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3 REITs to Consider Selling

Dec 17, 2020 by Reuben Gregg Brewer
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Every investment decision doesn't turn out to be a winner -- not even for legends like Warren Buffett. The problem, however, is often in figuring out when it's time to get out from under a losing position. Here's why investors who own real estate investment trusts (REITs) EPR Properties (NYSE: EPR), Preferred Apartment Communities (NYSE: APTS), and Whitestone REIT (NYSE: WSR) might want to abandon ship.

Deeply troubled tenants

EPR Properties owns experiential assets like ski resorts, casinos, and amusement parks. Although these types of assets are relatively immune to the shift toward online shopping, they proved highly exposed to the impact of the coronavirus pandemic. Basically, experiential assets like the ones EPR Properties owns are specifically designed to bring people together into group settings, which can spread this novel illness.

With vaccines on the way, however, some investors might reason the worst is nearly over. If only that were true. In the first quarter of 2020, before the impact of COVID-19, roughly 45% of the REIT's rental income was derived from movie theaters. That's a huge concentration in just one property type.

Theaters are also facing massive financial strains today, with the company's largest tenant at nearly 18% of the 2019 rent roll, AMC Entertainment (NYSE: AMC), teetering on the edge of bankruptcy. Not surprisingly, the REIT's last dividend payment was in May.

There could be material recovery potential here, of course, if EPR's tenants can bounce back. But we remain a long way from normal, and it will be months (if not quarters) before vaccines are distributed widely enough to alter the course of the pandemic. That means there's still a difficult path ahead for EPR and its lessees. For all but the most aggressive investors, the risks here likely outweigh the potential rewards.

An odd way to raise cash

Next up is Preferred Apartment Communities. Although the REIT's name includes the word "apartment," it actually owns apartments, office buildings, and shopping centers. But the word "preferred" is highly descriptive, since a key funding source for the REIT is nontraded preferred stock. Selling nontraded preferred stock is an unusual approach to raising cash that management highlights as a net benefit.

The problem here is that every company would go down this route if it was really so great. Why, exactly, is Preferred Apartment Communities the only REIT doing this? Well, it provides a steady stream of cash to invest for growth is the obvious answer. But as an investor, there are some risks.

For example, preferred stocks rank higher than common in the capital structure. So while preferred stock isn't debt, it does take precedence over common stock in a liquidation scenario. Preferred dividends also take precedence over common dividends -- noting that the common dividend was cut in June, but preferred dividends were not.

In addition, preferred holders can redeem their preferred stock, effectively forcing Preferred Apartment Communities to buy it back. If that happens, as it did during the worst of the pandemic downturn, the REIT may be forced to sell stock to raise the cash it needs to redeem the preferreds, which is also what happened. In other words, it was forced to sell common stock at a bad time because of its focus on preferred stock.

In the end, Preferred Apartment Communities' use of an odd capital raising program adds a layer of complication most investors should probably avoid.

Small and hyperfocused

The last name here, Whitestone REIT, is more straightforward. It owns retail centers in Arizona and Texas, with virtually all of its portfolio spread across just four cities. That's a material amount of concentration. Phoenix alone makes up 42% of the rent roll, and three Texas cities make up all but 1% of the rest. Management pitches this as focusing on areas it knows well, but for most investors, that's just too much exposure to too few regions. This brings up the fact that the REIT cut its dividend by 63% in April. Clearly, there are problems here that need to be addressed.

Whitestone is looking to diversify, but at this point it's just too small (it has a $336 million market cap) and focused to be worth the risk for investors. That's particularly true when there are much larger and more diversified options out there in the shopping center space, like Federal Realty Investment Trust (NYSE: FRT). Note that Federal Realty has increased its dividend annually for over five decades -- including in 2020. Sure, Whitestone's yield is 5.3% and Federal Realty's is 4.6%, but the added yield here just isn't worth the added risks.

Admitting mistakes and moving on

There's no shame in putting money into a bad company, as long as you admit it and try to learn from the error. EPR Properties has a good concept but is too focused on experiential properties -- when trouble hit, the REIT's outlook crumbled. Preferred Apartment Communities is trying to raise cash in a way that's not common, something about which investors should have very material questions. That's especially true given the common stock dividend cut. And Whitestone REIT is just small and hyperfocused, which means the risks probably outweigh the rewards for most investors -- a fact that was true even before the 2020 dividend cut.

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Reuben Gregg Brewer owns shares of Federal Realty Inv. Trust. The Motley Fool recommends EPR Properties. The Motley Fool has a disclosure policy.