REITs Expert Chooses Small Cap Stock Winners: Brandywine (BDN) And Lexington Realty Trust (LXP) Among Top Picks
February 9, 2010 - The Wall Street Transcript has just published REITs Report offering a timely review of the REIT sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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David M. Fick, CPA, is a Managing Director of Stifel, Nicolaus & Company. He joined the firm's research team in connection with Stifel's acquisition of Legg Mason's Capital Markets Group in December of 2005. Mr. Fick joined Legg Mason in 1997. Prior to Legg Mason, he was Senior Vice President of finance and compliance at Alex. Brown Kleinwort Benson, as well as Equity Vice President at LaSalle Partners when the two firms merged. Mr. Fick was also Chief Financial Officer of Western Development/Mills Corporation, and a practicing CPA and consultant with a national accounting firm specializing in the real estate industry. Mr. Fick is an instructor at the Johns Hopkins University Carey Business School, where he teaches real estate finance, real estate accounting and taxation, and real estate capital markets. He has an M.B.A. from Loyola College of Baltimore and a B.S. from Towson State University. Mr. Fick is a member of the National Association of Real Estate Investment Trusts, the International Council of Shopping Centers, the Urban Land Institute and the American Institute of Certified Public Accountants.
TWST: What's your outlook for the REIT industry in 2010?
Mr. Fick: We think that the sector is entering a new era that will be characterized by lower leverage, more stability, spread investing, less value creation and more core "REITs-as-a-mutual-fund-of-real-estate'" strategies. We feel pretty good about where the sector is sitting right now because the cost of capital today is about half of what it was a year ago for public REITs. If we look at 2009 as a setup for 2010, at the beginning of 2009, REITs were seen by investors as the victims of a crisis and that many would not survive. Virtually all survived, including the only REIT that went into bankruptcy, General Growth Properties (GGWPQ.PK), and with some serious equity still remaining, even in GGP's situation. We went from being a victim of the crisis to being the beneficiary of the crisis in the eyes of many investors. What that has done has driven the average implied cap rate down into the 7%s. And for the better REITs like Simon Property Group (SPG) - the guys with the best balance sheets - we're seeing implied cap rates in the mid-6s. If they can put money out, if they can invest at an 8 cap, or 7.5, maybe even a 7, it's accretive to existing shareholders.
That's created optimism on the part of both dedicated and non-dedicated investors that there will be some external growth. I think that investors are now looking at that as a reason to pay up for the stocks. We think the average REIT is now trading at 120%, maybe even as high as 125%, premium to underlying asset value mostly because of that expectation of external growth. The other thing I would say related to that is none of us sell-side analysts have any significant acquisitions in our models at this point. We are already seeing some upside to estimates, and that is likely to continue. For example, Simon Property Group purchased for $2.3 billion Prime Retail last month. No one had that in their model because you didn't know who was going to win, and that created $0.20 of earnings upside for 2010 already for Simon, and they're just getting started.
TWST: What are some of your favorite names?
Mr. Fick: We recently published an overweight, underweight, equal weight portfolio for investors that is intended to answer that question. Just to give you an idea of the kinds of companies we like in the office space, covered by my colleague John Guinee, for the small-cap names we like companies like Brandywine (BDN) and Lexington Realty Trust (LXP). In the bigger caps, it would be companies like Brookfield (BPO) or SL Green (SLG), all for very different reasons. In my coverage area in retail, overweights tend to be smaller companies. The one larger-cap name where we're overweight for the year is Equity One (EQY). National Retail Properties (NNN) is a mid-cap; for income-oriented investors, it has a very nice dividend yield. And then Weingarten (WRI) would be the other strip center REIT and my number one pick in retail for the year.
I think it's under-owned, misunderstood by investors and a bit in the mode of trying to repair its reputation with institutional investors, but we think they will get there. We only have one multifamily overweight, and that's Essex Property Trust (ESS) because we're equal weighting the multifamily space this year. My partner, Rod Petrik, is overweight on lodging, and if we were picking one it would be DiamondRock Hospitality (DRH). We also like Host (HST) and Hospitality Properties Trust (HPT), both more of an income play than anything else. And then lastly, LaSalle (LHO). Not a whole lot left in our target prices, frankly, on any of those names except DiamondRock. Jerry Doctrow on our team has seven health care names that are overweight. And I won't go through all of them, but if you were to pick one it's probably Ventas (VTR). Virtually all of them are going to have pretty significant external growth, so we think you almost can't go wrong owning a health care name at this stage. There are a couple of ways to look at health care REITs - you can play defensive names and then there are some that are a bit more offensive in terms of their ability to consolidate. If we were buying one health care company, we would actually not buy a REIT, we'd buy Emeritus (ESC), which is a need-driven assisted living provider.
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