You know the old maxim, “Good things come in small packages?” This is especially with REIT investing.
In my work as a longtime real estate developer, investor, analyst and writer, I’ve a particular fondness for the so-called “Small-Cap” Real Estate Investment Trusts, and appreciate their unique, even delightful nature – a kind of “little guy” spunkiness.
With small caps, I can fish for bargains and try to identify a soon-to-be “big player” in an otherwise small-cap pond. Frankly, I think it’s a place many analysts, “the Street,” and other investors might have overlooked.
I like seeking trends and finding them: the small-fry company on an upswing, the underdog racing past in victory, the seemingly “overnight” sensation whose business plan has been underway for a decade.
I’ve some ideas, and in this article I’ll uncover five Small-Cap REITs that I think are ready to break out.
All of a sudden, I recall that 1970’s video game by Atari (do you remember it?), where I easily spent hours and hours as a youth “bashing bricks with a joystick.” But now having matured, I can clearly connect that with the hours and hours (and days) I currently spend concentrating on and researching REITs – to help investors build up a strong portfolio, for themselves and their family.
The small-cap portion of the REIT investing game – has its own rules and criteria – but it’s also just like other REITs as they’re required by law to distribute 90% of their income as dividends to you, which can grow over time as you merely, hold the shares and smile.
But here are 3 fair warnings for Small-Cap REIT investing:
With less volume of shares getting traded, the price spread for a given ticker symbol will – by necessity – be wider. So placing limit orders, instead of market orders, will likely help to keep your final price from getting attached to the higher (“ask”) side of the spread.
Also, with these more thinly-traded instruments, you may not find enough supply at the time you want to buy, so, again, patience is in order.
And due to smaller company balance sheets, fewer and less diverse holdings, and often limited or narrower future prospects, it’s a good idea to restrict your small-cap holdings to a smaller portion of your portfolio. Often, as “speculative” buys, you might not want to exceed a 1% holding in any one stock. (Check all of my REIT recommendations, including nearly two-dozen in my Small-Cap Portfolio – by subscribing to the monthly Forbes Real Estate Investor newsletter).
Let’s look at four Small-Cap REITs that can enhance your investments:
1. City Office REIT (CIO)
The Big WHY: City Office was formed on November 26, 2013, to acquire, own, and operate high-quality office properties located within its specified markets in the US. The company listed on the NYSE on April 11, 2014 (over four years ago) by raising ~$82 million at a price of $12.50 per share. It is one of the smallest office REITs in our research lab, with a market cap of around $461 million.
Feathers in its Cap: CIO invests in high-quality office properties in mid-sized metropolitan areas with strong economic fundamentals, primarily in the southern and western US. The company focuses on assets valued at $25-100 million with targeted cap rates of 7-8% (not as much competition for these assets, and this is a competitive advantage).
Downsides: CIO’s continued focus has been to push out-lease terms, with high credit tenants, reinvest in buildings to elevate its market position and find creative ways to unlock value at the properties. Retention risk is a primary concern.
Performance YTD: 2.3%
Alpha Insider Management Update: CIO’s dividend is $.235 per share, and the company generated $.18 per share in Q1-18; however, the company expects it will cover the dividend (by AFFO) in Q4-18. Maintaining STRONG BUY recommendation and we believe that as CIO’s dividend becomes safer (payout ratio under 100%), the valuation gap should tighten.
Bottom Line: CIO shares trade at $12.80 with a P/FFO multiple of 12.2x. The dividend yield is 7.34% and CIO is expected to generate 18% FFO/share growth in 2018 and double digits in 2019.
2. CatchMark Timber (CTT)
The Big WHY: In December 2014, CTT completed its public offering of 10.526M shares of Class A stock at $13.50 per share and raised gross proceeds of around $142M. CTT is a company that has opted to focus on high-demand southeastern US markets – “the fiber markets” – where it owns around 508,000 acres of timberlands. CTT operates in four distinct markets – Mid-Atlantic, Coastal, South Central, and Southwest – with diverse mills, well-capitalized customers, and strong productivity.
Feathers in its Cap: CTT’s business model focuses on harvest operations of owned and leased timberlands to secure durable earnings and does not include more volatile land development and manufacturing. CTT strategically manages harvest plans, operating in prime mill markets for sawtimber and pulpwood, to serve customers and optimize yields within sustainable parameters.
Downsides: CTT is seeing acquisition opportunities from a pricing and return perspective in the company’s very robust pipeline. These opportunities extend throughout the U.S. South as well as in the Pacific Northwest.
Performance YTD: -1.9%.
Alpha Insider Management Update: CTT announced a joint venture that will buy 1.1M acres of east Texas timberland for $1.39B. For an investment of up to $227.5M, CTT will more than triple the number of acres under its control and management to about 1.6M acres. The JV will assume existing long-term sawtimber and pulpwood supply agreements with Georgia-Pacific and International Paper (NYSE:IP).
Bottom Line: CTT’s shares trade at $12.10 with a P/EBITDA of 13.2x. The dividend yield is 4.49% and analysts forecast CTT to grow substantially in 2018 and 2019. This is a small cap ($617 million), but we find this pick worthy of consideration.
3. Gladstone Land Corporation (LAND)
The Big WHY: As Mark Twain was credited saying “buy land, they’re not making it anymore.” LAND is a farming REIT that owns 75 farms with 63,000 total acres in 9 states, valued at approximately $537 million. All farms are 99.7% leased. LAND primarily buys farmland used to grow healthy foods, such as fruits, vegetables and nuts.
Feathers in its Cap: The company’s primary focus is acquiring land to be purchased and rented for annual (or more frequent) plantings to grow fresh fruits and vegetables. These crops are grown mostly in California, Florida and adjoining states.
Downsides: Tariffs could create volatility, but LAND is focused on the more profitable specialty crop segment.
Performance YTD: 2.0%
Alpha Insider Management Update: LAND is arguably the safest farming play, and the focus on specialty (vs. row) crops provides “greater returns with less volatility”. In our view, Gladstone Land has the best potential to outperform over the next 12-24 months and management owns around 20% of the shares.
Bottom Line: LAND trades at $12.89 per share with a P/FFO of 12.9x. The dividend yield is 4.1% (and paid monthly).
4. Easterly Government (DEA)
The Big WHY: DEA is the only internally managed REIT with a focus on investing in U.S. government-leased buildings. The other direct peer is Government Properties Income Trust (GOV), an externally advised REIT. Since 2010, DEA has acquired 48 properties encompassing 3.8 million square feet, including 44 properties leased primarily to U.S. government tenant agencies, and two properties entirely leased to private tenants.
Feathers in its Cap: DEA sticks to critical missions of the Federal government that don’t go out of favor – agencies such as the Federal Bureau of Investigation and the Immigration and Customs Enforcement.
Downsides: DEA’s common stock offering in June prompted a pullback, in which the company said it was acquiring 14 new buildings for $430.0 million (at a 6.5% cap rate).Given DEA’s cost of capital today (of around 5.5%), the portfolio appears to be accretive, but there is integration risk to consider.
Performance YTD: -7.0%
Alpha Insider Management Update: DEA has a high-quality earnings stream that provides the company with stable divided growth. The combination of these two (5.28% yield + 5% growth) suggests that the company is a SWAN-a-Be (soon to be a “sleep well at night” holding, familiar to readers of Forbes Real Estate Investor).
Bottom Line: DEA shares trade at $19.90 with a P/FFO multiple of 15.3x (2-year average is 17.1x). The dividend yield is 5.28%, and we like this small cap ($1.162 B market cap) for its durable pure-play focused platform.
IN CLOSING: I hope I can prove my gamesmanship in the REIT sector, and boy do I have big shoes to fill (my small-cap REIT portfolio in 2017 generated returns in excess of 22%). The key to my success is to focus on fundamentals and to always maintain adequate diversification.
I hope that my research will enable you to become a better “gamer,” and I cannot overemphasize the importance of not putting all of your eggs in one basket. As Sir John Templeton explained, “The only investors who shouldn’t diversify are those who are right 100% of the time.”
Let me cap this column with an ongoing and appreciative nod to the Editors at Forbes.com, who allow me great pride in writing and publishing these articles on the website… and for the many readers who enjoy reading – and sharing with others – these labors of love.
I am long CIO, LAND, and DEA.
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