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REITs: Strategies for Dividend Growth Amid Market Challenges

August 11, 2024

Note: We reveal investment insights through the quotes of top business leaders.

Key Takeaways

  • REITs are leveraging strong demand and strategic market positioning to maintain high occupancy rates despite pricing pressures.
  • Higher interest rates are increasing borrowing costs, impacting earnings and cap rates negatively.
  • Sector-specific challenges are being met with targeted strategies, such as focusing on senior housing for demographic-driven growth.
  • Consistent dividend growth is achieved through disciplined investments, financial models, and operational efficiencies.
  • Enhancing operational efficiencies and managing costs through technology and portfolio optimization are key to maintaining financial health.

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Current Market Conditions Impacting REITs

REITs are navigating varied market conditions: EQR faces pricing pressures but maintains high occupancy due to strong demand. Realty Income notes real estate values fluctuate with market conditions. Simon Property Group remains undeterred by potential recessions. Ventas benefits from its senior housing focus amid economic slowdown. Prologis sees stability and optimism in its global portfolio.

"Our Southern California markets have good demand, but are feeling some pressure on pricing. In our expansion markets, we continue to feel the impact of new supply as expected, but have been able to maintain occupancy at or above 95% given the strong demand in those markets." --- (EQR, earning call, 2024/Q2)

"Since real estate values historically rise and fall with market conditions, presentations of operating results for a REIT, using historical accounting for depreciation, could be less informative." --- (O, sec filing, 2024/Q1)

"So -- and honestly, I'm not looking at a current potential recession or tough market as any basis to slow down." --- (SPG, earning call, 2024/Q2)

"As the broader economy shows significant signs of flowing down and the labor market softens, Ventas' business with over half in senior housing is highly advantaged across the REIT space." --- (VTR, earning call, 2024/Q2)

"puts and takes across our global portfolio have provided conditions that are largely stable with reason for intermediate-term optimism due to several quarters of low starts and subdued but positive demand. Turning to capital markets." --- (PLD, earning call, 2024/Q2)

Impact of Interest Rates on REITs

Higher interest rates have led to increased borrowing costs for REITs, impacting earnings and cap rates adversely. Companies like SPG, EQR, and VTR have noted significant effects on their financial performance, with interest rate hikes diluting earnings and affecting cap rates negatively.

"The weighted average interest rate was 5.30% for the six months ended June 30, 2024." --- (SPG, sec filing, 2024/Q2)

"And I think there's some fear now that if the Fed was to raise rates or stay higher for longer, that would affect cap rates in a way adverse to their interest." --- (EQR, conference, 2024/06/04)

"So there's a little bit of dilution from that. But I think when you look into 2025, we've got $1.8 billion, $1.9 billion, a 4.2% I just talked about how maybe there's 100 basis points of dilution if we were to do something like sterling and dollars based off of today's indicative rates that would have no more than about a 50 basis point impact to earnings. So it's obviously come in quite a bit." --- (O, earning call, 2024/Q2)

"And look at the interest rates, I mean, we're up a good 70, 80 basis points since the last time we all met." --- (PLD, earning call, 2024/Q1)

"The increase in our midpoint can be explained by a $0.03 per share improvement in organic SHOP NOI, partially offset by higher interest rates." --- (VTR, earning call, 2024/Q1)

Sector-Specific Challenges and Responses

Retail REITs like SPG face tenant bankruptcies and lease rejections, while residential REITs like EQR encounter debt challenges but see acquisition opportunities. Realty Income deals with space renewals and write-downs, and Ventas capitalizes on demographic demand in senior housing for growth.

"We don't -- as part of our discussion, we'll never get into a retailer-specific response, but obviously, bankruptcy for tenants has a lot of -- a lot goes on, leases have to be rejected depending on where they were on that and what happened." --- (SPG, earning call, 2024/Q1)

"And there's some other owners of more stable properties that also were seeing some debt challenges, and we just expect more opportunities where, as Bob has mentioned, really well poised to take advantage of them. We just need the right price given the rate environment." --- (EQR, earning call, 2024/Q1)

"And I think that was one of the lessons that this particular sector had to learn the hard way when they went through renewals and they were taking write-downs in space. But outside of that, make sure that things that can become obsolete are investments that we would want the operator to make. And we stay as close and as true to the" --- (O, earning call, 2024/Q2)

"It’s an exciting time for our business. We are driving performance in the early stages of an unprecedented multi-year NOI growth opportunity, fueled by powerful demographic demand and the most favorable fundamentals ever in the senior housing industry. Ventas plays an essential role in the longevity economy, serving a large and growing aging population, with over half our business and senior housing." --- (VTR, earning call, 2024/Q2)

"Specific to other income, our expectation remains unchanged that this will be a contributor of 30 basis points to our full year same-store revenue growth." --- (EQR, earning call, 2024/Q1)

Strategies for Maintaining and Growing Dividends

REITs maintain and grow dividends through consistent growth strategies, disciplined investments, and financial models. Prologis emphasizes consistent high returns with leverage, Simon Property Group focuses on disciplined investments for long-term growth, and Realty Income uses financial models to ensure cost-effective growth. Ventas and Equity Residential highlight enterprise growth and expense discipline.

"Secondly, we pay a 3.7% dividend and we have consistently grown at high single digit, low double digit returns on growth with 20% leverage for decades." --- (PLD, conference, 2024/05/30)

"Demand for our space from a broad spectrum of tenants is strong and steady. Our company is focused on creating value through unique and disciplined investment activities that will continue to deliver long-term growth and cash flow, funds from operations and dividends, as you've seen by our recent increase in our dividend per share." --- (SPG, earning call, 2024/Q2)

"It's largely driven by the CAPM model and the dividend growth model. And I think we take the average of the two to come up with our cost effective long-term cost of equity and the long-term cost of debt and it's 65%, 35% weighted. And all of our investments need to meet that hurdle rate and exceed that." --- (O, earning call, 2024/Q1)

"Debra Cafaro: Yes. I mean our whole strategy is designed to increase our enterprise growth rate, expand our shop footprint and because of the way we are funding the assets to continue to improve our balance sheet." --- (VTR, earning call, 2024/Q2)

"So being able to drive that kind of top line revenue opportunity, coupled with expense discipline that we've demonstrated and continue to demonstrate, we think that we can deliver a margin that is approaching 70% or hopefully even better as we kind of layer in these innovation and this technology and just -- the team operates at maximum efficiency." --- (EQR, earning call, 2024/Q2)

Operational Efficiencies and Cost Management

REITs are enhancing operational efficiencies and managing costs by leveraging technology, optimizing asset portfolios, and improving leverage metrics. Ventas achieved lower operating expenses through cost efficiencies, while Orion Office REIT identified non-core assets for divestment. Realty Income focused on leverage management and free cash flow generation to support operational efficiency.

"REVPOR performed in line. Operating expenses were lower than expected due to continued strength in net hiring and cost efficiencies realized by our operators, leveraging insights from our Ventas OI platform." --- (VTR, earning call, 2024/Q1)

"And that's the analysis that the asset management team is undertaking far more directly today than I think we've done in the past and that's the reason why we've come up with the $400 million to $500 million of assets that we feel like does not necessarily have a long-term future in our portfolio. And that's how we come up with the list." --- (O, earning call, 2024/Q2)

"Strong SHOP organic growth also drove a 20-basis-point sequential improvement in our net debt-to-EBITDA in the first quarter, further supporting our leverage trajectory was $94 million in equity raised at an average price of $44.04 to fully fund senior housing investments." --- (VTR, earning call, 2024/Q1)

"As a reminder, we manage our leverage through the lens of net debt and preferred equity to annualize pro forma adjusted EBITDA.During the second quarter, we generated approximately $200 million of adjusted free cash flow, over $100 million in real estate sales proceeds, and approximately $185 million of forward unsettled equity sold through the ATM." --- (O, earning call, 2024/Q2)

"In this edition, Rui Jin shares his experience applying technology to develop operational efficiencies: https://t.co/sWcqbrgkgW https://t.co/0VUAgZ5BH2" --- (O, twitter, 2024/04/23)

Regulatory and Technological Impacts

Regulatory reforms in housing are essential for public safety and attracting employers, while emerging technologies present both opportunities and risks for REITs. Historical regulatory risks, such as rent control measures, have significantly impacted the apartment industry.

"Right now, our opinion is you need to have some regulatory reforms away from housing just to make public safety better in some of those places and both to sort of encourage employers to relocate or to stay located in those markets." --- (EQR, earning call, 2024/Q1)

"I think the origin, the emerging technologies that could help emerging technologies that could help our customers or potentially disrupt our business." --- (PLD, conference, 2024/06/05)

"year? So regulatory risk in the apartment industry really started to go up in 2017 with the advent of a ballot measure in California that failed on rent control." --- (EQR, conference, 2024/06/04)

Investor Sentiment and Market Perception

Markets with significant exposure to 3PLs are highly sensitive to shifts in sentiment, impacting investor perception. Realty Income's commitment to monthly dividends bolsters investor confidence, while conflicts of interest at Ventas erode trust. Investors seek valuation increases, and favorable market conditions are expected to improve sentiment.

"In other words, companies use 3PLs as a way of flexing up and down. So markets that have a bigger exposure to 3PLs are likely to feel the impacts of shifts in sentiment sooner than other markets on the way down and on the way up." --- (PLD, earning call, 2024/Q1)

"Even more than the lease structure, Bill and Jones' insistence to pay a monthly dividend to their investors has resonated with those investors since the founding of the company and has been a hallmark of conveying in a tangible way the belief that the investor or shareholder always comes first at Realty Income." --- (O, AGM, 2024/05/30)

"With the litany of concerning issues with the structure and makeup of the Board, namely, the conflicts of interest caused by some members of the Board possessing significant investments in and relationships with NHC, as well as the longstanding interlocking relationships among members of the Board, we believe it is impossible for shareholders to trust that key decisions are being evaluated with full independence and objectivity." --- (VTR, press release, 2024/04/18)

"And we just think investors want to see a quarter or 2 of the increase in valuations versus just sitting flat." --- (PLD, conference, 2024/06/05)

"I think that's starting to compress that bid-ask spread, which is the reason why we feel pretty confident that the markets here in the U.S. is going to start to materialize favorably for us. And yes, so that's what we see." --- (O, earning call, 2024/Q2)

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