In just a few days I plan to publish my top REIT picks for 2019, many of them are referred to as SWANs, or companies that help me “sleep well at night”.
To be considered a SWAN, the company must be a high-quality stock with strong operating fundamentals. This means that it must generate very reliable earnings (or funds from operations) and consistent dividend growth. I also like to see a track record of dividend growth, with no dividend cuts and a wide payout ratio.
Accordingly, most of the SWAN picks are mid to large cap REITs that have established a growth profile and are battle-tested through various economic cycles (i.e the great recession).
Conversely, the small-cap REITs have always been viewed as the riskier bets than mid and large caps. They often do not have the diverse revenue streams or stable cash flows that allow them to weather difficult economic environments (like their larger-cap counterparts).
Also, small-cap stocks are more susceptible to wide swings in price due to lower trading volumes. This greater volatility deters action and often provokes fear more readily.
Yet, we have found that stocks that “fly under the radar” are offer better positioned for growth over the long term. Due to the decreased institutional support, there’s a better chance that the operational health and prospects of these small caps will be underestimated.
In 2017 our small cap REIT portfolio generated returns in excess of 22% and so far in 2018 (through November) our small cap REIT portfolio has returned 5.1%. With less than 30 days left in the year, I’m hoping that the Small Cap REIT portfolio will move closer to our target of 9% (annual total returns), and not backwards.
Today I wanted to provide readers with a list of our 5 highest conviction small cap REIT picks for 2019. I have carefully screened these stocks based on a variety of metrics, including their overall cheapness (price).
5 Small Cap REIT Picks For 2019
Safety Growth & Income (SAFE) is a specialized small cap REIT focused on investing in long-term land leases. The company is externally-managed by iStar Inc. (STAR), a pioneer of the market for mezzanine real estate debt in the early 1990s. SAFE has around $630 million in total assets and has plenty of dry powder (around $300 million assuming a 2x debt/equity target) to get to a billion dollars quickly (without the need of some type of equity raise).
SAFE is trading at $19.01 per share (was 16.37 per share when we wrote in the Forbes Real Estate Investor) with a dividend yield of 3.2%. Although SAFE’s payout ratio is ~94% today (based on AFFO), the forward outlook suggests that the payout ratio will decline to the high 70% range by year-end 2019. We like the growth prospects and consider this small cap REIT to be a gem worth holding.
Gladstone Land (LAND) is a farming sector REIT that is also externally-managed. The company went public around six years ago and now has 75 farms with 63,000 total acres (in 9 states). Gladstone struggled during its first several days of trading, likely due to its 70% tenant concentration with Dole Food Company; however, the company has since diversified its portfolio considerably.
Gladstone Land typically doesn’t farm any of the land, but rather leases the properties to unrelated third-party farmers. Currently, over 85% of total revenues come from farms that are growing the types of food you would find in either the produce or nut section of your local grocery store (i.e. healthy food). Gladstone Land is trading at $13.41 per share with a dividend yield of 4.0% (the company pays month dividends). I expect to see the company return 15% in 2019 and possibly 20%.
Catchmark Timber (CTT) is a small timberlands REIT that has a $500mm market cap. Unlike other timber REITs, Catchmark does not engage in higher risk activities like lumber manufacturing or land development and the recent Triple T Timberlands acquisition has the potential to both improve earnings and establish CatchMark as an asset manager.
The compelling argument for Catchmark is that on a strict land value basis, the shares now trades at a discount to the true value of timberlands acreage. The company has capital availability and at the end of Q3-18 had $86mm in borrowing capacity on its credit facilities and $15mm in cash. Catchmark shares now trade at $8.07 with a juicy dividend yield of 6.7%.
CorEnergy Infrastructure (CORR) owns assets that are critical to upstream counterparties, that are located in desirable fields that are integral to their overall operations. The small cap REIT (also externally-managed) has proven that the revenue stream is reliable, even in periods of distress, as long as the assets are critical to the upstream operators. The REIT is primarily focused on acquiring and financing midstream and downstream real estate assets within the U.S. energy infrastructure sector and concurrently entering into long-term triple-net participating leases with energy companies.
CorEnergy’s credit facility is borrowing base-driven and has approximately $148 million of availability and including cash ($19.6 million), total liquidity is around $167.9 million. The company continues paying a stable dividend of $0.75 a quarter and maintains a “comfortable” level of coverage level (72% on an AFFO per share basis). Shares now trade at $36.0\99 with a P/AFFO multiple of 8.9x. The dividend yield is 8.1%.
Investors Real Estate Trust (IREIT) has transitioned itself from being a diversified REIT into a “pure play” apartment REIT. The company has successfully sold its medical office building portfolio (for $427.5 million) and is exclusively focused now on becoming a recognized best-in-class apartment owner and operator. The leadership team expects to improve IRET’s portfolio by enhancing its operations, adding quality assets, and strengthening its financial position.
IRET has fundamentally changed its approach to leverage, moving from 100% secured to 80% and heading lower. The company has also lowered the absolute amount of leverage and today IRET has more liquidity and balance sheet flexibility than ever before. The company is focusing on Minneapolis and Denver, two top 25 markets, further shifting out of North Dakota. IRET shares are trading at $5.28 wit a P/FFO multiple of 14.4x. The current dividend yield is 5.3%.
Note: I will soon be writing on “5 Spec Buy REITs for 2019” and “ 5 REITs To Avoid in 2019“…stay tuned…
I own shares in CORR, CTT, LAND, and SAFE.
