acquired are under long term leases (15-20 years) with tenants from a variety of industries and geographic location. The average remaining lease life was 11.4 years in 2010. Tenants are typically responsible for monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, occupants are also responsible for future rent increases based on increases in the consumer price index, fixed increases or, to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level. Due to the stability of company's revenue streams and above average yield, the company might be a good pick for investors who are seeking current retirement income.

As a Real Estate Investment trust, the company has to distribute almost all of its net income to shareholders. An important metric for evaluating REITs is Funds from operations (FFO), which stood at $1.83/share in 2010. Realty Income distributed $1.722 /share in 2010. FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items. The company doesn’t have any debt maturing until 2013 and also has an unused credit facility worth $425 million.

Over the past decade FFO has increased by 3.90% on average.

Over the past decade distributions have increased by 4.90% per annum. A 5% annual gowth in distributions translates into dividends doubling every 14 years. In 2010 the company has raised distributions by 0.90%.

The FFO payout ratio has increased to 94.10% in 2010, which is higher than the range over the past decade. In addition, FFO payout ratio of over 90% is not very sustainable for a real estate investment trust.

The main risk for the company is if occupancy rate decreases. About 3% - 4% of the company’s properties face lease expirations each year, which is why it has to be able to find new tenants. The company could try to sell properties which are not occupied currently however, which might be problematic in the current market for real estate. The portfolio occupancy rate for Realty Income hit a record low of 96.60% in 2010, which was down slightly from 96.80% in 2009. Another negative for the company is the fact that it typically expands its operations through additional sales of its common stock, which dilutes the stakes of existing stockholders.

Realty Income acquired 186 new properties in 2010 for $713.5 million dollars. The average lease term was 15.70 years and the initial weighted average lease rate was 7.90%. The company’s strategy is to acquire existing seasoned properties, which are already profitable and where profits far exceed the rent the retailer pays to Realty Income. This characteristic makes it more likely for the retailer to renew their lease after the 15 -20 year term is up. In addition to that, the company is spending a lot of time, effort and research to uncover new areas of investment which would allow the company to increase FFO and dividends.

Realty Income has also acquired 13 properties so far in 2011 for $18.40 million and also has signed definitive purchase agreements to acquire 33 additional properties for $544 million. The tenants of these properties include Caterpillar, FedEx, International Paper, Walgreen Co, Cinemark, T-Mobile, Coca Cola Enterprises and others.

The company owns and actively manages a diverse mix of properties, which provide a stable and dependable income stream for the company’s shareholders. Realty Income currently yields 5.10% and has raised distributions and FFO’s for over 16 years in a row. I believe that Realty Income is a good addition to any dividend growth portfolio, since it provides growing income and also provides diversification into commercial real estate.

Full disclosure: Long O


Relevant Articles:

Monday, June 28, 2010

Four High Yield REITs for current income

One asset class that dividend investors could use in order to diversify their portfolios is real estate. The sector includes rental real estate on residential buildings, offices, malls etc. Owning a piece of rental real estate outright however comes with headaches, such as dealing with tenants and not being properly diversified. In order to avoid managing buildings and finding tenants, investors could use real estate investment trusts (REITs).

Real estate investment trusts own different types of real estate, and they offer instant liquidity to investors, since most are publicly traded. In addition to that REITs are required to distribute almost all of their earnings back to shareholders. As a result REITs are not taxed at the corporate level, but distributions from earnings are typically taxed as ordinary income. The rest of distributions from REITs are typically treated as returns of capital, which reduce your basis and would be taxable as a capital gain if you sell your shares.

Real Estate Investment Trusts offer instant diversification to investors, as most of them typically own hundreds of properties across many states. In addition to that, since they distribute all of their earnings to shareholders, their yields are typically much higher than yields on stocks. An important metric for evaluating REITs is Funds from operations (FFO). FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items.

Most REITs have rather stable revenues and as a result are able to maintain and even consistently raise distributions over time. I have highlighted four trusts for further research:

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The company leases its retail properties primarily to regional and national retail chain store operators. Realty Income is widely known among its investors as the monthly dividend company. The company is a dividend achiever, which has increased its dividend for 15 years in a row by raising its monthly distributions several times per year. (analysis)

Universal Health Realty Income Trust (UHT) operates as a real estate investment trust (REIT) in the United States. The company invests in health care and human service related facilities, including acute care hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers, and medical office buildings. The company is a dividend achiever and has raised distributions for 22 consecutive years. (analysis)

Health Care Property Investors, Inc. (HCP) operates as a real estate investment trust in the United States. The company invests in health care-related properties and provides mortgage financing on health care facilities. This dividend achiever has raised distributions for 24 consecutive years. (analysis)

National Retail Properties, Inc. (NNN) is a publicly owned equity real estate investment trust. The firm acquires, owns, manages, and develops retail properties in the United States. It provides complete turn-key and built-to-suit development services including market analysis, site selection and acquisition, entitlements, permitting, and construction management. The firm also focuses on purchasing and financing net-leased retail properties. The company is a dividend achiever as well as a component of the S&P 1500 index. It has been increasing its dividends for the past 20 consecutive years. (analysis)

While I generally find these companies attractive, each one has its own risks. Realty Income (O) has slowed the growth in distributions, and its FFO payout ratio is above 90%. In addition to that the rate of vacancies there has increased over the past few years, as the number of assets under management has increased.

National Retail Properties (NNN) has not raised distributions since 2008. The company does have a lower vacancy rate than Realty Income and in addition to that has a much lower FFO payout ratio. If the company doesn’t raise distributions by the end of 2010, it would lose its dividend achiever status.

Fifty-one percent of Universal Health Realty Income's revenues are derived from leases to Universal Health Services. UHT’s advisor is a subsidiary of UHS, and all officers of Universal Health Realty are employees of UHS, which could create conflicts of interest.

One warning statistic for Health Care Property Investors, Inc. (HCP) is the fact that average occupancy percentage for Senior Housing has dropped from 95% in 2005 to 86% in 2009. This occupancy ratio represents occupancy and unit/bed amounts as reported by the respective tenants or operators. Certain operators in HCP Inc’s hospital portfolio are not required under their respective leases to provide operational data however. The company’s focus on senior living facilities should benefit from increasing demand by retiring baby boomers. There will be a significant increase in the number of people over the age of 65 in the US over the next decade, which would be beneficial to overall healthcare facilities.

Overall, I like the stable income streams generated by real estate investment trusts. I believe that getting exposure to real estate through REITs could not only help in diversifying your income portfolio, but also boost your current yield. In addition to that most REITs also grow distributions, which provides some hedge against inflation.

Full Disclosure: Long O, NNN, UHT

Relevant Articles:

- Realty Income (O) Dividend Stock Analysis
- National Retail Properties (NNN) Dividend Stock Analysis
- Universal Health Realty Income Trust (UHT) Dividend Stock Analysis
- Health Care Property Investors, Inc. (HCP) Dividend Stock Analysis

Friday, April 16, 2010

Health Care Property Investors, Inc. (HCP) Dividend Stock Analysis

Health Care Property Investors, Inc. (HCP) operates as a real estate investment trust in the United States. The company invests in health care-related properties and provides mortgage financing on health care facilities. This dividend achiever has raised distributions for 24 consecutive years.

Over the past decade the stock has delivered a total return of 18.20% per annum to its shareholders.

As a Real Estate Investment trust, the company has to distribute almost all of its net income to shareholders. An important metric for evaluating REITs is Funds from operations (FFO). Over the past decade FFO has increased by 3% on average. The fund has a diversified portfolio of healthcare properties by tenants, type of asset or geography. The major tenants include Sunrise Senior Living, Brookdale Senior Living, HCA, Tenet Healthcare, HCR ManorCare, Covenant Care In addition to that the trust has approximately 14% of total assets invested in debt issued by high-quality healthcare operators, secured by their real estate, rather than in the real estate itself.

The company’s focus on senior living facilities should benefit from increasing demand by retiring baby boomers. There will be a significant increase in the number of people over the age of 65 in the US over the next decade, which would be beneficial to overall healthcare facilities.
The company’s assets produce a relatively stable stream of income, which is predictable and resilient in times of recessions. There won’t be much growth however asides from general rate increases on its leases, unless management starts acquiring more properties. The trust routinely disposes or acquires properties in order to enhance shareholder value.
One warning statistic is the fact that average occupancy percentage for Senior Housing has dropped from 95% in 2005 to 86% in 2009. This occupancy ratio represents occupancy and unit/bed amounts as reported by the respective tenants or operators. Certain operators in HCP Inc’s hospital portfolio are not required under their respective leases to provide operational data however

In terms of lease expirations, only Medical Office properties face a steep expirations cycle of leases until 2014. For Senior Housing segment, there aren’t any major lease expirations until 2016.

The company doesn’t face any major debt maturities until 2013, when it has a total of $1.225 billion in Mortgage debt and senior unsecured notes maturing.

Analysts expect FFO to reach $2.15 and $2.24 for 2010 and 2011 respectively. HCP Inc’s leases often provide for either fixed increases in base rents or indexed escalators, based on the Consumer Price Index or other measures, and/or additional rent based on increases in the tenants’ operating revenues. Substantially all of their senior housing, life science, and skilled nursing and hospital leases require the operator or tenant to pay all of the property operating costs or reimburse us for all such costs.

Over the past decade distributions have increased by 2.50% per annum. A 2.5% annual growth in distributions translates into dividends doubling every 29 years. In 2009 the company raised quarterly distributions by 1.00%.

As a Real Estate Investment trust HCP, Inc. must make distributions to its stockholders aggregating annually at least 90% of its REIT taxable income, excluding net capital gains. The FFO payout ratio is at 86%, which was the first increase in this indicator since it exceeded 100% in 2003. Overall a lower FFO payout is preferable, as it minimizes the effect of short term fluctuations in rental incomes on the distribution rate.

Overall I find HCP Inc an attractive company for investment, with a business model that generates stable income streams in the healthcare field. I like the low Price/FFO ratio of 15, which is one of the lowest in the past decade. I would not expect much growth in funds from operations and distributions above the rate of inflation however. I own two Real Estate Investment trusts dealing with retail properties on a triple net lease terms, so adding a healthcare related REIT would add to diversification in my portfolio.

I plan on adding a small position in HCP Inc. on dips over the next month. My ideal starter yield however would be 6%, indicating an entry price of $31 however. I would not settle for a current yield of less than 5% on this investment however.

Full Disclosure: None

Relevant Articles:

Wednesday, February 6, 2008

Is Realty Income (O) a good stock to own?

I was browsing through yahoo finance, and I read an article about a real-estate investment company which has paid increasing dividends for 451 straight months. I looked at the monthly dividend payments over the past 10 years, and they looked promising for a real-estate investment trust. It looks very appealing to receive monthly dividend payments, as opposed to the quarterly ones that almost all dividend achievers worth their salt are paying these days. The dividend growth looked ok at an average of 5.21% annually over the past 10 years and an average of 6.46% annual dividend growth over the past 5 years. The major contributor for the growth is the 13% dividend hike in 2005. Without it, the growth would have been below my 5% dividend growth criteria. It also seems that the company is trying to raise its dividend three to four times per year, which is also a bonus.
I was seriously considering adding this company to my portfolio until I looked into the 10 year trends in its balance sheet, cash flow and net income statements. Looking at the income statement , it seemed that the annual income had tripled from 41.3 million in 1998 to 139.9 million in 2007. The number of shares outstanding had almost doubled though, from 52 million in 1998 to a whopping 92 million in 2007, which was bad news for EPS growth. Earnings per share increased at a slower pace, from 0.78 in 1998 to 1.18 in 2007. After looking at the cash flow statement though, it seemed that the company is financing its capital spending exclusively through debt origination and stock sales. That’s diluting existing shareholders’ interest in the company. It also seems that the growth in the cash flow from existing operations is due to the increased leveraging of the business. The Long-term debt portion of the balance sheet has increased from 110 million in 1997 to 1.47 billion in 2007, which is a 13 fold increase. At the same time the total equity has increased only 3.5 times, from 433 million in 1997 to 1.551 billion in 2007. In addition, the ratio of cash flow from operations to net PPE, which shows the return on investment that the company is generating per dollar of property that it owns has decreased from 9.01% in 1997 to 6.48% in 2007. This indicator does fluctuate between 6 and 12 % normally. It shows that the company cannot operate effectively if there is any large turbulence in the debt and equity markets where it obtains its financing. If these sources of capital dry out for O, then stockholders would expect flat to slightly down EPS.
In conclusion, although the company has managed to increase its dividends and revenues over the past 10 years this is primarily due to the increased use of outside capital from debt and equity markets. This dilutes stockholders equity over the long run and might lead to smaller EPS growth. The huge increase in debt relative to owners’ equity is definitely a red flag for me. If management slows down its debt accumulation and stock sales in order to obtain financing, the company might be in trouble, because its earnings growth will suffer. Even though the yield looks very attractive, the dividend growth is sluggish. In addition, the dividend payout ratio for O and REITs in general is above my 50% rate, which leaves the dividend rate exposed to fluctuations in the company’s earnings. The P/E ratio is above 20, which is a little pricey for me. Thus I would not own this stock at this time.

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