TRADE ALERT - Core Portfolio August 2024 (New Listing)
Today, we are offered an opportunity to upgrade the quality of our real estate holdings without having to sacrifice on its future upside potential.
Sila Realty Trust (SILA) was just recently listed on the New York Stock Exchange and it is superior to Global Medical REIT (GMRE) from nearly every perspective.
But despite that, it is currently offered at a lower valuation, likely due to the lack of interest in new REIT listings and the fact that this one has largely gone unnoticed by investors so far. There is almost research on it available yet.
It reminds me of when Essential Property Realty Trust (EPRT) went public back in 2018. For a brief period, the company traded at a huge discount relative to its close peers even despite having less leverage and enjoying faster growth prospects. We recognized that this was due to the lack of analyst coverage, started buying the stock, and end up earning very strong returns on it.
Today, the same appears to be happening with SILA and we think that its risk-to-reward is far superior to that of GMRE.
For this reason, we are today selling our stake in GMRE, earning a 55.7% total return over our ~2 year holding period, and redeploying all the proceeds and then some into SILA, which now represents ~5% of our Core Portfolio.
SILA is a new net lease REIT that specializes in healthcare properties. However, it has made sure to avoid riskier segments like hospitals and skilled nursing, which have greatly suffered in the post pandemic world. Instead, it focuses primarily on medical office buildings, inpatient rehab facilities, and surgical facilities that are occupied by high credit tenants, provide unit-level reporting, and enjoy strong rent coverage:
GMRE has a higher weight to medical office buildings, but the focus is not materially different. Both target fairly similar single-tenant net lease healthcare properties that commonly trade at higher cap rates than typical multi-tenant medical office buildings such as those of Healthcare Realty (HR).
They both enjoy similar 2.2% annual rent escalations, rent coverage in the high 4s, but SILA enjoys longer average remaining lease terms at 8.2 years versus just 5.8 for GMRE.
GMRE also seems to have weaker tenants on average. As an example, Steward generates about ~5% of its FFO. GMRE is known for having historically targeted higher cap rate properties, mostly in secondary markets. It is a higher risk / higher (potential) reward approach to healthcare real estate investing.
SILA is similar in this regard but it places a slightly greater emphasis on quality at the cost of a bit lower cap rates.
But the real difference here is the balance sheet quality and future growth prospects.
SILA is underleveraged with a low ~20% LTV and 3x Debt-to-EBITDA and no debt maturities until 2028.
In comparison, GMRE is a bit overleveraged in today's environment with a ~45% LTV, a near 7x Debt-to-EBITDA, and much shorter debt maturities, even despite owning weaker assets on average.
Moreover, SILA retains 30% of its AFFO to reinvest in growth, whereas GMRE's dividend currently isn't even fully covered despite having to deleverage.
Normally, higher leverage should be punished with a lower valuation multiple, but oddly, this isn't the case here. It is the actually the opposite as SILA is currently offered at a lower valuation multiple than GMRE:
GMRE is likely to face growing difficulties because its >100% payout ratio is preventing it from addressing its leverage, and this may even lead to a dividend cut if it faces more rent collection issues.
SILA, on the other hand, is well positioned to grow its cash flow given that they could significantly expand their portfolio by taking on more debt.
If they wait a bit for interest rates to come down and cap rates remain high, they could earn strong spreads, leading to a rapid expansion of their AFFO per share, especially for a REIT that trades at just 10x AFFO.
Here is what they said earlier this month:
"With our strong balance sheet, ample liquidity position and an expansive acquisition sourcing network, SILA is in a uniquely strong position to expand our presence in this capital-constrained, high-interest rate environment.”
Assuming that they can acquire properties at an 8% cap rate and they can raise debt at a 5.5% interest rate, that would result in a 250 basis point spread.
That's a very big spread for a net lease REIT. Other net lease REITs like Realty Income (O) are typically happy if they can get a 150 basis point spread.
Moreover, those spreads could really move the needle for them given that they could expand the size of their portfolio by about 20% and still maintain a reasonable level of leverage.
Combine these acquisitions at a positive spread with the 2.2% annual rent hikes, 30% of retained cash flow, and the lack of debt maturities, and you have a compelling growth story.
I would add that the management has a history of strong shareholder alignment and always talk about putting the shareholder first:
"I am incredibly proud of our company, management team, employees, and board of directors, who strive each day to put the Company’s shareholders first."
On that note, they only pursue accretive growth on a per share basis, and even did a share buy back earlier this year.
GMRE also has good management, but this is just to say that SILA is not worse off from this perspective.
So to recap, I think that SILA is more attractive than GMRE, which has much more leverage, is smaller in size, isn't covering its dividend, has Steward exposure, and still trades at a higher AFFO multiple.
The only reason for this anomaly is because SILA is a newly listed REIT that has gone unnoticed to the masses, but not to specialists like us who monitor the REIT market on a daily basis.
The 7% dividend yield (paid monthly) coupled with 5-10% annual growth and potential upside from multiple expansion makes SILA a very compelling new IPO and it now represents 5% of our Core Portfolio.
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Analyst's Disclosure: I/we have a beneficial long position in the shares of all companies held in the CORE PORTFOLIO, RETIREMENT PORTFOLIO, and INTERNATIONAL PORTFOLIO either through stock ownership, options, or other derivatives. High Yield Landlord® ('HYL') is managed by Leonberg Research, a subsidiary of Leonberg Capital. All rights are reserved. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The newsletter is impersonal and subscribers/readers should not make any investment decision without conducting their own due diligence, and consulting their financial advisor about their specific situation. The information is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The opinions expressed are those of the publisher and are subject to change without notice. We are a team of five analysts, each contributing distinct perspectives. Nonetheless, Jussi Askola, the leader of the service, is responsible for making the final investment decisions and overseeing the portfolio. We do not always agree with each other and an investment by Jussi should not be taken as an endorsement by other authors. Past performance is no guarantee of future results. Our portfolio performance data is provided by Interactive Brokers and believed to be accurate but its accuracy has not been audited and cannot be guaranteed. Our portfolio may not be perfectly comparable to the relevant index. It is more concentrated and may at times use margin and/or invest in companies that are not typically included in REIT indexes. Finally, High Yield Landlord is not a licensed securities dealer, broker, US investment adviser, or investment bank. We simply share research on the REIT sector.