In real estate, different asset classes offer various attributes tailored to investor needs. For example, some real estate portfolios focus primarily on appreciating the underlying assets. In contrast, others are comfortable giving up the upside for a reliable and stable income. Such REITs (Real Estate Investment Trusts) which focus on appreciating their underlying assets through strategies such as 'value-add' are Equity Residential (NYSE: EQR) and Essex Property Trust (NYSE: ESS). As a result of allowing their portfolios to be exposed to more aggressive appreciation, dividend yields are on the lower ends of 4.2% and 4.3%, respectively.
A REIT that paints these returns with a different yield shade is Simon Property Group (NYSE: SPG). SPG dividend sits at 6.60%, thus creating a positive spread compared to peers in other asset classes. While Simon Property does not necessarily focus on upside appreciation potential but on stabilizing its underlying assets to generate predictable income, first-quarter 2023 earnings results may give investors the best of both worlds.
Undervalued Assets
As Warren Buffett would say, "Be greedy when others are fearful." The shopping and entertainment branch of real estate has been out of favor for quite some time now, given public sentiment towards 'dying' shopping malls which will never see the light of day again. If these doom and gloom theories were even slightly true, Simon Property would not have reported occupancy in excess of 94.4% as of March 31, 2023, compared to 93.3% twelve months prior.
Investors typically look at the infamous Capitalization Rate (cap rate) of real estate assets to determine whether a property is risky or determine a proper price relative to income generation. Computed as NOI (net operating income) divided by the value of the property. As a rule of thumb, the lower the cap rate, the more expensive the property, and vice versa. Dividing Simon Property's net operating income by its current market cap as a proxy for NAV yields a 7.5% cap rate, where 6-8% would be considered an attractive valuation.
Another proxy for this income-to-value ratio is the current dividend yield. A high payout of 6.6% compared to historical yields between 2.5% and 3.0% when valuations hit the ceiling during 2012-2014 may raise undervaluation suspicions. A similar dynamic comes to light when looking at more conventional valuation methods, such as the price-to-earnings ratio. During 2012-2014, peers like EQR and ESS traded at their highest ratios; likewise, Simon Property's P/E stood between 45x and 50x. Today, alongside high dividend yields and capitalization rates, SPG stock delivers another piece of undervalued evidence by sporting a 16.5x P/E ratio.
Quantitative evidence aside, the simple fact that Simon Property increased its lease rates by 3.1% during the quarter, alongside resilient consumer activity within shopping centers, speaks to the company's ability to navigate the business cycle comfortably. Current bearish sentiment toward the asset class may be a thing of the past as investors realize the potential for high yields and growth upside.
Reliable Income: By the Numbers
Simon Property Group delivered some pleasant news to investors during its earnings release. The board of directors declared a quarterly common stock dividend of $1.85 for the second quarter, an increase of $0.15 or 8.8% year-over-year. During 2022 packed with inflation concerns and rising credit costs, investors can be reassured that their dividend income will be raised accordingly.
The last twelve months of earnings per share would reflect $6.60; management guidance keeps relatively flat assumptions for the rest of the year at $6.40 to $6.60. Considering that the company, according to SPG financials, can raise its lease revenue by low-single digits year after year, management guidance may be conservative when both top-line revenue and earnings per share result in the same predictable low single-digit growth rate.
Increasing earnings by these rates would cause a trickle-down effect of funds from operations and net operating income, which would feed into shareholder dividend payouts and possible share repurchases. For those investors seeking reliability in payment, Simon Property has been paying out dividends since 1995, even throughout COVID-19. While some companies suspended their dividends to navigate challenging free cash flow conditions, SPG only saw to lower its payout instead.
During a rising interest rate environment where appreciation may not be present, markets may be in the beginning stages of realizing how important income predictability and higher yields are. SPG stock trades at an 81% discount to its 52-week high, while the Vanguard Real Estate ETF (NYSEARCA: VNQ) trades at a lower 78% discount to its 52-week high prices.
