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Berkshire Hathaway’s (NSYE: BRK.b) recent $377 million investment in STORE Capital (NYSE: STOR) has revived interest in real estate investment trusts (REITs).
I understand Berkshire’s interest in STORE Capital. STORE Capital is an intelligently run retail REIT that’s immunized itself against the e-commerce threat.
Many investors are less interested in STORE Capital today. STORE Capital’s share price spiked up 12% after news of the Berkshire investment hit the wires. In turn, the dividend yield spiked down to 5.1%.
A 5.1% dividend yield is respectable. But If you’re willing to wander off the Berkshire beaten path, you can find considerably more dividend yield. You can also find it accompanied with considerable dividend growth.
I refer to Colony NorthStar (NYSE: CLNS), a REIT whose portfolio is composed of industrial, health care, and hospitality real estate properties. These real estate ventures are supplemented by a money-management venture. The money-management venture claims $56 billion of assets under management.
But real estate is what butters the bread. Proper management of the real estate business enables Colony NorthStar to pay a $1.08 annual per-share dividend. The dividend yields 7.4% at the going market price. Colony NorthStar raised the quarterly dividend 12.5% with the most recent payment.
Dividend Increases Will Continue
More dividend increases are in store. I base my prognostication on Colony NorthStar revamping the business to further favor efficiency and cash flow.
Management has sold incongruous assets. A 19% joint-venture interest in the health-care portfolio was sold in the first quarter. The sale of 50% stake in publicly traded Colony Starwood Homes (NYSE: SFR), a REIT that buys and rents single-family homes, soon followed.
More sales will occur. Sales of debt and equity investments stored in Colony NorthStar’s junk-draw “other equity and debt” segment is in the works. The segment houses private-equity investments and real estate loans. The proceeds of the sales – targeted at $1 billion – will be allocated to conventional equity real estate.
Some segments will shrink, but others will grow.
Colony NorthStar’s investment management business, though a small segment, remains a consistent cash generator. Revenue is sticky because customers are loathe to leave. Assets under management can increase by extending the reach to retail investors through retail funds.
To wit, Colony NorthStar created the NorthStar/Townsend Institutional Real Estate Fund, an interval fund in registration that seeks to raise $1 billion of new capital. The NorthStar Capital Income Fund, a $3.2 billion closed-end fund, was declared effective by the Securities & Exchange Commission (SEC) in 2016. These funds will grow assets under management and fees collected from managing these assets.
Ensuring cash flow continually rises is the end to the revamping means. Cash flow is always king in the REIT sphere.
REITs are valued on their dividends, and dividends are supported by funds from operations (FFO) – the key cash-flow metric. Management expects FFO to land between $1.40 and $1.58 per share in 2017. If we use the low end of the range – $1.40 – the dividend consumes only 77% of FFO.
Given the present FFO coverage, Colony NorthStar has the financial wherewithal to not only maintain the dividend but to increase it generously.
This prospect has yet to resonate with individual investors. If Colony NorthStar shares were to trade were to trade at the peer average, they’d trade at $21 each. That’s 45% price appreciation from the market price.
Colony NorthStar Shares Are a Bargain
Colony NorthStar shares are cheap – absolutely and relatively. I have company in my assessment. A surge of institutional buying occurred in the first quarter.
Notable buyers include Vanguard Group, which bought 68.5 million Colony NorthStar shares; Baupost Group, led by value-investor guru Seth Klarman, bought 29.2 million; BlackRock bought 23.2 million shares to increase its holdings to 30.9 million.
A lot of institutional investors have boarded the Colony NorthStar bandwagon. In the first quarter, 222 institutions bought new positions in Colony NorthStar’s stock.
Time to join the institutional crowd and board the bandwagon. Once Colony NorthStar’s cheapness reverberates with the investing public, you can be sure its shares won’t remain cheap for long.