Janney/IRET: Initiating coverage of IRET with a Buy rating

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Investors Real Estate Trust

IRET - BUY

Price - $6.46 | Fair Value Estimate - $7.00

Initiating coverage of IRET with a Buy rating

We are initiating coverage of IRET with a Buy rating. Our $7 estimate of fair value implies ~10% upside for the stock, which when combined with an 8.1% dividend yield, provides an attractive potential return in the current market environment.

  • Transitioning into a pure-play apartment REIT. Based in Minot, ND, IRET owned a portfolio of 102 apartment assets totaling 12,974 units across 7 states in the upper Midwest (as well as healthcare, office and industrial assets slated to be sold) as of April 30, with over one-third of its NOI coming from North Dakota. As of F4Q16, IRET’s apartment portfolio was 90.8% occupied with an average monthly rent of $960 (both among the lowest in the apartment REIT subsector).

  • De-leveraging via asset sales, inexpensive valuation, and strong returns from redevelopment the reasons to own IRET. We see upside to IRET’s stock price given (1) management has targeted ~$600M of non-core assets for dispositions and will use a portion of the proceeds to reduce debt, (2) a reasonable valuation from both an NAV and multiple perspective (plus an 8.1% current dividend yield), and (3) strong returns (11.3% thus far) on its kitchen and bathroom redevelopment program being rolled out across its portfolio.

  • 8.1% dividend yield as well as NAV and multiple valuations are attractive. IRET is trading at a 7.4% implied capitalization rate (7.2% or $81,000 per unit for their apartment assets), and C2017 FFO and AFFO multiples of 13.3x and 15.1x, respectively. Our $7 fair value estimate is based on our DCF valuation model.

  • Exposure to “unloved markets”, lengthy transition to an apartment REIT, and the North Dakota market overhang are our biggest concerns. However, the IRET story is not without risks, most notably: (1) IRET’s core upper Midwest markets are largely “unloved” by investors; (2) the transition to a pure-play apartment REIT could take several years and become messy (including a potential “right-sizing” of the dividend); and (3) we believe IRET’s ND markets (~35% of NOI) are likely to remain operationally challenging and an overhang on the stock.

  • We remain Neutral on the US REITs despite the group having already exceeded our 10% total return expectation for 2016. Heading into 2H16, we believe strong generalist investor interest, solid internal growth, and continued access to inexpensive and plentiful capital are somewhat offset by strong valuations, greater levels of new supply, and the threat of higher interest rates