This article was published on iREIT at Alpha on Thursday, May 18, 2023.
It was no surprise this morning when I woke up to see the news that Regency Centers Corporation (REG) was seeking to acquire Urstadt Biddle Properties Inc. (UBA) in an all-stock transaction valued at ~$1.4B, including the assumption of debt and preferred stock. The combined company is expected to have a pro forma equity market capitalization of ~$11B and a total enterprise value of ~$16B.
The combined portfolio will be comprised of 481 total properties encompassing more than 56 million square feet of gross leasable area, validating the powerful scale advantages of Regency Centers.
In REIT-dom, we have seen other examples recently in which the bigger fish have gobbled up some of the smaller players:
- Simon Properties Group, Inc. (SPG) and Taubman Centers
- American Tower Corporation (AMT) and Coresite
- Prologis, Inc. (NYSE:PLD) and Duke Realty
- Kimco Realty Corporation (KIM) and Weingarten Realty
- Healthcare Realty Trust Incorporated (HR) and Healthcare Trust of America
- Extra Space Storage Inc. (EXR) and Life Storage (LSI)
- VICI Properties Inc. (VICI) and MGM Properties
As I reflect on the latest Regency / Urstadt Biddle news, it dawned on me that now is an excellent time for the larger well-capitalized REITs (like Regency) to pursue M&A.
Shares in most REITs are beaten down, which makes it more difficult for the mid-size companies to transact.
Thus, we expect to see continued consolidation within the REIT sector, which as a result drives the returns of the dominant names like Realty Income Corporation (NYSE:O) and Prologis.
Realty Income vs Prologis
Last week we did an article comparing Prologis, Inc. to STAG Industrial, Inc. (STAG), and this provided an interesting contrast between the two companies due to the difference in size and investment strategies.
Per the subscribers’ request, we will now look at Realty Income compared to Prologis, which should also be an interesting comparison.
While the two real estate investment trusts (“REITs”) operate in different sectors, both are the leaders in their space, and both are high-quality REITs. What do I mean by high quality?
I mean both have excellent debt metrics and large amounts of liquidity, both have high-quality tenants and are very diversified by both tenant and geographic location, both have excellent management teams, and both have a strong dividend track record and low payout ratios.
I could go on but suffice it to say that both companies could easily be considered the top two blue-chip REITs. There are just a handful of REITs that I would put in the same ballpark in terms of quality and safety.
Realty Income Corporation
Realty Income is a triple-net lease REIT that specializes in acquiring single-tenant retail properties through sale-leaseback transactions. Leases that are structured on a triple-net basis have favorable attributes for the owner of the real estate because the tenant is responsible for property expenses including property taxes, building insurance, maintenance, and any other capital expenditures that are incurred.
Realty Income owns or has an ownership interest in 12,237 properties that are located in all 50 U.S. states, the United Kingdom, Spain, and Italy. In total, Realty Income’s properties cover 236.8 million square feet of leasable space, has an occupancy rate of 99.0%, and have a weighted average lease term (“WALT”) of 9.5 years.
Their properties are leased to 1,259 tenants that operate in 84 industries, and the majority of their tenants operate in industries that are resistant to e-commerce.
While Realty Income has many strong features, they are probably best known for their monthly dividend, which has been increased for 29 consecutive years.
All-in-all, they have paid 634 monthly dividends and have increased the dividend for 102 consecutive quarters. This excellent dividend track record makes Realty Income one of the few REITs that can claim the title of a Dividend Aristocrat.
Prologis is an industrial REIT that specializes in logistics real estate located in high-growth markets with high barriers to entry. PLD owns or has an ownership interest in 5,489 properties that encompass 1.2 billion square feet across 19 countries. PLD has 6,600 customers, an occupancy rate of 98.0%, and a weighted average lease term of approximately 5 years.
Additionally, they have $39 billion invested in land banks that they can use for future expansion. To give you an idea of how large and critical PLD is to global commerce, $2.7 trillion (2.8% of global GDP) flows through their distribution centers.
Prologis also generates ancillary income through its Essentials Platform, which includes services that enables its tenants to optimize the properties they lease. Through this platform, PLD is able to provide forklifts, generators, workforce training, robotics, automation, and EV charging stations.
With the expected growth of e-commerce, industrial real estate and distribution centers should see increasing demand, making industrial real estate one of the more attractive sectors to invest in currently.
Realty Income and Prologis both have a well-diversified tenant base that includes recognizable and well-established businesses. Prologis has the most concentration in its top tenant (Amazon), which makes up 5.2% of their effective rent, whereas Realty Income’s top tenant (Dollar General) contributes 4% of their contractual rent.
However, when looking at their top 10 combined, Prologis has less concentration. Prologis’ top 10 tenants make up 14.8% of their effective rent compared to Realty Income’s top 10 tenants that contribute 27% of their contractual rent.
If I had to pick a winner here, I would choose Prologis, since their overall top 10 tenant concentration is about half of the concentration that Realty Income has in its top 10.
Realty Income has an A- investment-grade credit rating and strong debt metrics, with a net debt to pro forma adjusted EBITDAre of 5.4x, a long-term debt to capital of 41.21%, and a fixed charge coverage ratio of 4.6x.
Their debt is 95% unsecured and 90% fixed rate with a weighted average interest rate of approximately 3.47% and a weighted average term to maturity of 5.9 years. Additionally, they had $3.1 billion in total liquidity as of the end of the first quarter.
Prologis has a credit rating of A from S&P Global, ranking them one notch above Realty Income. PLD has excellent debt metrics. They have a debt-to-adjusted EBITDA of 4.0x, a long-term debt-to-capital of 32.77%, and a fixed charge coverage ratio of 11.2x as of year-end 2022.
PLD’s debt is 85% fixed rate, with a weighted average interest rate of 2.5% and a weighted average term to maturity of 9.4 years. Furthermore, PLD had $6.7 billion in total liquidity as of April of this year.
Both Realty Income and Prologis have conservative debt levels as it relates to their total assets. Realty Income’s debt-to-asset ratio has averaged approximately 40% over the last 5 years and was 36.46% as of the end of 2022. Prologis’ level of debt is even more conservative, averaging a debt-to-asset ratio of roughly 30% over the last 5 years and a debt-to-asset ratio of 27.16% at the end of 2022.
Both companies have great credit and debt metrics, but overall I’d say that Prologis beats Realty Income on this front. PLD has a lower debt-to-EBITDA ratio, a lower debt-to-asset ratio, and a higher fixed-charge coverage ratio. Plus, they have a slightly better credit rating and a substantial amount of liquidity.
One of my favorite ways to access the profitability of a REIT is its funds from operations (“FFO”) Return on Assets (“ROA”). The primary driver of earnings for REITs are tangible assets, or more specifically real estate assets. I like to look at the FFO ROA to compare between REITs to see which one is utilizing their assets more effectively.
I also like to look at historical returns on the same company to see if there are diminishing returns as their asset base grows. Over the period from 2018 to 2022, Realty Income’s FFO ROA has ranged between approximately 5% to 6%, with the exception of 2021. Prologis FFO ROA has ranged between approximately 6% to 6.5% over this same time period.
As previously mentioned, 2021 was an outlier for Realty Income’s FFO ROA as it came in much lower than its average. The lower FFO ROA may in part be the result of the VEREIT acquisition that closed on November 1, 2021.
I’m not an accountant, so I’m not going to act like I know all the nuances involved, but pre-acquisition deferred revenue is often marked to fair value post-acquisition and not fully recognized as revenue by the acquiring company per GAAP accounting rules.
The VEREIT acquisition more than doubled Realty Income’s asset base, but some or all of the deferred revenue on VEREIT’s books may not have been recognized by Realty Income.
Again, I’m not an accountant so I cannot say with 100% certainty that this is what caused the drop, but their FFO ROA rebounded closer to its historic average the following year, so I’m not too concerned with the return in 2021. This one is close, but all in all, I’d have to give this one to Prologis since they have historically generated a higher rate of return on their assets.
AFFO, or adjusted FFO, Growth is an interesting comparison between Realty Income and Prologis.
Realty Income has more consistent growth rates, whereas Prologis has more choppy growth rates. Prologis grew AFFO by 7% in 2019, 37% in 2020, but then AFFO fell by -12% in 2021 before rebounding to 39% in 2022.
Realty Income grew AFFO in each year from 2018 to 2022, but on average grew AFFO by 6%, compared to Prologis, which grew AFFO by 17% over the same period. While PLD’s AFFO growth is more volatile, I would give them the win on this metric since their average growth rate far exceeds that of Realty Income.
Realty Income pays a 5.08% dividend yield compared to Prologis’ dividend yield of 2.87%. However, PLD has much higher dividend growth rates than Realty Income. Realty Income has averaged a dividend growth rate of 3.95% since 2018, while PLD has averaged a dividend growth rate of 12.59%.
Another aspect to consider is the dividend history.
Realty Income has increased its dividend for 29 consecutive years. Prologis, on the other hand, cut their dividend in 2008 and 2009 and did not increase the dividend until 2014. I’d say Realty Income wins on this metric. They don’t have the dividend growth rate that PLD has delivered, but they pay a higher yield and have been more consistent over the years.
When accessing dividend safety, the best measure to use is the AFFO payout ratio. Both companies have a conservative payout ratio that easily covers the dividend, and both companies have generally improved this metric since 2018.
If I had to pick a winner here, I’d give it to Prologis as they have a more conservative payout ratio, but to be clear both companies have sound payout ratios and the dividend is well covered by both.
Realty Income currently trades at a P/AFFO multiple of 15.26x, which is well below their normal P/AFFO multiple of 18.86x. Prologis trades at a P/AFFO of 26.34x, which is just slightly below their normal multiple of 27.95x.
This is a clear win for Realty Income, as they trade for a lower multiple in absolute terms and trade at a larger discount when compared to their normal multiple.
I want to reiterate that both companies are blue-chip REITs and both have stellar fundamentals.
Prologis beats Realty Income on growth and debt metrics, but Realty Income has a higher yield and a better dividend track record. Plus, Realty Income trades at a better (cheaper) valuation.
Reasonable people could disagree on which REIT has delivered better performance, but I say why not own both?
Both companies are two of the best REITs you can own and would complement each other when combined in a portfolio. They are in different sectors, so if e-commerce starts to have a major impact on brick-and-mortar retailers it would negatively impact Realty Income but would likely have a positive impact on Prologis.
In contrast, if e-commerce does not grow as expected (or if Amazon sneezes), it would have a negative impact on Prologis but would likely have a positive impact on Realty Income. I don’t think this comes down to an “either or” decision and think both would be a great addition to an investor’s portfolio.
Realty Income and Prologis are two of my top holdings, representing close to 10% of my total REIT holdings.
These anchor positions are a good reason that I sleep like a baby…
…how about you?