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

Friday, January 30, 2015

HCP Inc (HCP) A High Yield REIT Play on Healthcare

HCP, Inc. (HCP) is an independent hybrid real estate investment trust. The fund invests in real estate markets of the United States. It primarily invests in properties serving the healthcare industry including sectors of healthcare such as senior housing, life science, medical office, hospital and skilled nursing.

HCP is a dividend champion which has increased dividends for 30 years in a row. The latest dividend increase was in January 2015 , when the board of directors increased the distribution by 3.87% to 56.50 cents/share.

Over the past decade, FFO/share has increased from $1.64 in 2003 to an expected $3.10 in 2014. This comes out to an annual FFO increase of 5.90%/year on average.

The company operates under 5 segments. Senior housing contributes 37% of revenues in 2013, while Post-Acute/Skilled properties contributes 31% of revenues. The Life Science and Medical Office Segments contributed 14% and 13% respectively, while the remaining 5% is generated from Hospital properties. I also like to look at the tenant diversification, in order to determine if revenues are overly dependent on a single customer. Based on the 2013 annual report, the four largest customers were HCR Manor Care with 29% of revenues, Emeritus Corporation with 13% of total revenues, Brookdale Senior Living with 8% and Sunrise Senior Living with 5%. The 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. Most of our the leases require the tenant to pay a share of property operating costs such as real estate taxes, insurance and utilities. Substantially all of HCP’s senior housing, life
science, post-acute/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. The statistic to use is same-store growth, which has consistently been above 3% since 2009, and ranged between a low of 3.10% in 2013 to a high of 4.80% in 2010.

FFO/share growth has definitely been helped out by the low cost of debt, which has also been decreasing throughout its life as a public company since 1985. The nice thing about its debt profile is that almost all of liabilities are with fixed interest rates. Approximately half of the debt matures by 2018, which would mean that it would have to be refinanced at the rates available at the moment. The risk of course is if those rates start going up, it could leave less money for acquisitions and growing distributions.

Another factor that has helped FFO/share growth is the acquisition of properties, as well as strategic debt investments it has made. As the population ages in the US, the demand for health care services is only expected to increase. The percentage of senior citizen population is estimated to increase over the next 30 – 40 years, as is the growth in healthcare services. Therefore, a company like HCP should be able to enjoy stable occupancy in its medical properties, and recurring rents from that diversified portfolio that grow over time.

Over the past decade, dividends per share have increased from $1.66 in 2003 to $2.18 in 2014. This comes out to an annual dividend increase of 2.70%/year on average. The company offers a drip discount of 1% for those shareholders who elect to reinvest distributions back into more HCP shares. As a REIT, the company is required by law to distribute at least 90% of its taxable income. Since it is not taxed at the entity level, most distributions are not eligible for the preferential qualified dividend tax rates. Instead, a large portion of distributions are usually taxed under the ordinary income tax rates. The percentage allocations by tax source vary each year however. For example, in 2013, approximately 86% of the distribution was treated as ordinary income for tax purposes, while 7% was treated as capital gains income and the remainder was treated as a return of capital, which is nontaxable but reduces shareholders’ basis in the stock.

The reason behind the slower dividend growth relative to the higher FFO growth is due to the steady decrease in the FFO payout ratio over the past decade. Back in 2003, this indicator stood at 99%, which was certainly unsustainable. However as of 2014 it stands at 70%. The company also has another indicator called Funds Available for Distribution, which stood at $2.52/share in 2013. Therefore the dividend is well covered, and also has potential for growth at close to the rate of inflation for the foreseeable future.

HCP is an investment for those who need current income today, which will at least match the rate of inflation. I believe that the income stream is defensible, which means that dividends are secure, and are very likely to continue growing at least by the historical rate of annual inflation of around 3% over the next decade. As a result, the lower the entry price paid by the investor, the better the chances for higher returns, especially since the majority (approximately 60%) of long-term returns for REIT investors come from their distributions. The shares currently yield less than 5% and are selling for a forward price/FFO ratio of 15.40. I recently initiated a small position in HCP Inc. However, I would like to build a position in this REIT at an entry yield of 5 - 5.50% or higher.

Relevant Articles:

Five Things to Look For in a Real Estate Investment Trust
Dividend Champions - The Best List for Dividend Investors
Dividends Provide a Tax-Efficient Form of Income
Using DRIPs for faster compounding of dividends
Six Dividend Investments I Made Last Week

Friday, December 19, 2014

Should I hold on to American Realty Capital Properties (ARCP)?

There have been some recent developments over at American Realty Capital Properties (ARCP). First of all, on Monday, the REIT said Nicholas Schorsch, its founder and chairman, and David Kay, its chief executive, stepped down. Chief Operating Officer Lisa Beeson also resigned. The happened approximately six weeks after American Realty Properties disclosed accounting irregularities that erased more than a third from the company’s market value. Then the company’s credit rating was downgraded to a notch below investment grade by Moody’s. To many investors, those are new facts to take into consideration.

Prior to that, I did do some tax loss harvesting. I essentially doubled up my exposure in early November, bought a put, and then 31 days later sold the original shares and the put. I was expecting to essentially keep my shares and do nothing with them, but then decided to think about it again. In this article, I am going to outline my thinking for selling and against selling. Just as a reminder, just because I do something, doesn't mean it is a recommendation for you to act on. Everyone’s situation is different, which is one a one size fit all approach or article should be taken as advise.

Reasons to sell American Realty Capital Properties (ARCP)

1. The cost of capital will increase as a result of the credit downgrade. According to WSJ “Moody’s said the return to a stable outlook would require the resolution of the accounting issues and the timely filing of its third quarter and 2014 financial results. Missteps in resolving its accounting issues and other concerns could lead to another possible downgrade”

This would not be felt right away, but when significant amounts of debt need to be refinanced after 2016, this could be costly. Of course, if the audit does not uncover anything new, then chances are that financial statements will be submitted with the SEC, and the credit rating up for review. Thus, this could or could not affect anything. The nice thing is that in the short-term, credit should not be an issue, because maturities are stacked up and debt does not mature all at once but is spread out over time. In the long-run, access to credit could impede FFO.

2. There was an accounting problem, affecting FFO/share by a few cents/cents. Accounting errors do happen, but the problem with this error was that it was concealed, leading to departure of two key executives in October. While an error of a few cents/share is not that much, it could be an indication that financial reporting is not accurate. If the financials are not accurate, then whoever is putting their money in American Realty Capital Properties (ARCP) is speculating, not investing. Speculation is fine, but it is riskier since the person putting their money in something they hope is doing well, rather than objectively analyzing cold data. The uncertainty is definitely killing a lot of the investors out there.

3. The other reason for selling would be if the company lowered its dividends to shareholders. Given the high yield today, I believe that a dividend cut is already factored into the price. At a price of $8/share, a dividend yield of 6% would translate into an annual payment of 48 cents/share. As a dividend growth investor, I usually sell after the dividend cut is announced, in order to avoid situations where I stick to a position due to behavior failures as an investor. If things get better, and distributions resume their growth, I would get back in. However, if the dividend were cut, I would expect a lot of extra selling by investors and prices falling even lower potentially.

4. Another reason to sell is in order to harvest tax losses. An investor could sell, and buy back in 31 days. Of course, the stock price might go higher during that time period. Or it could go lower, making you feel/look like a genius.

5. For many investors, selling American Realty Capital Properties (ARCP) today is because they seem overwhelmed by the negative news about it. Many investors read all the news releases, then articles on popular blogs or Seeking Alpha and get worried. For some, they sell because they want to “sleep well at night”. In my opinion, this is a bad reason to sell, because most of the companies one holds on to, usually end up having some type of difficulty. While the problems of American Realty Capital Properties (ARCP) are large ( accounting errors (or even fraud), management shake-ups indicating more problems ahead), an investor should not be selling merely because things are tough and they are scared. If you want to sleep well at night, keep your money in FDIC insured CD’s. If one is unwilling to hold on to a stock falling by 50%, then stocks might not be the correct vehicle for them. Also, if one spends all of their time checking stock prices, news about companies they own, people’s opinions on them , or worrying, then maybe they are speculating and not really investing for the long term. However, if they sell because the new information changes their perspective about the company's prospects, they lose faith in management, or they believe the new information makes it difficult to hold due to unreliable financial information, then that is a valid reason to sell.

Reason to hold American Realty Capital Properties (ARCP) ( and potentially buying ARCP)

1. The Real Estate Investment Trust owns thousands of properties under long-term triple net leases. Payments are contractually scheduled to escalate over time, and almost all of the lease costs (rent, taxes, utilities) are paid by the lessee (the tenant). Since those leases are long-term in nature, it would be very difficult for the tenant to get out of them. Therefore, the majority of revenues from those leases are relatively stable. There are some revenues related to sales and management of non-traded REITs. With all the hoopla around the trust, a large portion of those revenues will be going lower. But still, the properties and leases are not going away. Those have a value.

2. The other reason for holding on to the stock is that the value of the properties under its ownership is potentially higher than the current market price. Of course, the value of those properties at $13.25/share was provided by David Kay, who has resigned from the company. So those numbers should be taken with a grain of salt. Assuming the leases are not made up, they should have a value that could be realized. I would say that financing a property that is leased under a 10 year lease might be easier, even if your credit rating is not stellar.

3. The third reason to hold is if one believes that the company would not go under. This is a belief that those problems that the company has are temporary of nature (despite the fact that management has really screwed up big time). A pass-through entity like American Realty Capital Properties (ARCP) would pay a dividend as long as it earns taxable income. Hence, an investor who only focuses on current weaknesses and projects them onto the future is doing what investors have been doing from the dawn of stock market investing – potentially missing the big picture by extrapolating recent losses into infinity. Investors tend to overreact to good news, and overreact to bad news. If the REIT is cleaned up, chances are it could deliver a nice stream of dividends to shareholders going forward.

4. Most investors now believe that Nicholas Schorsch was a toxic influence, hence his departure is actually bullish for the company. Most investors might not know about another REIT that Schorsch built up aggressively in the early 2000s -American Financial Realty Trust. The trust grew rapidly as well, but ultimately the growth was too quick again, and Schorsch was ousted. American Financial Realty Trust, cut dividends by 30% after he was ousted in 2006. The company was ultimately acquired in the next year by Gramercy Capital (GKK). The trust didn’t go under, as it sought to sell assets, reduce liabilities, and match dividends to revenues. The share price was flat for most of 2006 and early 2007, after which it fell by 50%. This was probably due to the beginning of the financial crisis. If interest rates start going up, and REITs in general lose investor appetite, this would be bad news for investors in the REIT.

5. The fifth reason is because most of sales that investors do are not optimal. I have reviewed the sales of companies I have done, and the subsequent purchases, and have found out that in most situations I would have been better off simply to hold on to the original company. Selling is difficult, and it does not mean to never sell. But if one sells when they are scared, they are essentially letting emotions run them. When things are bad, all you get is negative headlines and negative facts. The problem of course is that very often those get priced into the company. Inexperienced investors (myself included) tend to project recent headlines into infinity and sell. However, those experiences have made me think that a large portion of investing is based on facts and data, and the rest is based on personal experiences, biases and common sense. Sometimes however, it might make sense to ignore the data and have a belief that things could get better. I know that when I sold GE, I was expecting it to go under after the dividend cut, since many of the dividend cutters of 2008 went under. I also thought that BP had a lot of issues in 2010, which is why I sold after the cut. In reality, if a company can survive a crisis, it could deliver decent returns. Most investors lack the patience to hold a company stock that has a large loss. However, this is the price to pay for earning equity returns – volatility, uncertainty and negativity. I witness investors losing patience over companies like Intel (INTC), who failed to increase dividends. They sold, and then the shares went up and the dividend was increased – the company had merely experienced short-term weakness. However this weakness was projected onto the future into the potential demise of the company. Same was true for Apple (AAPL) in 2012 – 2013. Many investors, myself included, believed that the future is bleak, but they were proven incorrect.

6. The sixth reason is somewhat correlated with the fifth. It is the concept of opportunity cost. If I sold American Realty Capital Properties (ARCP) today, I would deploy the capital elsewhere. However, other triple-net REITs like Realty Income (O), W.P. Carey (WPC) or National Retail Properties (NNN) look pricey today. Hence, it might not make sense to buy them if I sold. In addition, even after a dividend cut, I could see how ARCP could still offer better yields than the above mentioned REITs and possibly faster distribution growth. (although it will be riskier). I could also purchase oil companies with the proceeds, like ConocoPhillips (COP), Exxon Mobil (XOM) or Chevron (CVX). However, energy companies like those sell a commodity whose prices fluctuate greatly. Hence their income is going to be more volatile and less dependable than that of a company like American Realty Capital Properties (ARCP) which has long-term triple net leases that are stable and growing over time.

What I decided to do

When I purchased this REIT, I violated my entry criteria since I purchased a stock with only 2-3 years’ worth of dividend increases. I also chased yield, and did not really dig into the financials, which were not comparable due to the steep pace of acquisitions. Based on my experience of looking at/following financial markets for 16 - 17 years, companies that grow to fast or change strategies too quickly are dangerous and possibly run for the benefit of management egos, not shareholders. The rapid acquisition growth, lack of long-term track record, lack of comparable financials, prior history of Nick Schorsch with AFRT and fat dividend yield, was something that should have raised a red flag for me, yet I kept buying the stock on three occasions in 2013. Now we know that the financials are not very clean, and we have management shake-ups, which means that we might have bigger problems potentially under the surface. Selling the stock today would be the obvious choice, since I am now speculating of whether the company will do fine or not. I do not know whether the financials are fine or not, hence I cannot do an objective analysis of the situation. As Buffett likes to put it, this company is on the “too hard” pile. This is the pile of items to ignore, because based on publicly available information, it is difficult to make a decision. I would assume however that even if the financials are worse than expected, the nature of the business itself has a stable core of long-term triple net leases with dependable revenues. I believe that a large portion of uncertainty is already priced into the company. The dividend cut could lower stock prices – or it could not. What I am saying is that I made a mistake buying American Realty Capital Properties (ARCP) in the first place – hence by selling I am correcting that mistake.

Since my rule is to sell after a dividend cut, and I do expect a dividend cut, I am going to cut my losses there. If the REIT cuts dividends, but then starts raising them again, I would give it a second look. I would keep the few shares I have in an IRA account though, and have dividends reinvested. I am essentially disposing of approximately 80% of my exposure to American Realty Capital Properties (ARCP) (all the shares in taxable accounts). My way of monitoring companies is by owning a few shares in many, receiving alerts on press releases, annual and quarterly reports, and major news on them.

I am also considering selling, because I am realizing that the relentless increase in stock prices, have caused me to soften my entry criteria, in order to put capital to work. When I make my entry criteria less rigid, I am opening the can of worms to buy securities which look cheap, but which might lack in quality. If I compromise on the purchase side, then I am not really sticking to my original strategy, and then I am mostly hoping and speculating, rather than investing. When I buy a company like Johnson & Johnson (JNJ), I expect growth in dividends from a stable time tested company with a long-term track record. If things change, I know that dividends will be cut and I should sell. With a company like American Realty Capital Properties (ARCP) that I bought without requiring as much in terms of track record and management integrity, I do not have a good idea of when I should sell. This is because I didn't really have a good idea of why I bought in the first place. Thus when I don't follow my entry rules, I do not really have the edge, which is dangerous when it comes to investing.

Being too lenient is costly, as I have also been doing dangerous things like buying stocks on margin, in one of my accounts and also selling puts for premiums. Luckily, I have been profitable as stock prices have been rising on those endeavors. I believe the time to cut back on margin and options trading is now, so that I am in a better position to endure the next bear market. Being overconfident in my abilities, being more lenient on my investing criteria, speculating in derivatives and using margin could be the slippery start of a dangerous path towards financial destruction.

I am also in the process of selling approximately 80% of my position in Gazprom (OGZPY), covering almost all puts sold (except for BP, General Mills (GIS) and a General Electric (GE) expiring in 2015 and 2016).  Those positions did not match my goal of generating a reliable dividend income that grows over time, and comes from a diversified portfolio of dividend growth companies. While Gazprom could be worth $15 - $20/share easily in a decade, it could also be worth less if sanctions are not lifted timely and Russia is further pushed into a second Cold War. My long-term investment goal is not to speculate on prices, but look for ways to generate sustainable income to live off in a few years. My near term goal is to de-leverage and reduce all margin activities and options selling to minimum in 2015.

For 2015, I will focus on maxing out my 401 (k), SEP and Roth IRA’s and HSA in the first half of the year. This should save me money on taxes, meaning I would have more money to keep to my name and invest. I have also cut recurring expenses like housing, transportation and auto insurance, which should also let me keep more money and invest. I am also going to be more stringent on quality from companies I invest in on a going forward basis.

Full Disclosure: Long ARCP, OGZPY, JNJ, GE, GIS,

Relevant Articles:

What should I do with American Realty Capital Properties (ARCP)
American Realty Capital Properties (ARCP) Dividend Stock Analysis
Five Things to Look For in a Real Estate Investment Trusts
The right time to sell dividend stocks
Dividend Cuts - the worst nightmare for dividend investors

Monday, November 3, 2014

What should I do with American Realty Capital Properties (ARCP)?

Last week, American Realty Capital Properties (ARCP) announced some accounting mistakes, where it overstated Adjusted Funds from Operations (AFFO) by 4 cents/share for the first half of 2014. The reason why the stock price declined by a third however was that there was a mistake done in the first quarter, and there was an attempt to conceal it in the second quarter. This made many investors nervous, mostly because they fear that this could be an indication of a bigger cover-up.

I have made purchases in American Realty Capital Properties on three separate occasions in 2013, after which I have mostly collected the dividends in cash to place elsewhere. The third occasion was an investment in a Roth IRA, where dividends are automatically reinvested into more American Realty Capital Properties shares. I viewed American Realty Capital Properties as a company with promise, which wanted to grow enough to gain the scale and prominence of a Realty Income (O). After my purchase however, the company grew its size very rapidly. This prompted me to reevaluate whether they are doing this for management or for shareholders. As a result of the very rapid acquisitions of companies and properties, the hefty compensation package proposals for Nicholas Schorch, as well as the warning that the above average yield provided, I was beginning to question my investment in American Realty Capital Properties.

After reviewing the press release, as well as the conference call transcript, I have identified three options for my investment in the company.

My Options

1) Sell and never look back.

Accounting issues are always a red flag. If you cannot trust the numbers, this means that you cannot properly value the business. If management produced bad numbers, this means that internal controls over financial reporting are probably very weak. Those who are selling are likely believing that the insane are running the asylum – in other words the tone at the top is bad, which has cascaded down into a rotten organization at its core. If the current accounting irregularities are just the tip of the iceberg, and there are more things uncovered, it is quite possible that share prices will fall further, the dividend will be cut, and more losses could be in store. Things can cascade down pretty quickly in a wave of investigations, credit downgrades and management would have to focus on those fires, rather than focusing on the core operations. Even if the company survives, it would be unable to grow given the fact that cost of equity is prohibitively expensive at 11%, and the cost of debt could be even higher with possible credit rating downgrades.

2) Hold

While accounting irregularities are bad, and the dividend could be in jeopardy, the company looks cheap relative to others. While the bad publicity somewhat justifies a discount relative to the likes of Realty Income (O), W.P Carey (WPC) and National Retail Properties (NNN), I still believe that there are real revenue streams under long dated leases with quality tenants for American Realty Capital Properties. In addition, American Realty Capital Properties is a REIT, which means that it has to pay dividends as long as it generates enough income. Therefore, even if the dividend is cut, the company could still prove to be a decent long-term holding as long as it continues sharing its cash flows with shareholders and as long as it does not uncover more irregularities. The portfolio of properties is worth something, and some dividends will be paid out. It might take a while for the integration of other properties and companies is done, and until the whole accounting mess is sorted out. If the company survives, the investor that will come out ahead will be the one who held on, and might have even reinvested dividends.

3) Add more

We all know the saying that investors should buy when there is blood on the streets. There is some blood on the American Realty Capital Properties streets. I have been contacted by a lot of scared American Realty Capital Properties shareholders, who don’t know what to do. The fact that ordinary investors and probably even top management at American Realty Capital Properties don’t know the full extent of all problems is scary. However, it could be an opportunity given the low valuation of the assets on a price to book level. The problem is that this is now not dividend growth investing, but value investing with a dose of speculation. And I do not have the guts to add to this position. But I know some are adding to American Realty Capital Properties because of the low valuation.


Overall, I am going to hold on to American Realty Capital Properties for the time being. It is less than 1% of my diversified dividend portfolio, so I can afford to do that. Even if they were to cut dividends, I would violate my sell rule and keep holding. This is because as long as the REIT doesn’t go bankrupt, as a flow through entity it will deliver dividends to shareholders. I will be able to hold through SEC Investigations, further declines in the stock price, and even a dividend cut. I might however do some tax-loss harvesting at year end. I would do this either by buying a call option, and then selling the shares in taxable accounts after 31-32 days. Alternatively, I could buy 1 more share for each share in a taxable account I already hold and then buy a protective put for the additional shares. In about 31 – 32 days I will sell the original shares and generate tax-losses.

However, I made a mistake buying American Realty Capital Properties in the first place. I violated my principles for sound investment in the first place, and now the investment genies are coming for a payback.

I invested in American Realty Capital Properties based on my gut and viewed it as a potential for becoming the next Realty Income. There are five things I look for in REITs, such as sustainable dividends, growth in FFO, ability to grow FFO further. However, the financials were not comparable, due to the rapid pace of acquisitions. I did discuss this a few weeks ago, as a warning sign that management was trying to get to be the largest triple net REIT potentially as an ego boosting exercise, rather than to maximize shareholder returns. This was a sign that things might not be what we as conservative income investors with long term holding periods expect from companies we are investing our hard earned money into. Therefore, when I purchased American Realty Capital Properties I was speculating. The relentless increase in share prices had made me a little less lenient on quality, and I ended up chasing yield. The truth is that anyone who bought American Realty Capital Properties was likely speculating, since financials included so much in new acquisitions done so rapidly, that they were difficult to rely on.

Full Disclosure; Long O, ARCP

Relevant Articles:

American Realty Capital Properties (ARCP) Dividend Stock Analysis
Realty Income - A dependable dividend achiever for current income
Avoid Dividend Cutters at All Costs
Five Things to Look For in a Real Estate Investment Trusts
Undervalued Dividend Stocks I purchased in the past week

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, (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.

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