Warren Buffett (Trades, Portfolio) is picky about his real estate investment trusts. Of the 200 REITs publicly traded in the U.S., Buffett has purchased only one for his 47-stock portfolio at Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) and one more for his personal holdings. Buffett purchased both of the REITs in the past two years, suggesting an increase in interest in the sector or in their attractiveness. An analysis shows what his picks have in common and how they align with his stated investment criteria.
Buffett acquired 18,621,674 shares of STORE Capital Corp. (STOR, Financial), the more recent purchase, through Berkshire subsidiary National Indemnity Company, for a price of $20.25 per share on June 23 in a private placement. The 9.8% stake in the company cost $377 million, a 0.39% fraction of Berkshire’s cash storehouse at the end of March.
Berkshire purchased Store Capital at a 17% year-to-date decline, an 11.5% gain since its November 2014 IPO. Since his buy, shares have shot up 8% to trade above his purchase price at $22.18 Friday afternoon.
“Berkshire Hathaway’s investment solidly positions STORE for continued growth, while adding measurably to our already strong financial position,” Christopher Volk, president and CEO of STORE Capital said the announcement.
Store stands for Single Tenant Operational Real Estate, a unique asset class consisting of profit-centered real estate locations where businesses operate to produce revenue and earnings. The company distinguishes itself by focusing on tenants that provide rent payments directly from their business operations, which includes gaining access to the businesses’ financial statements. Through this business model, Store reduces the number of tenants vacating unprofitable units if they become insolvent. Store collects additional payments like other REITs from two other sources, tenant credit quality and underlying real estate value.
The company has one particular catch phrase that would draw Buffett’s eye: a menu heading on its website labeled with a concept employed by famed value investing founder Ben Graham, “Margin of Safety,” which lists ways the company seeks to offer value and protection for investors.
Operating 1,750 properties to 369 tenants across 48 states, Store comes in around the middle among 20 of its peers across many financial metrics. It has a $400 million market cap, near the average of $3.96 million among its competitors. It generated $399 million in revenue in 2016, in the lower half of its peers. It has a price-earnings ratio without NRI of 30.33, making it eighth highest in the list, and a price-book ratio of 1.32, placing it at 11th. Store also stands around the middle of its peers for operating and net margins, returns on assets and return on equity.
Chief for real estate investment trusts for investors is dividends. Store offers a 5.22% dividend yield, near the 5.39% average of its competitors. Where it stands out is its dividend payout ratio, which at 1.56 ranks higher than all but four peers. The company pays out a minimum of 90% of its taxable income.
Store has raised its quarterly dividend from 14 cents to 29 cents since the fourth quarter of 2014, including a 7.5% one-year increase. With its 29-cent dividend as September 216, Buffett should receive roughly $21.6 million in annual dividends from the holding.
Store describes itself as “a growth company that pays a high dividend.” Since 2013, it has generated 16.4% per-share net average annual income growth, with increases each year.
Buffett’s second REIT appears in his personal holdings. He purchased Seritage (SRG, Financial), a company formed from the real estate of Sears Holdings (SHLD, Financial), on Nov. 30, 2015. Buffett holds 2 million shares of the company, costing $73 million for the 8.03% stake. Seritage’s price has risen 15% from Buffett’s buy price of $36.50 to $41.97 per share and declined 1.85% year to date.
Hedge fund manager and Sears Chairman Eddie Lampert created Seritage in 2015 to own and lease Sears’ 266 properties back to it. The company has aimed to avoid investing in indoor-mall-type stores and begun leasing to grocery stores like Whole Foods, spin-class fitness shops and entertainment venues. At the end of 2016, Sears generated only 65% of revenue for Seritage, down from 90% initially. As of first quarter-end, it rented 201 properties to Sears after the company closed dozens of unprofitable stores.
Among 20 of its peers, Seritage places eighth for market cap, at $251 million and 14th for revenue of $251 million. It ranks as the fifth most expensive by a price-book ratio of 2.81, and comes in last for negative operating margins of 18.95% and second to last for net margins of 25.12%. It also ranks low for returns, with a negative 7.5% return on equity, higher than only three peers, and 2.3% return on assets, higher than only one.
Seritage has a less attractive dividend profile than Buffett’s other REIT and its peers, with more momentum in its business growth prospects. The REIT pays a dividend yield of 2.38%, the second lowest in its class, with a dividend payout ratio of zero. When Buffett bought the company, it paid a dividend of 50 cents quarterly but in the following quarter chopped it to 25 cents and has not raised it since. In 2015, Seritage said its dividend amounts would be at the discretion of its board of trustees, depending on its REIT tax status and its investment opportunities.
In the first quarter, Seritage signed 535,000 square feet of new leases with an average price per square foot of $16.41, bringing its new leasing activity to 2.8 million square feet at an average price of $18.13 per square foot since the start of business. Its potential for expansion aligns with Buffett's interest in where a company will be in five years. Seritage has also been charging new stores significantly higher rent than it asked from Sears. New rents averaged $16.34 per square foot in the first quarter versus $4.06 per square foot charged to Sears.Â
But the company remains unprofitable. In the first quarter, Seritage recorded a net loss of $19.8 million, or 59 cents per diluted share, compared to a net loss of $8.3 million, or 27 cents per diluted share in the previous first quarter. It also completed vacating of all Sears stores space in three cities in three states, giving it more space to rent to other stores at higher prices.
See Warren Buffett (Trades, Portfolio)’s personal portfolio here and his subsidiaries portfolio here.
