REITs offer ordinary investors and institutions alike exposure to real estate. An increasing number are publicly traded, giving investors more choice than ever before. The rise of REITs is not simply numerical, but also strategic. A proliferation of specialized REITs offers a vast menu of sectoral targets, from hospitality to hospitals, with an equally diverse profile of risk and return.
In this research note, we take a look at a particular REIT that has come onto our radar in recent weeks, EPR Properties (EPR, Financial).
Experiences are the specialty
EPR first listed shares in 1997. It started out small, with a narrow focus on the cinema sector. Originally, EPR owned just 12 theaters, all operated by AMC (AMC, Financial). Since then, the REIT has grown considerably and branched out to a range of property types.
EPR invests in three property verticals, entertainment ($2.96 billion), recreation ($2.13 billion) and education ($1.45 billion), and currently owns 396 properties across 43 states, offering a fairly impressive level of diversification.
Each of EPR’s three principal verticals is composed of a diverse array of properties. The entertainment vertical includes megaplex theaters, family fun centers and retail centers. The recreation vertical operates in a similar environment, but is aimed more toward kinetic activities: ski properties, golf complexes, theme parks and such.
The education vertical stands slightly apart from the other two, but makes sense in the context of the targeted audience: families. EPR owns a number of school properties that are now leased to charter schools, private schools and early childhood education providers.
Specialized, but not too specialized
EPR is a very different animal from the small, highly concentrated REIT that went public 21 years ago, but its theatrical DNA still runs deep. The company remains thoroughly focused on experiential properties.
EPR claims its approach gives it certain advantages over other REITs by neither over-diversifying, nor over-specializing:
“We focus on the white space that exists between traditional REITs that are either highly diversified or highly specialized. EPR Properties maintains a specialized orientation complemented by diversification across and within segments. Our strategy of investing in a limited number of segments allows us to focus our attention and develop greater depth of knowledge in our chosen segments but still enjoy some benefits of portfolio diversity.”
While a worthwhile take on its own strategy, EPR’s statements are a bit boiler-plate. That said, there appear to be some advantages to the sort of middle road specialization it has chosen, and the experiential space offers considerable room for growth. Indeed, as the millennial generation comes into its own as the dominant consumer group, their much documented preference for experiences over material things should offer considerable growth opportunities for EPR and its ilk.
The investor’s payoff
From an investment perspective, there is much to like about EPR at a glance. Shares closed at $70.30 on Sept. 10, representing a $5.23 billion market capitalization. Its dividend yield is 6.15%, which is healthy if not stellar. But payouts are monthly, which can offer a solid opportunity for compounded growth.
Likewise, the dividend yield has been growing at a healthy pace, averaging 7% since 2010. While we would expect that growth to slow in the next few years, we still see annual dividend growth of about 4% as likely. Combined with a growing experience-based economy, EPR paints a fairly enticing picture.
A look at financial sustainability
When assessing the investment opportunity in any income-based play, whether a dividend stock or a REIT, we must ask this fundamental question: Is the payout sustainable?
We already opined that dividend growth ought to continue, but it is worth justifying this in a bit more detail. EPR currently has an 84% payout ratio, which is high compared to industry peers, though not the highest by any means.
In second quarter 2018, EPR posted impressive numbers compared to second quarter 2017:
- Net income was $85.5 million, up 14.6%.
- Earnings per share was $1.15, up 12.8%.
- Fund flows from operations were $141.8 million, up 45%.
EPR has also strengthened its balance sheet, reporting sustainable coverage ratios and a net debt to adjusted Ebitda of 5.6x. The April issuance of $400 million 10-year senior unsecured note has contributed to paying down a credit line, and the 4.95% coupon looks manageable under virtually any circumstances. With no debt maturities until 2022, EPR is sitting fairly pretty, financially speaking.
Verdict
EPR has traded up more than 7% year-to-date. The first half of the year saw a significant drop in price, but it has since recovered and then some. Indeed, over the past three months, EPR has shot up 23%. That forecloses the opportunity of buying this REIT at extremely cheap prices.
That said, the recent appreciation has not rendered EPR an unattractive proposition. As an income play with growth opportunities over the next several years thanks to increasing appetite for experienced based amenities, EPR looks quite enticing.
EPR could make a great addition to an income-with-growth strategy, with an eye toward exploiting the budding experience-based economy.
Disclosure: I/We own no stocks discussed in this article.
