Real estate companies are plummeting. Headlines everywhere scream of the effects of this high inflation, high interest rate, macro environment, and real estate companies. These headwinds, however, hold little to no actual substance and neglect the very fundamentals of these businesses. To begin, we must understand how these businesses operate, we have to understand how REITs grow their AFFO(this is their version of free cash flow). AFFO growth rate= +Same store rent growth +AFFO retention%• acquisition cap rate•(100%-corporate overhead-maintenance expenses) +AFFO retention%•Debt to equity ratio•(acquisition cap rate-cost of debt)•(100%-corporate overhead-maintenance expenses) Let’s use an example: Realty Income($O) +1.2%=1.2% +1.8%=26%•7.3%•(100%-4%-1.5%) +.2%=26%•.79•(7.3%-6.2%)•(100%-4%-1.5%) note: 6.2% cost of debt is conservative relative to their historical 5.3% Only roughly 6% of this company’s growth is dependent on debt. This is the magic of a real estate company with a high cash retention rate. Realty income, and many other nnn REITs with high AFFO retention, like $VICI and $ADC, can operate in these environments with little to no effect on their growth, in fact for companies with high AFFO retention rates, these higher debt costs can actually allow them to get properties for a cheaper price when they pay cash which boosts their acquisition cap rate or initial return on investment. Furthermore, if we use a discounted AFFO model to value Realty income and we ignore debt entirely, then we can comfortably assume a 3% growth over the next 10 years and then 2% after that. With these very conservative assumptions, paired with a 10% cost of equity, I came to a fair value of about $62 per share. That means that buying at this price you are getting a forward return of 11% on what is arguably one of the most defensive companies on earth.(I might do a deeper dive on this one soon). Additionally, last quarter alone, the average institution increased their share count in real estate companies 6.8 times more than their 2 year average, increasing their share count by 4.5% in one quarter. Also, over the last two years, institutions deployed an average of about 1.9% of their cash into real estate versus last quarters nearly 3.5%, almost doubling their historical allocation. This transfer from historical underweight to aggressive allocation shows strong conviction from sovereign, wealth funds, as well as asset managers. So high-quality, inflation resistant companies are trading at a structural discount and institutions have clearly taken note. Could this be a generation buying opportunity? What are your thoughts on real estate right now?
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Larry @larryk · 15m
REITs are tax infefficient and suitable for retirement accounts
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