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The financial crises of 2008, better known as the Great Recession, raised new concerns about the operation of financial markets. That period of time was clearly a “black swan” event as investors were taking excessive risk that resulted in a catastrophic financial meltdown.
This sudden shift in investor sentiment was drastic as most every financial sector participant felt the pain sparked by broad disruptions within the capital markets.
Investors panicked in the financial collapse that was only paralleled by the Great Depression and saw the end of Lehman Brothers and Bear Stearns and the near collapse of Citigroup and AIG. There was no certainty that and sector would have access to capital, including Real Estate Investment Trusts (or REITs).
Many REITs, including Simon Property Group (SPG) and Kimco Realty (KIM) chose to be proactive and access capital (perhaps even over cautious) and the dominant mall REIT, General Growth (GGP) was forced to file bankruptcy.
There were just twelve REITs that continued to increase their dividend during these dark days, and in hindsight, we can now observe that most of these companies took extra precaution to control risk.
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Although many investors were blind-sided by the meltdown in 2008, the risks could have been avoided by taking the necessary steps to own safer securities with a history of managing risk. History has shown that investing consists of exactly one thing: dealing with the future. By preparing for the next market disruption, investors can look at a portfolio and decide whether it’s low-risk or high-risk.
By preparing for loss – that time happens when risk meets adversity – intelligent investors can distinguish the “wheat from the chaff” and begin to build a basket of stocks that generate steady returns in good times and bad. That’s what I call the Flight to Quality REIT Portfolio.
In my monthly newsletter, Forbes Real Estate Investor, I provide a list of real estate securities referred to as my SWAN (sleep well at night) picks. Many of the SWAN stocks are stalwart REITs that have built powerful forms of dividend repeatability. Essentially, I have designed the Flight to Quality portfolio of 10 REITS such that I believe are appropriate for investment today because they will help investors successfully navigate risk through multiple economic cycles.
In my upcoming newsletter I will provide the complete 10 REIT Flight to Quality portfolio and here are three REITs from the grouping that I consider safest based on their sustainable competitive advantages, valuation, and margin of safety.
Omega Healthcare Investors (OHI) is the largest Skilled Nursing Facility (or SNF)-focused REIT with a portfolio consisting of 932 operating facilities in 42 states and the UK, operated by 83 third-party operators. OHI's gross real estate investments total approximately $8.0B and the company's primary focus is on leasing long-term care facilities (primarily skilled nursing facilities) to strong regional and local operators. Around 90% of the portfolio is skilled nursing and around 10% is senior housing.
Part of OHI’s “flight to quality” thesis is related to the company’s improved credit profile - S&P upgraded OHI from BB+ to BBB- with a stable outlook -and the improved rating reflects OHI's seamless integration of its merger with Aviv REIT, its improved competitive position and bigger scale and tenant diversification.
OHI is one of the simplest REITs that I research - the company acquires healthcare assets at cap rates of 7.5%+ with a cost of capital of around 6.5%. On average, OHI generates spreads of around 150 bps and as the company continues to grow, it reduces its reliance on one operator (i.e. Genesis).
OHI has reduced its FAD payout ratio; it's now less than 80% - indicating that the company has a lot more room to grow (its dividend). In other words, OHI is growing earnings at a faster clip than its dividend, so I would not be surprised to see the company accelerate its $.01 per quarter pattern.
I consider OHI cheap today based on all metrics – FFO multiple (9.2x), dividend yield (7.9%), and Net Asset Value. Shares are trading at $28.91 and I have a BUY rating on this flight to quality pick.
DLR has an attractive five-year dividend growth rate of over 13% and a solid dividend yield of 4.2%. Its dividends are amply covered by FFO (funds from operations), with a 61.82% payout ratio. DLR also has benefited from major industry tailwinds as the demand for data storage took off and kept escalating, supporting DLR's growth right through the financial crisis and beyond.
DLR went public in 2004, and it has paid and increased dividend every year since then. Shares are currently trading at $80.40 per share with a P/FFO multiple of 15.4x. I have a BUY rating on the shares now.
My last “flight to quality” pick is Healthcare Trust of America (HTA).
Historically, medical office buildings, or MOBs, have been considered the most defensive sector within healthcare real estate but also benefit from significant macroeconomic tailwinds - not just the aging population, but also the rollout of the Affordable Care Act and strong healthcare employment growth.
REITs like HTA are able to operate their own properties and are not dependent on a third party operator for performance. From a cash flow perspective, Senior Housing and SNF operators only generate cash flow to cover their rent payments by 1.5x on a good day. For MOBs, that number is closer to 10x! That kind of cash flow cushion provides great support that is difficult to ignore.
This is a great asset class that has stable and growing cash flows. What's also great is that public REITs like HTA have a significant opportunity for continued public growth. There are over $350 billion worth of MOB's in the U.S., with less than 15% of that held by public REITs. This compares to most other asset types where REITs and institutional buyers own 40 to 50% of the total.
HTA shares are trading at $27.63 with a soundly valued P/FFO multiple of 17.3x. The dividend yield is 4.4% and I am anticipating the company to boost its dividend again in 2016.
The author owns shares in KIM, OHI, DLR, and HTA.
Brad Thomas is editor of Forbes Real Estate Investor and writes for Forbes.com. He is also writing a book, The Trump Factor, about presidential candidate Donald J. Trump.
