This is a guest contribution by Bob Ciura of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios for the long run.
Interest rates are declining again, which puts income investors in a difficult spot. The Federal Reserve lowered its benchmark interest rate this year, marking the first cut in rates since 2008 when the U.S. economy was in the midst of a deep recession. Now that the Federal Reserve has taken action to lower interest rates, yields of all types of investments are following suit.
Fortunately, there are still corners of the stock market that provide high dividend yields. Income investors looking for above-average yields should consider investing in Real Estate Investment Trusts, also known as REITs. Many REITs have high dividend yields, and even better, REITs are among the biggest beneficiaries of declining interest rates.
The following three REITs have high dividend yields, with payouts that appear to be sustainable. We also view these three REITs as significantly undervalued, especially in a low-rate environment.
Undervalued REIT #3: Brookfield Property REIT (BPR)
Brookfield Property REIT (BPR) is a subsidiary of Brookfield Property Partners (BPY) and their parent company Brookfield Asset Management (BAM). BPR was created in July 2018 upon completion of the acquisition of U.S. mall owner General Growth Properties (GGP) for $9.35 billion. Shares are aligned with parent company BPY, which controls 82% of the outstanding units.
We believe BPR has a positive outlook in the years ahead, as its assets are primarily comprised of Class-A U.S. shopping malls. BPR is led by an effective management team, which has demonstrated a long history of purchasing and developing premium real estate assets purchased at a discount. The acquisition of GGP is an additional catalyst for future growth.
BPR targets 12-15% total returns for shareholders over the long term, comprised of FFO growth and dividends, which appears to be a reasonable target. We expect 6% annual FFO growth per year, while the dividend yield is currently 6.9%.
Although the payout ratios have remained high in the 80-90% range historically, the actual payout ratios were 65% or lower since 2016, when accounting for asset sales, which imply a safer dividend than viewed on the surface. With the nature of their assets being premium real estate properties, we expect the stock to continue to generate stable cash flow and dividends even in the event of a recession as cash flows are tied to long-term leases in place with Class-A tenants.
Based on 2019 expected FFO-per-share of $1.57, the stock has a P/FFO ratio of 12.1. We feel a fair valuation for BPR is a P/FFO ratio of 16.4, which is equal to the 10-year average valuation of the stock. Expansion of the valuation multiple could boost annual returns by 6.3% per year. In addition to 6% expected annual FFO growth and the 6.9% dividend yield, total returns are expected to exceed 19% per year through 2024.
Undervalued REIT #2: Tanger Factory Outlet Centers (SKT)
Tanger operates, owns, or has an ownership stake in a portfolio of 40 shopping centers. Properties are located in Canada and 20 states, leased to over 500 different tenants. At first glance, it appears Tanger is a risky pick due to the decline in mall traffic in the United States. However, Tanger’s focus on outlet shopping centers has helped insulate it from the threat of e-commerce, as a segment of the population still values the discounts found at outlet malls.
In the most recent quarter, Tanger generated adjusted funds from operations (FFO) of $0.57 per share, a decrease of 5% compared with $0.60 per share in the same quarter last year. However, traffic increased 2.3% for the quarter, and Tanger grew its occupancy rate by 60 basis points from the previous quarter, to 96%.
Occupancy is expected to decline somewhat in 2019 to a range of 94.0% to 94.5%, due to anticipated store closures by certain tenants. Tanger is somewhat impacted by store closures, but again to a much lesser extent than REITs that rely on department stores or lower-quality retailers.
Tanger stock has a current dividend yield above 9%, which is highly attractive for income investors. Importantly, Tanger’s dividend appears to be sustainable. Tanger’s expected 2019 dividend payout ratio is 65%. The company has increased its dividend for 26 consecutive years, including the years of the Great Recession.
The dividend could be sustainable even in a recession, as Tanger went through the Great Recession virtually unscathed. Its adjusted funds from operation (AFFO) declined just 2.2% from 2008-2010. The underlying business model, outlet centers, still attract customers during a recession as shoppers look for discounts and lower prices.
Based on 2019 expected FFO-per-share of $2.25, Tanger shares trade with a price-to-FFO ratio of 7.0. Our fair value estimate is a P/FFO ratio of 11.5. Expansion of the valuation multiple could boost annual returns by 10.4% per year. In addition to 4% expected annual FFO growth and the 9.0% dividend yield, we expect total returns of approximately 23.4% per year through 2024.
Undervalued REIT #1: Macerich Company (MAC)
Macerich Company owns, operates, and develops retail real estate. It owns approximately 51 million square feet of real estate, consisting primarily of interests in 47 regional shopping centers. Macerich has a market capitalization of $4.2 billion.
The company has been affected by the weak retail environment, particularly its exposure to Sears. However, Macerich continues to perform well so far this year. In the most recent quarter, Macerich’s FFO-per-share increased 6% from the same quarter last year, due primarily to a 12% increase in mall tenant annual sales-per-square foot. One slight negative for last quarter was that the company’s mall portfolio occupancy slightly decreased, but still remained at a satisfactory level of 94.1%.
For 2019, management expects funds from operations of $3.50-$3.58 for 2019. With an annualized dividend payout of $3.00 per share, Macerich is expected to generate more than enough FFO to maintain its dividend payout. That said, with a projected payout ratio of ~84% for 2019, investors should closely monitor the company’s future results to make sure its FFO growth remains on track.
Macerich stock has a particularly low valuation. The stock has a P/FFO ratio of 7.6 using 2019 FFO guidance. Our fair value estimate is a P/FFO ratio of 13, which we believe to be a more accurate measure of fair value, given the company continues to generate strong FFO.
Expansion of the valuation multiple could boost annual returns by 11.3% per year. The stock also has a high dividend yield of 11%. In addition to annual FFO-per-share growth, which we estimate at 2% per year, Macerich stock could generate annual returns of more than 24% over the next five years.