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While bank CDs and money market funds have been paying next to nothing for the past 8 years, good REIT managers have delivered double digit total returns. But, Sam Miklosko says it’s time to sell REITs like American Tower that yield less than 3%.
Sam started his REIT Opportunity fund at Marketocracy in April, 2009. His returns have averaged 19.21% since then, which compares nicely to the S&P 500’s 15.04% return over the same period. His returns would rank him above all U.S. Equity fund managers for the last 12 months, and in the top quartile for the 5 and 3 year periods. Before taking anyone’s investment advice, you should always check out their track record. Here is Sam’s.
Ken Kam: Why do Wall Street analysts like American Tower Corp so much?
Sam Miklosko: Analysts like American Tower because they see AMT as a growth vehicle even though REITs are primarily purchased as income vehicles. Analysts see a company that owns satellite towers across the globe, especially in Latin America, where the potential for growth exists. A company such as American Tower Corp could supply the demand for advanced networks as consumers demand quicker internet speeds. American Tower Corporation is one of the most popular REITs, outperforming the S&P 500 by at least 6 points while paying dividends.
Kam: The mean recommendation from Wall Street is still a buy. What is Wall Street missing?
Miklosko: Well, as investors, we need to be more discerning in our selection of stocks as runaway growth has stalled. Despite articles of huge cash influxes into REITs, AMT is not necessarily a buy in terms of growth. An example of a sector that experienced runaway growth as a result of popularity is biotech, which experienced a bubble and consequently a collapse in stock prices thereafter. What’s the similarity between these two distinct sectors? Price to free cash flow is an integral metric in the evaluation of both. Once a growth stock stops being a growth stock, investors looking to hold for the long term should wait out for a correction in the price of AMT to enter what will become a value stock.
Kam: Is American Tower Corp fully valued or overvalued?
Miklosko: The real intrinsic value of AMT is questionable as the company is currently trading fifty times its free cash flow, a red flag in the REIT sector. American Tower has experienced growth but with its correlation to the S&P, a decision by the Federal Reserve to raise rates can easily send AMT back to January levels.
Analysts are not wrong to say that American Tower Corp has a great business model by preparing itself for the potential demand for better technology. But in the current state of the market, the mean recommendation from analysts to buy is hardly warranted.
Kam: As the economy weakens, what can investors expect to happen?
Miklosko: The reality is that American Tower will not be as attractive to investors as it loses it allure of being a growth stock. AMT has a dividend yield of approx. 2.03%, less than half of the industry’s yield of approx. 4.25%. Any yield below 3% in a low growth environment may limit an income investor’s potential.
American Tower leases space for communication sites, wireless service providers and radio/television broadcasts. They operate in many countries in Latin America, Africa, as well as India and Germany. With earnings per share down 30% this year, investors should be looking to healthcare REITs and possibly a mortgage REITs such as Apollo Commercial Real Estate Finance for their income needs which won’t be harmed as much by any potential rate hike.
Certain REITs might become a high risk low yield investment in a weakening economy considering investment grade bonds are currently yielding well over 3%. This is not to say that American Tower isn’t a great company with potential to be an investment for the long term but at current price levels, new investors could very well find undervalued companies instead of paying a premium for AMT.
Kam: Why will a yield below 3% limit an income investor’s potential?
Miklosko: The reason why a yield below 3% limits an income investor’s potential is because of the generally accepted drawdown rule that financial advisors use when planning their clients retirements. The rule states that if you were to withdraw 4% (now 3% as low interest rates have persisted) of their initial retirement portfolio balance, and adjust the dollar amount for inflation for each consecutive year, the result is a nice return on your cash that would allow you to live well for thirty years. Thus, a sub 3% yield could possibly force investors in the future to sell out a position for income needs. As a consequence, this would reduce the ability to compound dividends.
Kam: Are there other popular REITs that yield less than 3%?
Miklosko: There are other REITs with similar average volumes to American Tower that yield less than 3% such as Mack Cali Realty Corp and Sunstone Hotel Investors Inc. Using the formula of Market Capitalization divided by free cash flow, Mack Cali Realty Corp MC to FCF is equal to 97 and Sunstone Hotel Investors is equal to 50. All three firms have ratios above 50. This should provide a good idea of the market valuations of popular REITs.
Kam: What questions would you like to ask the top management at American Tower?
Miklosko: What measures are being pursued to extract more value for shareholders and will we see a dividend in excess of 3% in the future?
My Take: For many years now REITs have been the salvation for many investors on the conservative side of the risk-spectrum. But, the big risk now is that many REITs will lose value when interest rates start rising.
Sam’s strategy to address this risk is to invest in REITs that own properties in markets where rents are rising. By raising rents, these REITs may be able to increase their dividend payouts enough to offset the negative impact of higher interest rates.
However, in order to buy these stocks, he first has to decide what to sell.
For investors who are withdrawing 3% a year from their portfolios to meet living expenses, REITs that don’t yield at least 3% will put them in the situation of having to sell stock -- potentially at a bad time. Selling these low-yielding REITs now and putting the money into REITs with higher yields and the ability to grow their income by raising rents makes a lot of sense.
I don’t know of any REIT index fund that capable of executing this strategy.
To explore whether Sam’s strategy makes sense for you, schedule a One-on-One with Ken Kam.
Disclosure: I am the portfolio manager for a mutual fund advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.
