Undervalued REITs: Finding Opportunities in Commercial Real Estate

During their recent episode, Tobias Carlisle and Tim Melvin discussed Undervalued REITs: Finding Opportunities in Commercial Real Estate. Here's an excerpt from the episode:

[Tim] Well, again, apparently nobody’s ever going to an office again.

[Tobias] Yeah.

[Tim] And I’m guessing we’re all going to live in tents. I’m because, uh, multifamily, everybody is a very negative on multifamily housing. And I don’t understand how you can be right now because banks aren’t doing any new loans.

So supply is starting to ease up and we didn’t have a supply wave, but that’s easy. Most people can’t afford a house, right? So the old cycle of we’re going to graduate, we’re going to meet the spouse.

We’re going to have a first child. We’re going to live in an apartment while that’s happening. And then eventually we’ll move out of the apartment.

Well, there’s a whole generation now that’s stuck in front of the generation graduating. Now they can’t go anywhere, right? So there’s tonnes of demands for multifamily apartments.

And when I look at commercial real estate and this has been the case, right? Reads are now cheaper than the actual real estate. So you’ve got a disconnect in valuation because public money runs scared.

And we’ve seen what happened with office thanks to COVID. Um, so everybody assumes all offices are done, but then, uh, it was Jay Hadfield and infrastructure cap infrastructure capital went around and visited all of the office buildings in New York that were owned by the REITs that he was looking at. And what he found was, is that the bigger buildings, the newer buildings, the nicer buildings, they’re full, right?

They’re running at normal occupancy rates. And these are the properties usually that REITs own. So the only weak spot out there I see is offices.

When I look at warehouses, they’re full. When I look at apartments, occupancy rates are pretty high. When I look at, um, hotels, I mean, the recovery is kind of there.

Nobody’s staying home and avoiding, especially leisure travel because of COVID anymore. That’s not a thing that’s over. So they’re starting to catch back up.

And the two largest casino REITs in the country, extremely well-financed, very low debt ratios, uh, very high interest coverage ratios are now trading at, uh, about 80% of our internal, um, net asset value numbers. And that’s Vici properties, which is just this stunning collection of real estate.
[Tobias] That’s the Las Vegas, uh, casinos, right?

[Tim] Tonne of Las Vegas casinos, but they do have, they’ve diversified, right? They’ve got some other properties around the country off the strip, but they do, they own a large block of the strip. And they also have four golf courses in and around Vegas.

And they actually have 40 acres adjacent to the strip. That’s just sitting there as raw land that they haven’t done anything with. So for this thing to be trading at this price with this yield, uh, which is, I think it’s 8% now is just ridiculous.

I mean, it makes absolutely no sense because they didn’t miss a rent payment during COVID. They didn’t miss any rent payments back during the, um, great financial crisis, right? People love to gamble and I know you could do it on your phone and you could do it here, but there’s a certain allure in the American psyche for Las Vegas.

And now you add in Vegas has added all these sporting teams and sporting attractions. So it’s even more of a tourist destination now.
[Tobias] So there’s been some suggestion that Vegas has had this little bit of a slump recently because it’s too expensive. What do you think?

[Tim] There’s a little bit. And when we look at this, we have a bifurcated economy. Everybody knows the K shaped economy, right?

Well, the bottom leg of the case, get a little larger and you know, the bottom 50% of Americans, inflation, energy prices, all of this is starting to hit them. The affordability of housing, you know, look, I try to avoid it, but occasionally I have to go to the grocery store. Um, and prices are going up and they’re going up consistently, not as dramatically as they were, but stuff still costs more and energy has come down a little bit, but it’s been running consistently much higher.

And so that all, it takes a bite and that eventually takes a bite out of some of Las Vegas travel. And yeah, it’s expensive to go to Vegas, but the casino business, as long as they have the whales, everything else is just extra cashflow.
[Tobias] And it’s a cyclical business when it’s when you want to buy it.

[Tim] Yeah. Yeah. I mean, it’s, it’s, it’s going to come back and this real estate is all a very long-term leases 20 years and more with accelerator clauses in the lease.

So there’s kind of a natural dividend growth built into these things. So when you look at VG, which is VICI and a gaming and leisure properties, which is GLPI, I mean, GLPI. Yes.
[Tobias] What a, what a missed opportunity for those should have been selling those weight loss drugs.

[Tim] Yes. So, you know, we like both of those. Um, Cousins property, CUZ is a Sunbelt office street and it’s got to, this thing should be trading at a massive premium to net asset value.

It is not, it is trading at a discount to net asset value, very well financed. And these aren’t just classic buildings, right? First they’re in the cities.

Everybody’s moving to Charlotte, Tampa, Orlando, Atlanta. There were everybody’s moving from the Northwestern Northeastern cities in the Midwest. These aren’t the class A buildings.

They’re the trophy buildings. They’re actually getting a premium to class A office space and rent. They’re the very best buildings with the very best amenities and they charge for it and they’re full.

So this thing sitting here trading, it’s about a four and a half percent dividend. So this isn’t your, you know, this isn’t the one to invest in if you absolutely need the maximum cash, but it’s just sitting there just spitting out cash. It’s undervalued and it’s, you know, at some point that value begins to get recognised in the marketplace.

And it’s offices and that brush paints wide, but the truth is there’s still a lot of people going to work every day. Not in Greensboro, thankfully, we never had rush hour, but I’d rather imagine that in Atlanta, traffic hadn’t gotten any better because somebody or same with LA or anywhere else. But this is all mostly Southeastern Sunbelt, a little bit of Austin.

The buildings are full and they’re charging top dollars. So when we look at that, it’s hard not to get excited about that. We like the retail space too, especially the standalone retail space like ADC, which has seen very heavy insider buying.

And that’s a GE realty company. And that’s just, that’s Starbucks, that’s the Home Depot, that’s standalone properties. It’s yielding about 4.79%. It’s gas stations. We’ve got decent amount of insider buying pretty much continuously since the end of last year. And it’s just, you know, long-term standalone buildings, triple net lease properties, which means that the tenant is paying maintenance, they’re paying insurance, they’re paying taxes. All the REIT is doing is taking the money and cashing the check.

So to me, that’s a pretty good deal. And like I said, most of these tend to be essential businesses that never closed during COVID. They’re not franchises that are going out of business for the most part.

So we’re real comfortable owning that because again, very well-financed, very little actual financial risk and buying it at a discount to net asset value. And then the other one that we like is CTO Realty. This is the old CTO Consolidated Samocha, which at all value investors will instantly recognise the name because everybody owned it back in the day, right?

It was this collection of real estate. And then a few years ago, they did the real REIT conversion. And this one’s thrown off a huge dividend income.

And it is open-air shopping centres for the most part in areas with high property density and high average incomes. And you’ve got about a 7.7% yield trading at around 80% of our internal estimate of net asset value. Very low multiples of funds from operations.

So the dividends are covered and growing. They are going to disappoint earnings today because I talked about it on the show today on the 27th of October when we’re actually filming this. So they’re reporting earnings after the market and they’re probably going to disappoint.

So I think you’re probably going to get a better price tomorrow because that’s always how this happens for me.