As the editor of the Forbes Real Estate Investor, I have the responsibility to research over 125 individual Real Estate Investment Trusts (or REITs) and over a dozen property sectors.
Many of our choice picks come from the basic “food groups” or property sectors such as retail, apartments, healthcare, and industrial. Since these are considered “mainstream” property sectors, most investors can easily identify with their attributes and potential for growth.
However, sometimes the best opportunities are found within the specialty REIT categories, that lack investor understanding, and often shares are mispriced because of their complexity.
However, as an analyst, it’s my job to get deep in the weeds so that I can provide readers with a simplified understanding of the fundamentals and determine if there is a meaningful margin of safety that could possibly generate above-average returns.
Today I decided that I would introduce readers to three little-known REITs, that are unique because of their property attributes. I consider all of these REITs attractive based upon their valuations that offer potential for massive returns in 2019.
GEO Group (GEO) is a prison REIT that was established in 1984. The Florida-based REIT provides secure corrections and detention management services as well as secure transportation services to government customers in the U.S. and internationally. The company listed on the NYSE in 1996 and converted to a REIT in 2013.
GEO’s U.S. Corrections & Detention division oversees the operation and management of approximately 75,000 beds in 64 correctional and detention facilities providing services on behalf of the Federal Bureau of Prisons, U.S. Marshals Service, U.S. Immigration and Customs Enforcement as well as 10 state correctional customers and various local jurisdictions.
GEO’s International Services division provides correctional and detention services for government agencies in the United Kingdom, Australia, and South Africa managing seven correctional and detention facilities encompassing approximately 8,000 beds, including projects under development.
As part of a broader political move to focus on prison reform, there's a growing governmental shift on rehabilitation. GEO has been growing its halfway house business model, and this should mitigate some of the headwinds associated with the "incarceration for profit" argument. Through the delivery of high-quality, innovative, and effective programs, GEO Care has established itself as the premier provider of diversified community re-entry and rehabilitation services.
GEO is rated BB- by S&P and the company’s continued strong performance of its diversified business units has allowed it to increase its quarterly dividend payment. The dividend payment is well within its guided payout ratio of 75% to 80% of AFFO and is supported by stable and predictable operational cash flows.
GEO under-performed in 2018 (returned -8.5%) and shares now trade 1t 10.1x P/FFO, around 20% below the historical 4-year average (of 12.1x). The dividend yield is now 9.1%, signaling that there is the possibility of massive returns (in excess of 25%) in 2019. Analysts forecast around 5% growth in 2019 and over 10% in 2020.
Corporate Office Properties (OFC) is also wrestling with political headwinds, primary a result of the current government shutdown. However, one of the biggest misconceptions, as it relates to a temporary shutdown, is the impact to DoD spending.
While some important agencies are impacted, such as Homeland Security, Transportation, Interior, Agriculture, State and Justice, as well as national parks and forests; Social security, military, Medicare and Medicaid will remain in operation. In other words, a government shutdown will have zero impact on national security, the government will continue to pay all obligations (including rent).
Corporate Office Properties is the only REIT that is specifically focused on serving U.S. government agencies and defense contractors engaged in defense information technology and national security-related activities. This is a very strategic niche, and one in which Corporate Office tenants are generally focused on knowledge-based activities such as cybersecurity, R&D, and other highly technical defense and security areas.
The company owns 159 office and data center shell properties, encompassing 17.7 million square feet and that were 94% leased as of Q3-18. Of these, the company owns 152 buildings in Defense/IT (15.7 million sf) and 7 regional office buildings (2.0 million sf).
Corporate Office shares have been pummeled by the government shutdown, and this has created a buying opportunity. In 2018 shares returned -24.2% and this translates into an attractive dividend yield today of 4.9%. I believe that shares will begin to normalize in the first quarter and my Strong Buy recommendation is predicated on a total return target of over 25% in 2019.
Outfront Media (OUT) is the third specialty REIT that is also the largest out-of-home media company in North America with a portfolio of around 500,000 digital and static displays, which are primarily located in the most iconic and high-traffic locations throughout the 25 largest markets in the U.S. The company went public (IPO) on March 28, 2014 and began operating as a REIT on July 17, 2014.
The company is also the advertising partner of choice for major municipal transit systems, reaching millions of commuters daily in the largest U.S. cities. The company has displays in over 150 markets across the U.S. and Canada.
The key growth drivers for Outfront include digital billboard conversions, but and in the latest quarter the company grew AFFO per share by over 10%. The payout ratio was 72% on an LTM basis in line with the company’s long-term historical average compared to free cash flow. The company has ample liquidity of over $400 million, comprised of unrestricted cash and unused availability on the revolving credit facility.
Similar to the other specialty REITs (GEO and OFC) I see strong potential for Outfront to deliver high double-digit returns. The U.S. economy is on sound financial footing, thanks in large part to tax reform, and I believe that a recession is less likely in 2019. Outfront trades at 8.9x P/FFO with a dividend yield of 7.7%. Shares returned -15.7% in 2018.
In closing, a bit of caution, as these three REITs are not considered “sleep at night” enterprises. Shares could become more volatile as it relates to their business operations and investors should always remember to maintain adequate diversification (don’t put all of your eggs in one basket).
I own shares in OUT and OFC. Also, my co-author of The Intelligent REIT Investor is also an employee of Corporate Office Properties.
