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Avoid These 3 REITs at All Costs

Nov 10, 2020 by Reuben Gregg Brewer
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The global pandemic has had a material impact on real estate investment trusts (REITs). While some have prospered (warehouses), others have languished (enclosed malls). Now is not the time to take on extra risk if you don't need to, which is exactly why you should avoid these three REITs today.

A structural oddity

Preferred Apartment Communities (NYSE: APTS) is first up. There are two problems here. First the name implies the REIT owns apartments, which is true, since it owns 36 apartments with roughly 11,000 units combined. However, that's only one piece of the story, because until recently, it also owned eight student housing assets with around 2,000 units.

Student housing is often viewed as a distinct property type, and the company basically admitted it was overreaching by owning such assets when it sold this business in November. In addition to this, meanwhile, the REIT also has a history of making loans to companies building apartments. It has rights to buy these assets (holding around 3,000 units combined), but making construction loans is another sign of overreach.

If these things comprised the entire story, it wouldn't be that big a deal. However, the REIT also owns 54 primarily grocery anchored shopping centers and nine office buildings. Preferred Apartment Communities has moved well beyond what its name suggests it owns and, even after the student housing sale, has its fingers in what could be seen as four business lines. Although it operates in the desirable Sun Belt region of the country, it seems like the REIT is trying to do too many things at once.

And then there's problem number two: The REIT has a unique funding approach that involves selling nontraded preferred stock on what appears to be a continual basis. Owners of these securities can ask for their money back and during the pandemic have done just that, resulting in Preferred Apartment Communities selling common stock for cash. So this capital source can potentially turn into a liability when times get tough. However, it can be a problem in good times, too, since regularly selling preferred stock means the company has to put the cash raised to work. That might help explain why its investment portfolio has spread so far beyond apartments.

In addition, the preferred shares have priority over the common stock dividend. So, by design, common shareholders are second fiddle at a company that has a complex financing structure and owns assets across very different property types.

The common stock dividend was cut in June and remains at the level today. Add that fact to the student housing sale, and it suggests Preferred Apartment Communities really has bit off more than it can chew. Investors shouldn't do the same thing.

Too much focus

Next up is EPR Properties (NYSE: EPR), which bills itself as an experiential property owner. Before COVID-19, that sounded like a great concept, since people were shifting toward online shopping but still seeking out real-world experiences. EPR's list of property categories is pretty diverse, too, including movie theaters, amusement parks, ski resorts, and casinos, among others. These types of experiential properties make up around 90% of the rent roll, with the rest coming from educational assets.

So far, so good. The problem right now is that roughly 46% of the company's rent before COVID-19 started to hit in full force came from movie theaters. Another 22% was derived from what it calls "eat & play" assets. Government-mandated nonessential business shutdowns and people practicing social distancing have been terrible for these businesses. EPR Properties is only collecting around half of its rent, even after nonessential businesses have been allowed to reopen. No wonder it eliminated its dividend in March when the pandemic was starting to pick up steam.

Meanwhile, the struggles of its largest tenant, theater operator AMC Entertainment (NYSE: AMC), show just how bad things continue to be. AMC's third-quarter attendance was off by 93% year over year, and revenues were down 90%, despite having around 80% of its U.S. locations reopened. AMC doesn't see things improving anytime soon, and other movie theaters aren't doing any better.

Until the world figures out how to deal with COVID-19, EPR's portfolio will continue to struggle. There might be huge turnaround potential here, but it's just not worth the risk for most investors.

Bankruptcy is never a good thing

The final name up is Pennsylvania REIT (NYSE: PEI), which owns enclosed malls. The reason to avoid this one is pretty easy to explain: It just declared bankruptcy. That's almost always a bad thing for stockholders, and investors should usually stay away from companies that seek out court protections. But this bankruptcy effort seems to be a little different than most.

Although common stockholders generally get wiped out in a bankruptcy, the deal Pennsylvania REIT is working to get approved wouldn't impact shareholders. The goal is basically to push out debt maturities and leave everything else as is (that's a simplification, of course, but directionally correct).

There's two problems with this plan. First, not all of the company's creditors are on board. Thus, things could change as the mall REIT works its way through the bankruptcy process. Second, a heavy debt load has been a long-running issue for Pennsylvania REIT as it tried to adapt to the retail apocalypse, but the more important problem today is the impact of COVID-19. Retailers in malls are shutting locations, going out of business, and having troubling getting customers to visit their stores. None of that is good for their mall REIT landlords. And that won't change while COVID-19 continues to rage. Even after there's progress with the pandemic, it will probably still take time to get customers comfortable with shopping again.

Other mall REITs haven't had to go down the bankruptcy route. Even though the current plan at Pennsylvania REIT isn't supposed to wipe out shareholders, it's just not worth the risk of getting involved here now that the company's list of troubles includes the retail apocalypse, COVID-19, and bankruptcy proceedings.

The bottom line: Keep it simple

Let's be honest: Investing is not an easy thing. It requires a lot of effort and time to stay on top of your portfolio. Today, in the face of COVID-19, that has become even more difficult. There's no reason to make it harder on yourself by buying REITs like Preferred Apartment Communities, EPR Properties, or Pennsylvania REIT. Sure, they could all work through their issues, but you'd have to watch and worry all along the way. It's better to just keep your life simple and focus on REITs that aren't facing the same kind of headwinds.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends EPR Properties. The Motley Fool has a disclosure policy.