Dividends are nice, but a high dividend that is safe, has room to grow, and is paid by a business with lots of long-term potential to expand is the trifecta. One company that checks all these boxes and more is EPR Properties (EPR -0.32%).
While EPR isn't exactly a household name, it is a commercial real estate owner that serves as a landlord to some of the most well-known experiential brands in the world. Here's what the company does and how it could drive market-beating returns for years to come.
EPR Properties in a nutshell
If you aren't familiar, EPR Properties is a real estate investment trust (REIT) that specializes in experiential properties. Its top property type is movie theaters, which provide approximately 40% of its rental income. Admittedly, this is the biggest long-term risk factor to the business.
On one hand, EPR's theaters are among the best in their respective markets -- picture modern megaplexes in popular shopping districts. On the other hand, there's a lot of uncertainty surrounding the future of the movie theater business in general. EPR is actively and gradually diversifying to reduce the concentration of movie theaters in its portfolio, but that process will take time.
The company also owns a large number of "eat and play" properties -- one example is TopGolf, which is EPR's largest non-theater tenant. There are also water parks, ski resorts, experiential lodging, and fitness and wellness properties.
EPR is the only pure-play diversified experiential REIT, and while its growth is intentionally slow right now due to high interest rates, management sees a $100 billion addressable universe of properties it could acquire. It obviously won't buy all of them, but the point is that it has a lot of potential to expand its portfolio over the long term.
How could EPR beat the Dow Jones?
While the business model for REITs is a relatively simple one, many investors don't realize that long-term returns from real estate businesses come from a few different sources.
Dividends: The most obvious component is the cash distributed to shareholders. EPR is one of the few REITs that pays its dividends monthly, and at its current share price, it has a 7.7% annualized yield. Its payout is covered by its profits and should continue to grow. With this kind of yield, you don't need that much stock price appreciation to beat the market.
Property appreciation: One of the goals of real estate investing is to buy properties that will be worth significantly more in the future than they are when you buy them. This generally works out in commercial real estate, but while EPR has a generally high asset quality, its theater properties are a question mark, especially when it comes to future value.
Capital recycling: REITs (including EPR) typically sell mature or non-core assets from time to time and redeploy their capital into more attractive opportunities.
Development: The economics of real estate development are complex, but the basic idea is easy. Let's say that you can build a property for $8 million that will be worth $10 million upon completion. You've just created $2 million in value for your shareholders. EPR grows through a combination of opportunistic acquisitions and development, and the latter can help drive its long-term value creation.
Leverage: Just as most homeowners take out mortgages when they buy their homes, most REITs use borrowed money to help fund their growth. EPR is no exception. The general idea is that if you can borrow money at, say, 5% interest, and buy properties that produce an 8% to 10% yield on cost plus long-term appreciation, you can boost your returns.
When you put all of these factors together, EPR certainly has the potential to beat the Dow Jones Industrial Average for total returns over time. And this doesn't even consider the interest rate dynamics, as REITs generally experience negative price pressure when interest rates rise and tailwinds when they fall. Rates are widely expected to cool off over the next few years, which could be a positive catalyst for EPR.
Will EPR Properties beat the Dow Jones over the next 10 years?
Obviously, there's no way to know if EPR will outperform the market. A lot can happen. However, it's worth noting that EPR has handily outperformed the market since its 1997 IPO (by about 600 percentage points) and the company's business model has a proven track record of long-term success.
To be sure, there are some significant risk factors, such as its concentration in theater properties, but with a top-quality portfolio and a 7.7% dividend yield that's well-covered by its profits, EPR's risk-reward dynamics look attractive.
