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Thanks to the success of our public series on mortgage REITs, we’re testing a series on equity REITs. Your feedback on the layout is greatly appreciated in the comments section.

If the series is a hit with readers, we will look to expand on it. If not, it fades into the night. The goal of this series is to allow us to rapidly inform readers about the things we are seeing in any given sector (always some kind of REIT). At the same time, we will include some charts and tables to provide readers with raw data. Our commentary after the data explains what we’re seeing.

Let’s talk about housing REITs:

Symbol

Company Name

Subsector

AFFO Multiple

Div Yield

Price

Price to NAV

(AVB)

AvalonBay Communities, Inc.

Apartments

21.63

3.65%

$174.12

0.94

(EQR)

Equity Residential

Apartments

22.94

3.86%

$62.50

0.93

(CPT)

Camden Property Trust

Apartments

23.73

3.26%

$101.81

0.98

(ESS)

Essex Property Trust, Inc.

Apartments

22.42

3.20%

$260.00

0.99

(MAA)

Mid-America Apartment Communities, Inc.

Apartments

22.87

3.06%

$130.91

1.12

(UDR)

UDR, Inc.

Apartments

22.08

3.57%

$40.28

1.00

(AIV)

AIMCO

Apartments

21.45

4.00%

$32.29

0.89

(CLPR)

Clipper Realty

Apartments

10.18

6.22%

$6.11

0.40

(IRT)

Independence Realty Trust, Inc.

Apartments

19.14

3.43%

$14.01

1.11

(NXRT)

NexPoint Residential Trust, Inc.

Apartments

19.48

3.04%

$44.95

1.10

(APTS)

Preferred Apartment Communities, Inc.

Apartments

13.46

8.62%

$8.12

0.92

(BRG)

Bluerock Residential Growth REIT

Apartments

15.48

6.84%

$9.50

0.85

(ACC)

American Campus Communities, Inc.

Student Housing

23.46

4.51%

$41.69

0.89

(ELS)

Equity Lifestyle Properties, Inc.

MH Park

31.95

2.17%

$63.07

1.04

(SUI)

Sun Communities, Inc.

MH Park

28.10

2.16%

$146.57

1.09

(UMH)

UMH Properties

MH Park

18.21

4.91%

$14.66

0.87

(AMH)

American Homes 4 Rent

Single-Family Rental

26.66

0.68%

$29.47

1.02

(INVH)

Invitation Homes Inc.

Single-Family Rental

25.83

2.08%

$28.80

0.99

(RESI)

Front Yard Residential Corp.

Single-Family Rental

26.00

0.00%

$13.39

1.00

Note: AFFO multiples use a median forecast simply labeled as “AFFO” for the current year. NAV ratios use trailing values for the median analyst estimate. If there is no median analyst estimate or if I believe the estimate is unreliable, I may exclude it to avoid reproducing data that I believe is materially inaccurate.

Further, I’m conflicted about including a few of the REITs here. UMH is technically an MH Park (Manufactured Home Park) REIT, but is hardly comparable to ELS and SUI. Likewise, APTS has a much more diversified portfolio. Someone could argue that they belong in the “Diversified” section rather than being grouped in as “Apartments.”

Prices

Prices in the table and used for the chart were pulled on 11/17/2020 after the market closed.

Can You Pick REITs?

Today we want to talk to readers about an important concept. Rather than drilling into an individual REIT, this series will often take a more “high level” approach. We will highlight factors for individual REITs, but we want to start by focusing on a few bigger picture themes.

Today the area we want to emphasize is how to pick REITs. This is important because it is an area most retail investors get painfully wrong. One of the most painful things I hear from investors is that they demand a higher return, so they only buy high-yield stocks. These investors are automatically restricting themselves to a universe where the average REIT is substantially worse. We will demonstrate that after the charts.

They are giving up the opportunity for better returns. We’re going to provide investors with several charts and we encourage readers to tell us which other metrics they would like to see charted in the future. We will plan to add (not all, at least one terrible suggestion will probably come out) some of the suggested charts.

Pretty Charts

For the housing REITs, we color-coded the sectors. Apartments are blue, manufactured housing parks are green, single-family rentals are yellow, and student housing is orange.

Dividend Yields

Let’s start by comparing dividend yields:

Source: The REIT Forum

If you’re picking by dividend yield, the only 5 REITs you’re going to consider are BRG, APTS, CLPR, UMH, and ACC. Think that’s a good plan? It isn’t. A higher dividend yield doesn’t mean the stock is “better.” It means the last time the board of directors declared a dividend rate, it represented a higher percentage of today’s price. That’s ALL it means.

AFFO Multiples

Now as investors get smarter, they start thinking about FFO multiples. That is a typical earnings metric for an equity REIT. However, we can move one step further and go to AFFO multiples. In the AFFO multiples, we have adjustments for recurring capitalized expenditures (and a few other less material items). Consequently, the AFFO is usually lower than FFO. Since AFFO is a smaller number, the AFFO multiples will be higher.

Now if you’re trying to pick based on low AFFO multiples, ACC just got bounced out of the group. For better or worse, using AFFO multiples tells us dramatically more. We can also see that the gap between NXRT at 19.48x and UMH at 18.21x is pretty small. That’s very different from what the dividend yields would’ve suggested.

Leverage Destroys Your Portfolio

So what really wrecks investors? Even as they start thinking in terms of FFO and AFFO multiples, they often don’t fully appreciate the impact of leverage. When it comes to equity REITs, high leverage is terrible. You don’t want high leverage. When leverage is high, lenders will start demanding higher interest rates and the REIT can be squeezed out of assets at the worst possible time.

This is an important lesson for investors who think “high leverage = high income = great investor.” Kill that thought.

We put in some time and built models comparing the estimated gross value of real estate assets to the net amount of liabilities and preferred equity for each REIT. Why? So we could demonstrate what percentage of the company is financed with things other than common equity.

We aren’t valuing real estate at historical cost. We’re using estimated market values on the real estate portfolios. Someone is going to say that we couldn’t possibly do that and that person will be painfully wrong.

Here is the chart:

Chart

Source: The REIT Forum

Now that’s a powerful chart. When you’re looking at this chart, a few things stand out. You can’t help but notice that a handful of these REITs are carrying dramatically more leverage than others. The highest two are BRG and APTS. If you are considering leverage, you would start your process by crossing BRG and APTS off of your list. If you don’t want to consider leverage when evaluating equity REITs, there is a simple technique to get around it:

  1. Start dollar-cost averaging into a low-fee ETF of large stocks (REITs or corporate, whatever).
  2. Don’t log into your account.

That’s it. If you want to ignore leverage, don’t bother trying to pick stocks.

Manufactured Housing

Over the last several years, we’ve heard investors beat the drums for UMH vastly more than SUI or ELS. Many of those “experts” encouraged investors to pile money into UMH. Perhaps you followed that advice and bought UMH because it had a higher yield and a lower FFO multiple. How well did that work out for investors?

Source: Yahoo Finance

That chart is including the dividends paid over that period. For UMH, the dividends paid roughly offset the decline in the share price. On the other hand, investors in SUI and ELS earned total returns of 61% to 86% in that time period. Remember, these REITs all own manufactured home parks. In theory, UMH should’ve been able to outperform. After all, they are running high on leverage and the asset class performed very well. Yet in practice, UMH underperformed.

I bet you can even find people today telling you that this is the moment for UMH. Clearly, the market has simply been painfully wrong for many years and failed to recognize the value!

Total Returns

An emphasis on total returns is what allowed the REIT Forum to outperform.

We compare our performance against 4 ETFs that investors might use for exposure to our sectors:

Source: The REIT Forum

The 4 ETFs we use for comparison are:

Ticker

Exposure

MORT

One of the largest mortgage REIT ETFs

PFF

One of the largest preferred share ETFs

VNQ

Largest equity REIT ETF

KBYW

The high-yield equity REIT ETF. Yes, it has been dreadful.

When investors think it isn’t possible to earn solid returns in preferred shares or mortgage REITs, we politely disagree. The sector has plenty of opportunities, but investors still need to be wary of the risks. We can’t simply reach for yield and hope for the best. When it comes to common shares, we need to be even more vigilant to protect our principal by regularly watching prices and updating estimates for book value and price targets.

That chart hasn’t been updated to include November yet, but so far November looks like it will send all the lines significantly higher.

One of the points we want to make here is that KBYW simply underperformed other REIT index ETFs by a substantial margin. What happened? The high leverage! An ETF built to focus on high-yield equity REITs is naturally going to follow an index which will pick high-leverage equity REITs. Is it any wonder we’ve had such an easy time beating it?

Conclusion

Building your investment thesis on dividend yields is terrible. Building it on FFO multiples is only slightly less terrible. Moving over to AFFO multiples is a substantial improvement. However, to really understand REITs, you need to start looking at leverage. When you understand the leverage, you’ll start ditching the garbage that destroyed your portfolio already this year.

Let us know what other charts you’d be interested in seeing us introduce in the future.

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Disclosure: I am/we are long SUI, ELS, AVB, EQR, ESS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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