Sheila McGrath, a senior managing director covering equity REITs and real estate operating companies at Evercore ISI, was the recipient of the 2019 Nareit Industry Achievement Award. The award is given annually to professionals serving the REIT industry whose acumen and integrity have helped heighten awareness and understanding of the value of REITs and publicly traded real estate.
Prior to her role at Evercore, McGrath was sector head for REIT research at Keefe, Bruyette & Woods. McGrath has covered REITs for nearly two decades. During that time, she has seen the industry mature to a point where REITs have become leading players in the S&P 500 and are taking a key role in the development of sustainable real estate. Meanwhile, through her involvement with Nareit’s Dividends Through Diversity & Inclusion (DD&I) initiative, McGrath has been instrumental in broadening the appeal of real estate to attract more women and minorities.
Q: Do you see REIT stocks playing a more significant role in retirement portfolio allocations going forward?
With bond yields near record lows, retirees are starved for investments with a decent yield. REITs have historically offered investors an attractive dividend yield, the opportunity for long-term capital appreciation, and some inflation protection.
According to the Population Reference Bureau (PRB), the number of Americans age 65 and older is projected to nearly double from 52 million in 2018 to 95 million by 2060, and this share of the total population over 65 will rise from 16% to 23%. With REITs posting competitive returns versus alternatives, and considering this wave of retirees seeking yield, we believe REITs will represent a larger share of retirement portfolio allocations than they have historically.
Q: You’ve been covering REITs for many years. Looking back, what have been the most evolutionary changes you have seen from an operator’s perspective as well as from the investor’s perspective?
This past November was my 26th REITworld and REITs have certainly changed dramatically since the early 1990s. Management teams are more sophisticated and seasoned operating in the public markets than the early days.
The supplemental packages REITs provide investors with relevant real estate metrics, balance sheet disclosures, tenant concentration, and lease expiration data are comprehensive and an important part of REITs providing transparency to the investment community. Given REITs’ history of tapping the equity and debt markets for new capital more than most sectors in the public markets, the company disclosures are critically important. We have learned over time that investor capital rewards transparency. REITs with best practices for disclosures generally garner a better cost of capital.
REIT management teams have become better allocators of capital too. Post the global financial crisis, many REITs have adopted a more conservative dividend payout policy, paying out 100% of net taxable income—above the minimum requirement but much lower than historical norms that were greater than 100% net taxable income. This strategy enables the REIT to retain cash flow to fund growth. In my opinion, the discipline of having to pay a required dividend to shareholders also invokes a discipline on thoughtful capital allocation.
From an operating perspective, REITs, in general, have larger portfolios with state-of-the-art systems in place that track asset level data. The companies have the ability and the access to capital to roll out sophisticated initiatives to try to enhance operations which could entail yield optimization, bulk purchasing, solar power, and other energy saving initiatives. REITs are really taking leadership roles in focusing on best practices to have a more sustainable real estate industry. A focus on energy efficient properties benefits the environment and the bottom line.
Q: What are some of the challenges you anticipate for REITs and REIT investors?
While not REIT specific, I believe broadly the challenge for public equity investors at this juncture is the wave toward passive investing. Active managers typically tend to meaningfully outperform industry benchmarks in market downturns. With the last downturn over 10 years ago—and memories short—passive investing is garnering a substantial amount of inflows. I think institutional investors should continue to create differentiated products that will not be easily replicated with an ETF and that will have an income component that will appeal to the wave of retirees in the U.S.
As far as REIT challenges, I think that varies greatly by sector and at different points in the cycle. With the triple net lease and healthcare REITs currently trading at meaningful premiums to net asset value (NAV), these companies have access to both attractively priced equity and debt to fund external growth stories.
On the other hand, office and retail—both strips and malls—are not trading at premiums to NAV and consequently must fund growth with retained capital and joint venture equity capital.
Q: Playing that forward, what REIT sectors do you think will post the most dynamic growth over the next five years?
Although I do not formally cover the alternative or non-core property REIT sectors such as data centers or towers, I believe these will continue to have broad appeal as the public REIT players have established brands, expertise, and a cost of capital advantage. Interestingly, five of the top 15 largest REITs by market cap in the S&P 500 are from the tower and data center sectors.
I cover Iron Mountain Inc. (NYSE: IRM), which has been investing in data centers in recent years. Iron Mountain has a 70-year operating track record and is the global leader for storage and information management services. The company is leveraging its relationships with the Fortune1000 and its reputation for security and protection of highly sensitive data to grow in the data center segment. While this segment remains a small portion of Iron Mountain’s business, we view it as an important one to enhance EBITDA margins and to shift the business mix to capture more of its customers’ broader information and data management needs.
Q: As a member of Nareit’s Dividends Through Diversity & Inclusion steering committee, how do you see real estate attracting more women in the future?
There are many different career tracks in commercial real estate. From a REIT equity research or investment banking standpoint, college majors feeding into those areas would likely include finance or economics majors. According to a Glassdoor survey, almost 62% of finance majors and 65% of economics majors are men. This starting point straight out of college may have something to do with fewer women in real estate finance.
I think that the Dividends Through Diversity & Inclusion (DDI) initiative is a great program to promote women and members of other diverse groups in the REIT industry. I am proud to say that I was there from the start of the DDI initiative with Mary Hogan-Preusse (Sturgis Partners), Bonnie Gottlieb (Nareit), and Sherry Rexroad (BlackRock) when we first met in New York and crafted an initial framework and potential team. With younger women in our industry meeting and interacting more with successful senior women in REITs, perhaps this DDI initiative will help play a role in promoting more women in the future in senior real estate positions.
Q: On the flip side, what sectors are giving you concerns?
The consensus view is to highlight retail as the most challenged, given the spate of recent tenant bankruptcies and changing shopping patterns of consumers. The strip center and mall REITs reflect this mainstream view with shares trading at larger discounts to consensus NAV estimates and lower multiples than other sectors.
Interestingly, Brookfield Property REIT (Nasdaq: BPR) took a very contrarian view of malls and purchased the remaining part of GGP that the company did not own in August 2018. Brookfield’s view is that there are significant value creation opportunities at many of its retail malls. The upside for Brookfield will generally include densifying the projects with additional uses which include residential, office, and hotel components.
There is no denying that retail real estate is undergoing fundamental changes and having the broad expertise across commercial real estate property types that Brookfield brings to the table should prove to be the necessary tool kit to create additional value at its centers. While retail undeniably has challenges, this near-term broad consensus fear can create interesting long-term redevelopment or repositioning opportunities.