Artificial intelligence, or AI, is the name of the stock market game these days. Any company that can make the AI label stick has a good shot of seeing outsized gains.
Notice the wording there: "can make the AI label stick." Not "uses AI meaningfully" or "successfully showcases a viable AI product."
There's a lot of hype out there, to say the least. And that euphoria could easily backfire on imprudent investors.
Don't be one of them.
This isn't to say there aren't real opportunities. If I've given the impression that I'm all-in on the old school, I apologize. I'm actually embracing AI and other technological advancements.
I look for companies that are moving with the times and even advancing them. There's no point in denying that the 20th century has come and gone. It's history, including so many of the products it spawned, such as:
- Cassette tapes
- Videotapes
- Floppy disks
- Fax machines
- Rotary phones
- Dial-up modems
- Polaroid cameras.
Even compact discs - a shining late-century advancement that once awed everyone - are pretty much passé. We download our music now or listen to it on Spotify. And we have been for years.
CDs dominated for a very small window of time, especially when compared to its musical predecessors. There's just no denying that the 21st century keeps rolling out technological advancement after technological advancement at a blistering pace.
Which is why I'm not (denying it). But I believe it's equally foolish to discount the value of quality human interaction.
The Marvels of Modern-Day Reality - the Virtual Kind
Some might be quick to point out that technology is changing human interaction in more ways than one. It's not just AI that's threatening to disrupt our norms, traditions, and status-quos.
And, once again, I'll fully acknowledge that. I'll even embrace it, to some degree.
For instance, there have been several news stories this month about the value of virtue reality. This includes from the AP, which wrote on February 19 how:
"… 17 senior communities around the country… participated in a recently published Stanford University study that found that large majorities of 245 participants between 65 and 103 years old enjoyed virtual reality, improving both their emotions and their interactions with staff.
"The study is part of a larger effort to adapt VR so it can be beneficial to seniors' health and emotional well-being and help lessen the impact dementia has on some of them."
Apparently, almost 80% of study participants felt more positive afterward, and nearly 60% felt less socially secluded. In addition:
"Separate from the study, John Knox Village uses virtual reality in its unit that houses seniors who have Alzheimer's disease and other dementia. It helps spur memories that lead to conversations with caregivers."
It's hard to object to those technological interventions for people otherwise isolated from so many meaningful experiences. The same goes for the BBC's mid-February report that VR:
"… is helping patients on Sarum [Hospital] Children's Ward feel calmer and make their time in-hospital more fun. The headset creates three dimensional worlds for children to explore a variety of expeditions, including a visit to space and a Jurassic safari."
It can even be used during certain treatments to distract children from the fear and pain they'd otherwise be focusing on. As a father of five and the grandfather of one, that sounds amazing.
The Undefeated Appeal of Experiential Assets and the Investment Opportunities They Open Up
Let me make something clear, though. Technology is ideal for enhancing human experience, not for replacing it.
AI, for example, should make our inquiries more efficient and effective, not eliminate our entire role in research. Similarly, VR is a great substitute for going places and doing things you otherwise can't.
But when you can actually see the Great Pyramid of Egypt in person? I've admittedly never been there myself. However, I have to imagine it's uniquely impressive up close and actually tangible.
There's also the multitudinous benefits of interacting with other people at such sites and elsewhere. Don't laugh too much. I know not every human interaction is a pleasant one.
Even so, think about how much we learn about ourselves and the world around us when we interact with others. Not just facts and figures - which we can, of course, get from technology - but also perspectives, experiences, dialogues, and life lessons.
Plus, let's face it… it can just be more fun to do some things with other people. Going to the movies… amusem*nt parks… eating out… vacationing… shopping…
It's human nature to want to connect like that. And human nature just doesn't change over the ages, no matter how much everything around us does.
That's why the very smart members of management at select real estate investment trusts (REITs) are doubling down on the art of interaction. We call their engaging assets "experiential," a category that includes (but aren't limited to):
- Athletic venues
- Bowling alleys
- Casinos
- Driving ranges
- Gyms.
The list goes on.
Sure, Covid shut them all down for a time; but that time is over. People are actively seeking each other out again. And spending a lot of money to do so.
So while artificial intelligence, augmented reality, and virtual reality should all be taken seriously…
So should good, old-fashioned experiences.
VICI Properties Inc. (VICI)
Several real estate investment trusts invest in experiential properties that incentivize the consumer to go out and shop, dine, relax, or be entertained. Some of these properties include golf driving ranges, movie theaters, open-air shopping malls, theme parks, resorts and so on.
However, when thinking about experiential properties, the first REIT that comes to my mind is VICI Properties.
I mean, what is more experiential than this:
Or this:
VICI Properties is a S&P 500 (SP500) company that was formed in 2017 as a spinoff related to the Caesars Entertainment bankruptcy. The company filed its IPO the following year and is now one of the largest publicly traded net-lease REITs, with a market cap of approximately $30.5 billion.
VICI exclusively invests in experiential real estate and owns one of the largest portfolios of premium destinations for gaming, hospitality, and entertainment.
The experiential REITs portfolio totals 127 million SF and includes of 93 experiential assets comprised of 54 gaming properties and 39 non-gaming experiential properties.
VICI's core gaming assets are located in the U.S. and Canada and include several iconic trophy properties such as Caesars Palace Las Vegas, MGM Grand, and the Venetian Resort on the Las Vegas Strip. In total its gaming properties include more than 60,000 hotel rooms, over 500 retail outlets, and ~500 restaurants, bars, nightclubs and sport betting facilities.
On the Las Vegas Strip alone, VICI owns 10 trophy properties encompassing 660 acres that feature approximately 41,400 hotel rooms, roughly 5.9 million SF of conference, convention, and trade show space.
VICI's 39 non-gaming experiential properties primarily consists of 38 bowling alleys they acquired from Bowlero (BOWL) in 2023.
The acquired portfolio of family entertainment bowling centers is expected to generate initial annual cash rent of $31.6 million and covers 1.6 million SF across 17 states.
Additionally, the gaming REIT owns 4 golf courses that host professional tournaments and 33 acres of developable land next to the Las Vegas Strip.
VICI has an investment grade balance sheet with a BBB- credit rating from S&P Global. The company has solid debt metrics, including a net leverage ratio of 5.7x, a long-term debt to capital ratio of 42.02%, and an EBITDA to interest expense ratio of 4.07x.
Additionally, its debt is 83% unsecured, 99% fixed rate, and has a weighted average term to maturity of 6.1 years.
On the earnings front, VICI has not disappointed. Since 2019, VICI has had an average adjusted funds from operations ("AFFO") growth rate of 7.85% and an average dividend growth rate of 10.11%.
Over this time period, VICI has delivered positive AFFO per share growth in each year and is expected to deliver AFFO per share growth of 11% for the full year 2023 once the 4Q-23 results have been reported (scheduled on February 22, 2024).
The stock pays a 5.62% dividend yield that is well covered with a 2023 AFFO payout ratio of 74.88% and trades at a price-to-AFFO ratio of 13.65x, which is a discount compared to its average AFFO multiple of 16.29x.
We rate VICI Properties a Buy.
EPR Properties (EPR)
EPR Properties is a net lease REIT that invests in a diversified portfolio of experiential assets such as movie theaters, eat & plays, amusem*nt parks, ski resorts, entertainment destinations, and other cultural venues such as museums, zoos, and aquariums.
The company has a market cap of approximately $3.2 billion and a experiential portfolio that consists of the following property types as of the end of Q3 2023:
- 169 movie theaters
- 57 eat & plays (ex. Top Golf)
- 24 attractions (amusem*nt / waterparks)
- 11 ski resorts
- 7 lodging properties
- 16 health & fitness properties
- 3 cultural properties, and
- 1 gaming property.
EPR's experiential portfolio totals ~19.9 million SF, including 0.5 million SF of real estate the company is looking to sell. In its latest presentation, the company lists its strategic focus to grow each experiential property type, with the exception of movie theaters, which has a strategic focus to reduced exposure.
When excluding properties EPR intends to sell, its experiential portfolio was 99% leased and made up ~93% of its annual EBITDAre at the end of Q3 2023.
In addition to its experiential portfolio, EPR owns or has an interest in 62 early childhood education centers and 9 private schools that total 1.3 million SF and includes 0.1 million SF of properties the company intends to sell.
As with movie theaters, EPR has a strategic focus to reduce its exposure to both early childhood education and private schools. When excluding the properties designated for sale, EPR's education portfolio was 100% leased and made up ~7% of its annual EBITDAre.
EPR's combined portfolio (experiential / educational) totals 21.3 million SF and was ~99% leased when excluding properties it intends to sell.
EPR's unsecured debt is investment grade with a BBB- credit rating from Fitch and S&P Global and a Baa3 credit rating from Moody's. It has a healthy balance sheet with a net debt to adjusted EBITDAre of 4.4x, a long-term debt to capital ratio of 55.18%, and an EBITDA to interest expense ratio of 4.45x.
Its debt is 99% unsecured and is 100% fixed rate or fixed through interest rate swaps at a weighted average interest of 4.3%. The REIT has a well-laddered debt maturity profile with only ~$137 million of debt maturities in 2024 and a weighted average term to maturity of 4.5 years.
Additionally, at the end of Q3 2023, the company had $173 million in cash on hand and no outstanding balance on its $1.0 billion credit revolver.
Before we look at its earnings and dividend history, I want to point out that as experiential properties go, movie theaters may very well face the strongest headwinds. The industry has not fully recovered from the pandemic and technology has given consumers more options than ever before.
The rapid adoption of streaming services could forever change how consumers behave and, at best, competition from streaming services should reduce any pricing power theater operators have enjoyed in the past.
As of their most recent update, movie theater rent coverage for the trailing twelve months ("TTM") ending June 2023 stood at 1.4x, compared to 1.7x before the pandemic in 2019.
Additionally, 39% of EPR's experiential portfolio consists of movie theaters
Since 2014, the company has had an average annual AFFO growth rate of 2.39% but paid a lower dividend in 2023 compared to the dividend paid in 2014. EPR delivered solid AFFO growth from 2014 to 2018, but in 2019 AFFO per share fell by -12%.
Then came the pandemic…
It should be no surprise that EPR's AFFO fell significantly during the Covid shutdowns, as no one could go to the movies and almost 40% of the company's EBITDAre is generated from movie theaters. In 2020 AFFO per share fell by -65% which forced the REIT to slash its dividend by ~66.3%.
Since the reopening, EPR's earnings have materially improved, with AFFO per share growth of 72% and 50% in the years 2021 and 2022 respectively.
However, even after the significant AFFO growth experienced in 2021/2022, analysts expect AFFO per share to come in at $5.25 in 2023 (4Q-23 earnings report on February 29, 2024), but then to fall by -6% in 2024.
If analysts estimates are correct, EPR will earn $4.91 in AFFO per share in 2024, compared with $3.99 per share a decade ago. Similarly, analysts expect the REIT to pay a dividend rate of $3.33 in 2024, compared with a dividend of $3.42 per share in 2014.
Earnings growth over the past 10 years has been anemic at best and the dividend is going the wrong way.
Critics can easily point out that EPR had no choice but to cut its dividend during the pandemic, which was a black swan event. However, I have a different take.
Most if not all REITs were severely impacted by the pandemic, yet many of EPR's net-lease peers were not forced to cut their dividend in 2020. including Realty Income (O), Agree Realty (ADC), VICI Properties (VICI), Essential Properties Realty Trust (EPRT), NNN REIT (NNN), and Getty Realty (GTY). Even W. P. Carey (WPC) did not cut its dividend in 2020.
(Of course, WPC cut it later.)
Many of EPR's net-lease peers invests in properties that provide essential goods and services such as grocery and convenience stores which had to remain open during the lockdowns.
On the other end of the spectrum you have experiential REITs like VICI that collected 100% of its rents during the pandemic due to the nature of its well-capitalized tenants.
EPR on the other hand was (and still is) heavily invested in movie theaters which were not able to pay rent in most cases during 2020. Even worse is that some of EPR's largest tenants filed for bankruptcy protection, including Regal Entertainment Group in 2022.
While EPR has recovered significantly since the pandemic, I don't believe they are out of the woods yet. The impact of streaming services and the corresponding user adoption is still in the early stages, in my view.
There remains a lot of uncertainty surrounding the movie theater industry, which puts EPR in a precarious position given its concentration in these non-fungible properties.
EPR has no strategic cost of capital advantage, as I pointed out in a recent article:
Currently the stock pays a 7.82% dividend yield and trades at a P/AFFO of 8.11x, compared to its average AFFO multiple of 13.54x. While the stock is trading at a discount, we believe there is more pain to come and recommend investors avoid this stock.
We rate EPR Properties a Sell.
Tanger Inc. (SKT)
Tanger is a mall REIT that owns and operates a portfolio of upscale outlet and open-air retail shopping centers across 20 U.S. states and Canada.
The company has a market cap of approximately $3.1 billion and a ~15.0 million SF portfolio comprised of 38 outlet centers, 1 managed center, and 1 open-air shopping center.
SKT's properties contain more than 3,000 stores that are operated by over 700 brand name companies.
Its largest tenant is The Gap, which makes up 5.8% of SKT's annualized base rent ("ABR") and operates under the following brands: Athleta, Gap, Old Navy, and Banana Republic.
SKT's second largest tenant is SPARC Group, which makes up 3.9% of its ABR and operates under the brands Aéropostale, Eddie Bauer, Forever 21, Nautica, and Reebok.
Other notable tenants include Tapestry, Under Armour, American Eagle, Skechers, Adidas, Levi Strauss, and Nike, Inc.
In total, SKT's top 25 tenants make up 57.1% of its ABR and represent 50.8% of its gross leasable area ("GLA").
At the end of 2023, SKT reported a portfolio occupancy of 97.3%.
The mall REIT's largest presence is in South Carolina, which contains 5 centers totaling 1.6 million square feet of GLA, or ~13% of the GLA in its consolidated portfolio.
The only other state that holds over 10% of its GLA is New York, which has 2 centers covering ~1.5 billion SF of GLA, or 12% of the GLA in its portfolio.
Last week, SKT released its fourth quarter and full year 2023 operating results. It reported total revenues during the FY 2023 of $464.4 million, compared to $442.6 million for the FY 2022.
Funds from Operations ("FFO") for the FY 2023 came in at $218.4 million, or $1.96 per share, compared to FFO for the FY 2022 of $201.5 million, or $1.83 per share.
The company provided an update on its balance sheet and reported a net debt to adjusted EBITDAre of 5.8x, up from 5.1x in 2022, and an interest coverage ratio of 4.7x, which was unchanged from 2022.
SKT reported a weighted average interest rate of 3.5% and a weighted average term to maturity of 4.7 years (inclusive of extension options).
Additionally, 94% of its debt is set to a fixed rate and the company reported $507 million of capacity under its unsecured lines of credit and no material debt maturities until 2026.
Tanger's AFFO per share growth was pretty much flat from 2014, when it was reported at $1.97 per share to 2019 when AFFO came in at $1.95 per share. In 2019, AFFO per share fell by -13% and then fell by -35% during the pandemic in 2020.
Since the pandemic, SKT has returned to growth, with AFFO per share increasing by 13% in both 2021 and 2022 and then increasing 7% in 2023.
However, even after the post-covid rebound, AFFO in 2024 is expected to come in at $1.70 per share, lower than the AFFO reported in 2014 of $1.97 per share, and much lower than the AFFO reported in 2018 of $2.23 per share.
SKT's dividend has followed suit and was reported at $0.97 per share in 2023, compared to $0.945 per share a decade ago. This translates into an average annual dividend growth rate of ~0.35% over the last 10 years.
Currently the stock pays a 3.63% dividend yield that is well covered with a 2023 AFFO payout ratio of 56.07% and trades at a P/AFFO of 16.59x, compared to its average AFFO multiple of 13.80x.
I've been following SKT for quite some time. While there are some good qualities including an investment grade balance sheet (credit rating BBB-), a very conservative AFFO payout ratio, and a well-diversified portfolio, currently the stock is trading at a rich valuation.
Not only is it trading at a premium relative to its average AFFO multiple, but it is trading at higher multiple compared to what I consider higher-quality REITs with better growth rates and better dividend track records such as Realty Income (P/AFFO: 12.97), Simon Property (P/AFFO: 13.55x) and Agree Realty (P/AFFO: 14.37x).
Due to its premium multiple of 16.59x, we rate Tanger a Sell.
In Closing
One of the great things about my job as a real estate analyst is that I get to visit many exciting experiential properties.
In fact, in just a few hours I will be boarding a plane to Las Vegas, where I will be attending The MoneyShow.
While there, I plan to visit many properties owned by VICI, such as these:
I want to assure you that I know the difference between investing and speculating, which simply means that I will limit my time at the tables.
However, as part of my job, it's important to "experience the experiential," which simply means I will play a few hands of blackjack and study diversification (while playing roulette).
Heck, Ben Graham new a thing or two about the game of roulette:
"There is a close logical connection between the concept of a safety margin and the principle of diversification. One is correlative with the other."
And:
"Diversification is an established tenet of conservative investment. This point may be made more colorful by a reference to the arithmetic roulette wheel… Therefore, the more numbers (a gambler) wagers on, the better his chance of gain."
He added,
"For most investors, diversification is the simplest and cheapest way to widen your margin of safety."
So, it's time for some "boots on the ground" research...
Let's Go!
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