Yesterday, I wrote about the potential M&A wave that Green Street Advisors thinks may hit the REIT industry. According to the research firm, REITs trade for about 85% of the value of the properties they hold and that makes them attractive to private equity and real estate fund managers. Sam Zell, one of the best real estate investors in history, has commented several times in the past year that small REITs have the asset size or access to capital to compete with bigger REITS and will need to seek merger partners.
Zell's theory is really similar to my trade of the decade in small banks that has been working so well, so it has my attention. I have done very well with REITs over the years, and I am pretty sure they run second only to banks as a source of funds to pay for my bad habits.
I sat down this morning and ran a screen looking for REITs that own real property and have less than $2 billion in total market capitalization. Ashford Hospitality Trust (AHT) is at the top of my list of smaller REITs that are very cheap when compared to asset value. The hotel REIT it spun off back in 2013, Ashford Hospitality Prime (AHP), has already announced it is conducting a strategic review to consider a sale, and I would not be shocked to see its former parent company go on the block as well. The company is refocusing to concentrate on its portfolio of luxury hotels. It has a portfolio of 23 select service hotels for sale.
In their most recent earnings report, management pointed out just how undervalued the stock is at the current price. They noted in the press release that "The company's common stock is currently trading at a trailing 12-month NOI cap rate of approximately 8.4%. Based on deals the company has seen trade and other market information from industry consultants, the company believes similar assets to those in its portfolio are trading in the private market at an approximate average trailing 12-month NOI cap rate of 7.0%, which would imply a share price for Ashford Trust common stock of $15.85, which is approximately 91% higher than the current trading price of Ashford Trust common stock."
At that steep a discount, they have to be considering some steps to unlock shareholder value or they will almost certainly attract an activist who pushes for strategic measures. You get paid to wait for future developments that unlock shareholder value as Ashford Hospitality has a current dividend yield of 7%.
Independence Realty Trust (IRT) has been on a buying binge since the start of 2014 that culminated in its recent takeover of Trade Street Residential (TSRE). Post-merger, the apartment REIT now has 50 properties with a total of 14,044 units for lease. The current high demand for apartments is driving high occupancy rates; the merged company will have an occupancy rate of 94.5%. Management at Independence said the deal should be accretive to earnings starting in 2016 and put them in a strong position to continue raising the current $0.18-a-share quarterly dividend.
The management firm running Independence is committed to growing the company and has given no indication of any desire to sell, but if you look at the properties it owns on a map, it is clear it has a strong presence in some of the hottest markets in the Southeast, as well as Texas and Arizona. Apartment demand is expected to stay strong for some time. For a wide range of demographic, economic and social reasons, the millennial generation has very little interest in homebuying so far. In addition, a significant percentage of American who suffered a steep financial loss or foreclosure in the recent credit crisis have no desire to own a home again.
Talking with my 27-year-old son and his friends about this trend is eye-opening. They are all doing well in their careers but are simply in no hurry to form a family or buy a home. They are keeping career options open and want to be flexible enough to walk away if an attractive job opening becomes available in another location. Homeownership is not high at all on their priority list, and they do not expect that to change soon.
Given the high demand for multifamily housing, I have no problem seeing a larger REIT looking at the geographically attractive, high-occupancy, profitable apartment portfolio of Independent and deciding it makes sense to just expand by acquisition. Even if it never happens, this a nice portfolio of properties with management committed to growing the value and dividend payout over time, so it should work out very well. The stock is trading right at the pro-forma book value as calculated in the merger prospectus, so there appears to be plenty of long-term upside from this price no matter what happens.
Smaller REITs seem to have the same choice as my small banks -- get big or sell. Either outcome should be rewarding for shareholders who buy at low multiples of current asset values.