13 Fast-Growing REITs With Strong Balance Sheets

seekingalpha05-04

There are two types of REITs: COWs (Cash Only Wanted) that focus on high dividend yield, and FROGs (Fast Rate of Growth) that prioritize maximizing total return.Higher yield usually means lower gain, ...

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One is COWs (Cash Only Wanted), where the object of the game is to milk the company for its safe, above-average dividend yield. The other is FROGs (Fast Rate of Growth), where the object of the game is to maximize total return by maximizing share price gain. Historically, since the invention of REITs about 60 years ago, the average Yield on a REIT is about 4%, (give or take a fraction of a point), and the average total return is about 11%, so the average share price Gain is about 7%. Total Return = Gain + Yield. The Yield you sign up for tends to be the Yield you get, at least in the first year. Gain is much less predictable, but there is no limit on how high the Gain can go. In a good year, a well-chosen FROG can gain 30% or more. That is many years' worth of dividends! Yield and Gain tend to move in opposite directions. As Hoya Capital says in a seminal article, The highest-yielding REITs have persistently underperformed while the lowest-yielding REITs have delivered outperformance by roughly 3.6% per year over the REIT average. So higher Yield usually means lower Gain, and vice-versa. Otherwise, REIT investing would be easy. We would just pick the REITs with the highest Yield. As a REIT investor, you can focus on Yield, to maximize your dividend cash stream, and that's what many professional REIT investors do. But they usually sacrifice a significant measure of Gain in the process, and sometimes end up with inferior total returns. Optimal Conditions for FROGs Hunting FROGs gave me nice results for the first few years. Back then, inflation was around 2%, and interest rates were near zero. Those are ideal conditions for growth stocks. In 2021, inflation spiked over 8%, degrading the value of future cash flows, thereby discouraging growth investment. And as interest rates climbed over 5%, investors found they could get better cash flow at no risk, via debt instruments, than they could get from most REITs. So for all of 2022 and most of 2023, REITs got pummeled, despite stellar operating performance, as I showed in a recent article, and one in 2023.   VNQ price movement (Seeking Alpha Premium) The list of FROGs I published last year is shown below, along with their trailing 12-month returns as of April 1.   Ticker Purchase Yield % Price 4/1/23 Div. pd. 12 mo. YAE % Price 3/31/24 12-mo Gain % 12-mo Return   VICI 4.78 $32.62 $1.64 5.01 $29.60 (-9.26) (-4.25)   CUBE 4.24 $46.22 $2.00 4.33 $45.03 (-2.57) 1.75   EPRT 4.43 $24.85 $1.13 4.55 $26.20 5.43 9.98   WY 2.52 $30.13 $0.91 3.02 $35.56 18.02 21.04   PCH 3.64 $49.50 $1.80 3.64 $46.68 (-5.70) (-2.06)   IRT 3.49 $16.03 $0.64 3.99 $15.65 (-2.37) 1.62   PSA 3.97 $302.14 $12.00 3.97 $286.50 (-5.18) (-1.21)   FR 2.41 $53.20 $1.33 2.50 $51.66 (-2.89) (-0.39)   AMH 2.80 $31.45 $0.92 2.93 $36.34 15.55 18.47   EGP 3.02 $165.32 $5.06 3.06 $176.32 6.65 9.71   INVH 3.33 $31.23 $1.34 4.29 $35.07 12.30 16.59   PLD 2.79 $124.77 $3.57 2.86 $127.92 2.52 5.38   REXR 2.55 $59.65 $1.56 2.61 $48.84 (-18.12) (-15.51)   MAA 3.71 $151.04 $5.67 3.75 $128.70 (-14.79) (-11.04)   TRNO 2.50 $64.09 $1.75 2.73 $64.60 0.80 3.53   CPT 3.82 $104.84 $4.03 3.84 $96.42 (-8.03) (-4.19)   IIPR 9.47 $75.99 $7.24 9.53 $100.88 32.75 42.28   Mean 3.73     3.92   1.48 5.40   Median 3.49     3.75   (-2.37) 1.75   VNQ 3.71     4.16   2.40 6.56   Click to enlarge Source: MarketWatch.com, Seeking Alpha Premium, and author calculations. The FROGs as a group slightly underperformed the pedestrian 6.56% posted by the Vanguard Real Estate ETF (VNQ), returning an average of 5.40%. This underperformance came despite continued rapid growth in revenues, cash flow, and dividends. How do you identify a FROG? That question is answered in detail in my December 2021 article. For now, suffice it to say, you can do it with just 14 commonly available data points and a few simple calculations in a homemade spreadsheet. You are looking for 6 key numbers:  Funds From Operations per share (FFO) growth rate (at least 10%, preferably 20%) Total Cash From Operations (TCFO) growth rate (same levels as FFO growth) Liquidity ratio (Assets/Liabilities) (at least 1.66, preferably 2.0) Dividend growth rate (the faster, the better. Average is currently 5.1%) Market cap (at least $1.4 billion, with sweet spot $4-$10 billion) Price Gain (the bigger, the better).  Once you have identified the REITs that pass the criteria above, add their 3-year Price Gain CAGR to their dividend score (which combines current Yield with dividend growth rate, projecting the Yield on cost 3 years from now) to arrive at a Modeled Return. If that Modeled Return exceeds the 3-year total return for the Vanguard Real Estate ETF (VNQ), then the company is a FROG. The more the Modeled Return exceeds the VNQ's, the better the chance the REIT in question will outperform in the coming year. At least, that's the theory. Welcome To The FROG Pond, 2024 Here are the 13 REITs that currently meet all the above-listed criteria, in order by Modeled Return. As you can see, FROGs are becoming something of an endangered species. Even though the VNQ's modeled return is below zero at (-2.54), setting the bar very low indeed, only 14 companies clear that bar and meet all the other FROG criteria.   Company Price Grwth FFO Grwth TCFO Grwth Liq. Ratio Modeled Return   American Homes 4 Rent (AMH) 0.40 11.57 15.95 2.21 7.40   Invitation Homes (INVH) 0.85 10.45 16.67 2.24 7.06   CubeSmart (CUBE) (-0.64) 11.90 20.29 1.81 5.98   EastGroup Properties (EGP) (-0.09) 13.69 19.92 2.00 4.82   Essential Properties (EPRT) (-0.77) 11.58 37.08 2.85 4.42   VICI Properties (VICI) (-2.70) 16.67 35.12 2.40 4.17   $Public Storage(PSA-N)$ (PSA) (-2.15) 12.07 16.70 2.35 3.66   Independence Realty (IRT) (-1.86) 10.67 51.73 2.22 2.07   Prologis (PLD) (-3.34) 13.43 22.30 2.48 1.89   Innovative Industrial Properties (IIPR) (-18.69) 30.45 32.12 5.33 1.15   Terreno (TRNO) (-5.16) 12.76 21.24 3.56 (-0.44)   Rayonier (RYN) (-5.84) 12.52 13.47 1.97 (-1.49)   Rexford (REXR) (-8.07) 27.88 32.74 3.35 (-1.60)   VNQ -6.50 -- -- -- (-2.54)   Click to enlarge Source: Hoya Capital Income Builder, TD Ameritrade, and MarketWatch. (Price Gain and TCFO Growth = 3-year CAGR. FFO Growth = per-share 3-year simple average). Of the companies on this list, only PLD and TRNO are projected to continue growing FFO/share at 10% or faster in 2024. Near FROGs Companies that nearly made this list this year include:  First Industrial (FR), which failed only on TCFO growth at 8.32. Storage REITS Extra Space Storage (EXR) and National Storage Affiliates (NSA), both of which failed only on liquidity ratio, at 1.37.  The truth about price Many investors, particularly COWhands, judge a REIT price by its Price/FFO ratio. I don't. \"Cheap\" REITs are usually cheap for a reason, and tend to stay cheap, while expensive REITs tend to stay expensive. My definition of an overpriced REIT is one that underperforms the market. My definition of an underpriced REIT is one that outperforms the market. Outperformers usually live above the average P/FFO ratio, ironically, which currently resides at about 15.8x. Although price matters, bargain hunting is usually self-defeating, if you are investing for total return. However, it is prudent to keep an eye on the average P/FFO for REITs in general. Near the end of 2021, that number had climbed to 26.2, much higher than its usual 18 - 20 range. That portended a sell-off, not just in FROGs, but in REITs across the board. Some FROGs sport unmistakably high P/FFO ratios. This is usually because their growth prospects are so exceptionally strong. David Gardner, the legendary growth stock investor of the Motley Fool, says it is common for great growth stocks to be perceived as \"overpriced.\" If you go along with the crowd and avoid such stocks, you may miss out on spectacular returns. Above average in dividend Growth, not dividend Yield Because of their rapid growth in FFO and cash flow, FROGs tend to grow their dividends at above-average rates. Yield at purchase is usually the Yield you get for the first year. After that, dividend growth can dramatically influence your Yield on Cost, which is the Yield you actually experience as an investor. To illustrate this, here is an extreme example. Innovative Industrial Properties sported a Yield at purchase of just 3.0% a few years ago, and in late 2021, its Yield at purchase was still an uninspiring 2.34%. But its 4-year dividend growth rate was a spectacular 81.74%. Shares bought at $45 with a 3.0% yield in 2017 yielded a whopping 13.33% on cost by late 2021, and currently yield a stunning 16.2%. Thus, many FROGs begin with below-average dividend Yield at purchase, but quickly close the gap with superior dividend Growth (though rarely as fast as IIPR has!). FROGs did especially well in 2020, another recent year in which there was a deep selloff. In part, this was because FROGs rarely cut their dividends. While most REITs slashed to the bone in 2020, most FROGs actually increased their dividends. So with all that in mind, here is a breakdown of our FROGs, showing market cap (billions), dividend growth rate, and P/FFO ratio.   AMH $13.0 B 2.88 34.5 20.8   INVH $20.9 B 3.24 24.2 18.3   CUBE $ 9.4 B 4.95 10.2 15.3   EGP $ 8.0 B 3.22 12.0 18.7   EPRT $ 4.5 B 4.33 6.2 13.9   VICI $29.7 B 5.71 6.4 11.0   PSA $46.2 B 4.56 8.5 15.3   IRT $ 3.5 B 4.51 (-4.5) 13.8   PLD $97.1 B 3.66 12.6 18.7   IIPR $ 2.8 B 7.38 39.1 12.4   TRNO $ 5.5 B 3.27 13.1 22.5   RYN $ 4.5 B 3.78 4.8 14.7   REXR $ 9.5 B 3.85 18.9 18.1   FROG Median $9.4 B 3.90 12.0 15.3   REIT average -- 4.06 5.1 15.8   Ticker Market Cap Yield 5-Yr Div. CAGR P/FFO '23   Click to enlarge Source: Hoya Capital Income Builder and TD Ameritrade. You might notice that the average rate of dividend growth for these 14 FROGs is 12.0%, which is more than double the REIT average of 5.1%. Because of this, FROGs are often better dividend payers than they appear at first blush. Meanwhile, Yield at purchase is 3.90% for the FROGs, compared to 4.06% for the average REIT. Note that just because a company is a FROG, that does not mean I will necessarily invest in it. This article does not constitute a Buy recommendation, and Modeled Return is not an attempt to predict total return. Not every REIT listed here will outperform the market in 2023 (probably), and I'm sure there are other REITs not listed here that will! Investor's bottom line How well FROGs do going forward depends on the conditions for growth stocks and commercial real estate in general. The no-risk rate stands between 4% and 4.5%, still slightly better than the average REIT dividend yield. If you are investing merely for cash flow, why go with a risk asset like REITs, when you can get equal or better cash flow at virtually no risk with treasuries? Meanwhile, as the graph below shows, the REIT rally that began in October, fueled by expectations of multiple rate cuts by the Fed, is showing signs of fizzling out.   VNQ price movement (Seeking Alpha Premium) Furthermore, double-digit growth has become very difficult in the current environment. Of the 16 companies mentioned in this article, only three -- Prologis (PLD), Terreno (TRNO), and First Industrial (FR) -- are expected to grow FFO/share at 10% or better in 2024, according to Bloomberg consensus figures. I will not be a FROG investor this year. Even though interest rates are still likely to fall a little, from where I sit it looks like the next couple of years will be rough on REITs. Even if FROGs manage to outperform the VNQ, that will be cold comfort if VNQ is losing the kind of altitude I think it will. This is a 180-degree about-face from my outlook at the beginning of this year. I base this new expectation primarily on the technicals, but also on a looming crisis in Office REIT debt. Where the technicals are concerned, I had thought that the VNQ's high of $116.71, struck on New Year's Eve, 2021, was the culmination of a long III wave, with a IV wave pullback and a V wave rally yet to come. When REITs rallied off the October 2023 low, I thought that was the start of the V wave, that would take VNQ to the $130 range. But the move down off the 2021 high was deeper than expected, and the rally off the October 2023 low now looks more like merely a B-wave bounce. We will know for sure if the price of VNQ falls below $70.61 before it regains its December 14 high of $90.09. If that is the case, then we are likely working on a C wave that will take the price down into the 50's before finding a bottom. Of course, there will be upward bounces along the way, but the overall picture is so bleak that I have liquidated all but two of my REIT positions.   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