STIFEL: Office/Industrial REITs - Bullish Base Case and Bullish Case for REITs. Office & Industrial REIT Metrics Update 9/12/16

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Bullish Base Case and Bullish Case for REITs. Office & Industrial REIT Metrics Update 9/12/16

  • While REITs share prices are proving to be volatile, we are focusing on a base case for the overall capital markets and then attempting to determine where REITs should fit.
  • If one assumes consensus well into 2017 of 1) slower US and global growth, 2) despite a modest fed funds rate hike or two, no pressure on the long end of the curve, 3) TINA (There Is No Alternative) and FOMO (Fear Of Missing Out) driving the U.S. equity markets up via multiple expansion, 4) assuming $125/sh for 2017 S&P earnings and a 20x multiple equates to the S&P reaching 2,500, and 5) continued risk-off and thirst for yield trades; it is relatively easy to project REITs outperforming a healthy U.S. equity market.
Pricing as of close 9/9/16.
 
  • We are also assuming that REIT managements are aware that, while Net Asset Value and other real estate valuation metrics are and will always be important, real estate is late in the cycle, the easy re-leasing spreads are gone, development is everywhere and the incremental investor is focused more on dividend yield and stock valuation metrics than anytime in the past decade. Accordingly, we expect strong dividend increases to be announced in 2H16.
 
  • Despite recent positive performance following 2Q16 earnings calls, we continue to favor Gateway City office REITs. However, we think most of these Gateway City office REITs need to increase their dividends substantially as sub 2.5% yields are a deterrent unless fundamentals are very strong and value creation (not just an NAV discount off an historically low private market cap rate assumption) is obvious.
 
  • These include Vornado (VNO, Buy, $99.45), SL Green (SLG, Buy, $111.00), Empire State Realty Trust (ESRT, Buy, $21.28), Boston Properties (BXP, Buy, $135.22) and Kilroy Realty (KRC, Buy, $69.18) due to a combination of fundamentals, real value-add platforms and attractive valuations relative to suburban or low barrier office REITs. We view suburban office REITs as often (but not always) encumbered by weak fundamentals with a pension fund advisor type, generic platforms.
 
  • In the low barrier office world, our only Buy-rated office REIT is Mack-Cali (CLI, Buy $27.73) due to its 1) substantial valuation discount relative to the other low barrier office REITs, 2) active asset recycling, 3) apartment development potential with low land basis and 4) leasing upside.
 
  • Despite excellent YTD 2016 performance, we continue to like Industrial REITs and have Buy ratings on six of the eight we cover. We expect industrial fundamentals to continue to modestly surprise to the upside and look attractive relative to other property sectors. We also note that the inevitable increase in supply about the time demand subsides continues to get kicked down the proverbial block.
 
  • So, will REITs overall be driven by: 1) the equity markets and a risk-on or risk-off mentality, 2) interest rates at either end of the yield curve, or 3) fundamentals?
 
  • While we think individual stocks and property sectors will be driven by fundamentals, value creation potential and dividends; we expect #1 and #2 and the corresponding funds flows to drive the REIT space overall. Which one? Likely, whichever is most volatile.
 

Below are links to wires we have recently published:

  

Below, we have our 2Q16 Earnings wires for each company under coverage (in chronological order from most recent reporter to first reporter):

 

      
  • Douglas Emmett (DEI, Sell, $36.72) - Staying with the southern California theme, we think the West L.A. and SoCal office markets are solid, but we still have questions regarding DEI. Beach Volleyball. What Else? Maintain Sell.
     
  • Equity Commonwealth (EQC, Hold, $31.04) - Sooner rather than later EQC will have some serious decisions to make regarding the portfolio they want to own in the long term. Javelin Throw? Javelin Catch? Hold.
      
       


Links to our most recent office and industrial REIT sector wires follow:

    

 

  

Farmland Partners to Acquire American Farmland Co. in Stock-for-Stock Transaction

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On the morning of September 12, Farmland Partners Inc. (FPI – Outperform) announced that it had entered into an agreement to acquire American Farmland Company (AFCO – Outperform) in a stock-for-stock transaction, creating the largest publicly traded farmland REIT. The merger is expected to grow FPI's total acreage by 15% and should yield a combined company with a market cap of roughly $360 million based on yesterday's close. We view the acquisition as a positive for shareholders of FPI as the new company should benefit from increased scale, better access to capital, a more attractive cost of capital, and cost-related synergies, which should ultimately drive AFFO growth. We believe that increased earnings power will further support the company's quarterly dividend of $0.1275, which currently offers a ~4.5% yield to buyers at these levels. Reflecting the announcement, as well as some adjustments made to our AFFO assumptions, we are increasing our FPI estimates for FY16 AFFO per share to $0.38 from $0.19 and our FY17 AFFO per share estimate to $0.48 from $0.26. We are also modestly increasing our NAV per share estimate for FPI from $12.03 to $12.09.

Japan construction and real estate market - Record gap for Mitsui Fudosan, Mitsubishi Estate

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Mitsui Fudosan's implied cap rate at 6.5% 
Looking at the spread between the implied cap rates (based on our calculations) for Mitsui Fudosan [8801] and Mitsubishi Estate [8802] since 2003, we see that while the spread between the two companies' implied cap rates has narrowed from 2.6ppt in late August, it is still at an unprecedentedly high level of 1.9ppt based on 8 September closing prices. Except for the brief time when real estate stocks dropped sharply in the wake of the global financial crisis in 2008, Mitsui Fudosan's implied cap rate has been consistently higher than Mitsubishi Estate's, and the spread between the two companies cap rates has generally been around 0-1ppt. Even in September 2014, when Mitsui Fudosan's market cap was temporarily higher than Mitsubishi Estate's due to increased expectations for Mitsui Fudosan's profit growth following its capital increase in June 2014, the spread was still only 0.4-0.5ppt. We believe this is because real estate in the Marunouchi area (the focus of Mitsubishi Estate’s portfolio) is valued higher than real estate in Nihonbashi (the focus of Mitsui Fudosan's portfolio), which results in a lower cap rate.

Janney/REITs: Weekly REITCap: Portfolio Managers Guide to Property REITs

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REITS

Weekly REITCap: Portfolio Managers Guide to Property REITs – September 9, 2016
 

Our Weekly REITCap Portfolio Managers Guide provides general corporate information, total returns, valuation and balance sheet measures for 150+ property REITs across the major asset types (e.g. office, multifamily, retail, industrial), as well as more esoteric REITs (such as the prisons and towers).

 

  • For the week ending September 8, the MSCI US REIT Index (RMZ) return was +0.9% versus the S&P 500 return of +0.5%. The NASDAQ was +0.6%, the DJIA was +0.3%, the Russell 2000 was +1.5%, the DJ Utilities were +2.6%, and the S&P Financials were +0.2%.

  • The best-performing REIT subsectors last week were Data Centers and Towers (+2.3%), Triple-Net Lease (+2.2%), and Office-Suburban (+2.1%), while the worst were Hotels (-2.7%), Storage (-0.6%), and Apartments (-0.1%).

  • The best-performing REIT stocks last week were GEO (+10.6%), IRT (+6.8%), and MNR (+5.4%), while the worst were CMCT (-8.2%), AHT (-5.0%), and HST (-4.3%).

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  • YTD REITs are now outperformingthe S&P 500 by 640bps. The REIT sector is now +14.8% in 2016, while the S&P 500 is +8.4%, both on a total return basis. YTD the Russell 2000 total return is +10.8%, the NASDAQ is +5.0%, the DJIA is +6.1%, the DJ Utilities are +18.0%, and the S&P Financials are +3.9%.

  • The best-performing REIT subsectors YTD are Triple-Net Lease (+34.0%), Industrial (+32.2%), and Healthcare (+25.4%), while the worst are Storage (-8.3%), Apartments (+0.2%), and Single-Family Rentals (+2.6%).

  • The best-performing REIT stocks YTD are SNH (+70.2%), GOV (+65.1%), and NXRT (+62.6%), while the worst are CXW (-37.4%), GEO (-19.8%), and NYRT (-14.3%).

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  • Over the past 12 months, the REIT sector total return is +27.9%, while the S&P 500 is +13.2%. Over the last 3 months, the REIT sector total return is +6.5%, while the S&P 500 is +3.5%.

  • The US is outperformingmany of the major global real estate markets YTD. The YTD US REIT total return of +14.8% compares to +1.8% for Europe, +12.2% for Asia, -6.8% for the UK, and +15.6% for Australia.

  • REIT sector’s average cash dividend yield is 3.7%. This compares to the average yields on the 10-year Treasury (1.6%) and Moody’s Baa Corporate Bond Index (4.2%).

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  • We remain Neutral on the US Property REITs. With a 10% total return expectation for 2016, we remain Neutral on the US Property REITs, as 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.

  • In terms of our subsector views, we are positive on the Multifamily, CBD Office, and Industrial subsectors; neutral on Data Centers, Regional Malls, Self-Storage, Shopping Centers, Student & Manufactured Housing, Tower, and Triple-Net; and negative on Diversified, Healthcare, Hotels, Suburban Office, and Single-Family REITs. Specific company ratings and operating details can be found inside.

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  • No changes to our earnings and fair value estimates this week

  • Our favorite small-cap REITs are ADC, AHH, CIO and TIER. We also like MAA and NNN among the mid-cap names, and AIV, EQR, and O among the large-cap REITs.

  • We launched coverage this week of Spirit Realty (SRC) and Monogram Residential (MORE). See our company-specific reports for complete details.

JANNEY - Monogram Residential Trust Inc MORE - BUY Price - $10.59 | Fair Value Estimate - $11.50

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We are initiating coverage of MORE with a Buy rating. Our $11.50 estimate of fair value implies ~9% upside for the stock, which we believe when combined with a 2.8% dividend yield, provides an attractive potential return in the current market environment.

  • Apartment REIT focused on Class A properties. Based in Plano, Texas, MORE owned a portfolio of 54 apartment properties (including 2 under construction) across 10 Coastal and Sunbelt states totaling 15,211 units as of June 30. Also, MORE’s portfolio was 94.6% leased with a weighted average monthly rent of $1,909.

  • Reasons to own MORE: One of the newest portfolios, discounted valuation, and growth potential. We see upside to MORE’s stock price given (1) the benefits of one of the newest portfolios in the apartment space, (2) a discounted NAV valuation, and (3) ability to produce outsized growth both internally and externally over the next few years.

  • NAV valuations are attractive. MORE is trading at a 5.8% nominal implied capitalization rate (5.5% economic) or $204,000 per unit. This compares to the apartment REIT peer group at 5.3% (4.9%) and $334,000 per unit, respectively. Our $11.50 fair value estimate is based on our DCF valuation model.

  • Complexity issues, higher leverage, cost of capital, and less liquidity our biggest concerns. The MORE story is not without risks, most notably: (1) the majority of its assets are owned within JVs, which causes complexity issues and may have difficulty attracting the generalist investor; (2) despite recent improvements, MORE’s leverage levels are significantly higher than its peers; and (3) MORE has a higher cost of (and less access to) capital and less liquidity than its peers.

  • 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.

Mortgage Market Continues to Shine; Raising our Origination Forecasts for 2016 to $1.9T; Setting 2017 at $1.75T

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With continued strength in the purchase mortgage market and a healthy boost to refis in light of the low interest rate environment throughout the year, we are raising our estimate for 2016 total mortgage industry originations to $1.9 trillion from $1.65 trillion. For some time now, we have articulated our belief that the normalized origination market in the U.S. shakes out at around $1.7 trillion with the purchase market representing somewhere in the range of $900 billion to $1 trillion and the refi market accounting for the delta. With that in mind, we think that the tailwinds from lower interest rates will boost production through that level in FY16, hence our $1.9 trillion estimate. Additionally, we are introducing our 2017 estimate of $1.75 trillion, which assumes continued positive momentum in the purchase market but a decline in refi volumes from 2016.

American Homes 4 Rent (NYSE: AMH) - Secondary Public Offering.

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AGOURA HILLS, Calif., Sept. 7, 2016 /PRNewswire/ -- American Homes 4 Rent (NYSE: AMH) (the "Company") today announced that Alaska Permanent Fund Corporation, a selling shareholder (the "selling shareholder"), has commenced an underwritten secondary public offering of 43,500,000 of the Company's Class A common shares of beneficial interest, $0.01 par value per share (the "Class A common shares"). The Company is not offering any Class A common shares in the offering and will not receive any of the proceeds from the sale of its Class A common shares by the selling shareholder. BofA Merrill Lynch will act as the sole book-running manager for the offering.