Now Is The Time To Buy These 2 Undervalued, High-Yield Stocks

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The goal of my high-yield retirement portfolio is to build a highly diversified mix of companies in all sectors and industries, including those with very strong growth characteristics. Industrial REITs fit that bill well, thanks to the strong tailwinds created by an expanding US economy.

Source: Monmouth Investor Presentation

In addition the rise of e-commerce is fueling rapid demand growth for warehousing space for distribution centers, further putting the wind in the sails of industrial REITs such as STAG Industrial (STAG), and Monmouth Real Estate Investment Corp. (MNR).

Let’s take a closer look at why these two high-yielding REITs represent a great mix of generous, secure, and growing income potential that might be just what your diversified dividend portfolio is looking for. That’s especially true at today’s attractive prices, made possible by the current REIT bear market.

In addition, learn what risks these REITs face in the coming years. And more importantly whether or not these could derail their enticing investment cases.

STAG Industrial: Fast Growing Niche Empire

STAG Industrial got its start in 2003 when STAG Capital partners was formed to own free-standing and single tenant warehouses and light industrial facilities. It IPOd as a publicly-traded REIT in 2011 and ever since has been on an impressive growth streak (goal of 25% portfolio growth each year).

Source: STAG earnings supplement

Today STAG owns 356 properties in 37 states, in over 60 cities, and leases its buildings to 312 tenants. The REIT is highly diversified in terms of geography, industry, and tenant. In fact, the single largest occupant representing just 2.6% of rent. And keep in mind that this tenant, the General Services Administration, is a federal agency, and thus represents a highly reliable income source.

Source: STAG earnings supplement

What sets STAG apart from most of its rivals is that it long ago concluded that Wall Street’s perceptions about the industrial sector were wrong. Specifically that the secondary market (cities with 25 million to 200 million of rentable areas) were being mispriced.

This was out of a belief that primary and super primary markets (big cities) have higher and more stable occupancy rates over economic cycles. This is why it was thought that they maintain stronger pricing power during economic downturns.

Source: STAG investor presentation

However, during the last recession (far more severe than most) this didn’t prove to be the case. In fact, occupancy rates for secondary markets held up better than primary markets, and rental rates fell less severely.

Management believes this is because in smaller cities there is less competitive industrial real estate. This means that tenants have less pricing power because of higher switching costs. In other words, secondary markets are more of a “sellers’ market.”

In addition, because most investment dollars have been focused on primary and super primary markets in recent years, there is less competition for acquiring new properties. Thus, STAG can buy quality properties for less, resulting in higher cap rates (cash yields), and achieve more profitable growth.

The key to STAG’s long-term investment thesis is management’s ability to strike a fine balance between very fast growth, but also remain disciplined in what it buys. This is possible thanks to its deep and experienced bench. For example, CEO Benjamin Butcher, who has been with STAG Capital since 2003, has 24 years of commercial real estate investment experience.

This explains why STAG is so selective about its purchases, usually only buying about 1% of properties it considers each year.

STAG 2016 Acquisition Selectivity

Source: STAG investor presentation

In 2017, the REIT closed on a record 53 property acquisitions, with an average lease term of 7.5 years and a cap rate of 7.4% (1.9% above industry average).

This helped drive very strong growth in revenue and core FFO/share.


2017 Growth (Except Payout Ratio)

Core FFO




Shares Outstanding


Core FFO/Share






AFFO Payout Ratio


Source: STAG earnings release

However, that didn’t translate into better bottom line results. Owing to the older nature of its buildings and a lack of economies of scale, its adjusted funds from operation (REIT equivalent of free cash flow and what funds the dividend) grew slower than its core FFO. Also due to the large number of shares issued to fund its growth last year, AFFO/share growth was mostly flat. This explains the tepid dividend growth in 2017.

The good news is that in 2018, management expects to rely less on equity markets because the share price has taken a hit recently due to rising rate concerns. Instead, it plans to fund its growth plans with modest amounts of cheap debt.

Source: STAG earnings supplement

Fortunately, management has been disciplined with its use of debt in the past. When shares were high it used equity to grow, allowing it to achieve a below average leverage ratio.

Today the REIT is safely capable of borrowing more and in fact, management intends to take leverage from 5.0 to about 5.5 in 2018. But this won’t risk breaching its debt covenants, which the REIT is nowhere near violating. The strong balance sheet is why STAG is rated BBB by Fitch, and enjoys access to very low-cost borrowing (average interest rate 3.5%).

This means that going forward, STAG should be able to achieve stronger AFFO/share growth, and raise its payout at a quicker pace. Currently, analysts estimate this to be about 5% over the long term.

To help drive that growth is STAG’s impressive $1.9 billion growth pipeline, consisting of 144 properties that total 32.4 million square feet. This is notable because right now STAG only owns 20 million square feet of leasable space. This means that the properties it plans to buy are larger, and likely to generate more rent per building than its existing property base.

Source: STAG investor presentation

And that $1.9 billion growth pipeline is just a drop in the bucket when it comes to STAG’s growth potential. Management estimates that STAG has 1% market share in the $250 billion industrial property markets it’s targeting. Or to put another way, STAG has potentially decades of strong growth ahead of it.

Monmouth Real Estate: A Fast-Growing Dividend Aristocrat With A Bright Future

Monmouth is one of the oldest REITs in the world, having been founded in 1968. Over that time it’s built up a property portfolio of 109 properties in 30 states. Almost all of its rent (85%) is from strong investment grade blue chips such as: FedEx (FDX), International Paper (IP), Coca-Cola (KO), and United Technologies (UTX).

Source: Monmouth Investor Presentation

While its property base is very small, it’s also the highest quality in the industry. That’s because Monmouth’s portfolio has: the youngest buildings (less maintenance cost, higher rents), the longest leases, and the highest occupancy.

Source: Monmouth Investor Presentation

This means that MNR’s rent roll (leases expiring in the next three years) is also the smallest, which gives it excellent cash flow predictability. Combined with a below average payout ratio (77% vs. industry average 83%) this makes this REIT’s dividend highly secure.

Source: Monmouth Investor Presentation

In 2017, Monmouth had a record year of growth, thanks to $287 million in new property acquisitions. All of these were effectively brand new facilities, with 10 to 15-year leases. This boosted its property count by 10%, and led to massive growth in its top and bottom line.


Fiscal Q1 2018 Growth







Shares Outstanding






AFFO Payout Ratio


Source: Monmouth Earnings Release

Note that Monmouth, despite its tiny size, was able to show signs of strong operational leverage, meaning that AFFO grew faster than revenue. This is a sign that management runs a tight and efficient ship, despite lacking the economies of scale of its larger peers. It’s also due in part to the very young nature of its buildings, which have very low maintenance costs.

Strong growth is nothing new to Monmouth, which has been growing at a quick pace for years.

Source: Monmouth Investor Presentation

This has helped it to generate some of the industry’s best total returns.

Source: Monmouth Investor Presentation

Monmouth has a $135 million growth pipeline to drive growth in 2018. When combined with the long-term industry tailwinds, including the continued exponential growth of e-Commerce, MNR is expected to remain one of the fastest growing industrial REITs in America.

Source: Monmouth Investor Presentation

Industrial REIT FFO/Share Growth Projections

Source: Brad Thomas

This bodes well for its future dividend growth prospects, which combined with a generous yield, mean that it could easily prove to be a market beater.

Dividend Profiles Point To Excellent Total Return Potential



AFFO Payout Ratio

Projected 10-Year Dividend Growth

10-Year Potential Annual Total Return

STAG Industrial



4% to 5%

10% to 11%

Monmouth Real Estate



6% to 7%

10.8% to 11.8%

S&P 500





Sources: earnings releases, FastGraphs,, CSImarketing

The primary reason for owning any REIT is the dividend. This is why I look at every stock’s dividend profile, which consists of: yield, payout safety, and long-term growth potential.

Both STAG and Monmouth offer attractive current yields, especially compared to the market’s paltry payout. More importantly, those dividends are well covered by AFFO.

Now there’s more to dividend safety than just a good payout ratio. The balance sheet is also important, because too much debt cannot just put a dividend at risk, but also decrease a REIT’s growth potential.


Debt/Adjusted EBITDA

Interest Coverage Ratio

Fixed-Charge Coverage Ratio

Credit Rating

STAG Industrial




BBB (Fitch)

Monmouth Real Estate





Industry Average





Sources: Gurufocus, earnings supplements

Here we see that Monmouth has the weaker balance sheet, though not one that should put the dividend at risk. Its leverage ratio is only just above the industry average. However, I would prefer if the fixed-charge coverage ratio (EBITDA minus unfunded capital expenditures and distributions divided by total debt service costs), were higher.

That being said, Monmouth’s access to low cost capital doesn’t seem to be impaired. For example, in the last quarter it was able to refinance its very long duration (11.5 year) fixed debt down to an average rate of 4.2%. This indicates the bond markets have confidence in: management’s long-term abilities, its very strong counter parties, and its long leases.

Meanwhile STAG industrial enjoys a leverage ratio right at the bottom of management’s long-term 5.0 to 6.0 target. And thanks to its very strong fixed charge coverage ratio it sports a strong BBB credit rating that allows it to borrow very cheaply and generate one of the highest interest coverage ratios in the industry.

All told I (and most analysts) expect STAG and MNR to be capable of strong long-term dividend growth. That’s courtesy of their small sizes and very long growth runways (industrial real estate is a $1 trillion market). Specifically that means 4% to 5% payout growth for STAG, and 6% to 7% for MNR, over the next decade.

Combined with their current yields, that should allow both REITs to easily beat the returns generated by the overheated S&P 500.

Valuations: Worth Buying Today


STAG Total Return Price data by YCharts

Ever since tax reform passed fears of an overheating economy stoking rising inflation have sent long-term interest rates up sharply. This has battered REITs, including STAG and MNR.

However, where some see this as a reason to stay away, I view it as a potentially good buying opportunity.


2018 P/AFFO

Historical P/AFFO


Historical Yield

STAG Industrial





Monmouth Real Estate





Sources: FastGraphs, Gurufocus

There are numerous ways to value a REIT, both in terms of historical valuation metrics, and forward looking ones. Today STAG and MNR are both trading at historically low price/AFFO (REIT equivalent of a PE ratio).

In addition STAG is trading slightly higher than its historical (since IPO) median yield. Monmouth, however, is not. But that doesn’t mean it’s not a good buy. Remember that over the long-term a dividend stock’s total return will usually follow the formula yield + dividend growth. So this is where a forward looking discounted dividend model comes in handy.

That’s because we can estimate the fair value of a dividend stock by the net present value of its future payouts.


Forward Dividend

Projected 10-Year Dividend Growth

Projected Dividend Growth Years 11-20

Fair Value Estimate

Dividend Growth Baked In

Margin Of Safety

STAG Industrial


3% (conservative case)





4% (likely case)




5% (bullish case, analyst consensus)




Monmouth Real Estate


5% (conservative case)





6% (likely case)




7% (bullish case, analyst consensus)




Sources: FastGraphs, Gurufocus

Since 1871 a low cost S&P 500 ETF (if it existed) would have generated a 9.1% total return, net of expenses. Since this is the default investment option for most investors (and what most people benchmark off), I consider this the opportunity cost of money, and a good discount rate.

Now of course there is a lot of uncertainty with any forward looking valuation model, especially one that uses a 20 year time frame. This requires smoothed out growth assumptions that aim to isolate long-term growth potential based on an industry’s fundamentals, and the capabilities of its management team.

This is why I use a range of conservative to bullish growth cases to try to estimate the intrinsic value of a dividend stock. In this case, based on the most likely growth scenarios, I estimate that STAG and MNR are 12%, and 13% undervalued, respectively.

This means that the market is assuming lower dividend growth than what they are likely to generate. Or to put another way, both REITs have a low bar to clear, and thus the opportunity to outperform. This seems to confirm my earlier estimates of their market beating total return potentials, and makes both stocks a good buy right now.

Risks To Consider

There are two kinds of risks to consider with industrial REITs. The first are company specific.

For example, two things potentially concern me about STAG Industrial. These are why I consider it a medium risk stock (5% max position size in my portfolio). First, the REIT’s historical focus on shorter-duration leases in secondary markets (and with older buildings) have caused it to see far lower retention rates than many of its peers.

Now in fairness to STAG this has largely been by design. That’s because the long economic expansion has meant that overall industrial rental rates have been climbing. This means that all industrial REITs have pretty strong pricing power, and thus have more incentive to not offer price breaks to retain older tenants.

For example, according to Monmouth CEO Michael Landy, the average asking price (per square foot) went up 5.3% in 2017. And while STAG has a lower quality portfolio ($4.09 per square foot vs. $5.96 for Monmouth), the point is that current retention rates are low for a reason. And in 2018 STAG does expect retention to climb to about 75%, as it focuses more on longer-term leases, and more primary market properties.

In other words, STAG is likely preparing itself for the next recession, by trying to increase its cash flow stability. That’s a smart long-term move since STAG hasn’t publicly been through a recession, and STAG Capital has been through just one. This means that the “secondary market occupancy and rent will hold up better than primary” theory hasn’t been fully tested yet across multiple downturns. At least not enough for me to call it a low risk dividend stock.

With an AFFO payout ratio of 81% STAG doesn’t seem like its dividend might be put in peril during the next downturn. However, its lower quality portfolio does mean that management might want to create a larger safety buffer before raising the dividend at the 4% to 5% that it’s likely capable of.

Basically this means that STAG Industrial shareholders may end up waiting several more years, and potentially until after the next recession, before they see more than token dividend increases.

As for Monmouth, there are two potential concerns I have. First, it has a very high concentration of its rent coming from just one company, FedEx.

Recently Amazon (NASDAQ:AMZN) announced it was launching its own competing delivery service. The good news is that JPMorgan (JPM) expects this to hurt the USPS far more than FedEx. This means that Monmouth’s most important tenant isn’t likely to fail anytime soon.

In addition in the last quarter the REIT acquired a 300,000-square foot distribution center in Oklahoma City leased for 10 years to Amazon. This indicates that even if Amazon ends up disrupting package delivery, (which is far from certain), Monmouth should be able to adapt as it has successfully done since 1968. After all, plenty of tenants have failed over that time period.

Still given its rental concentration, such a worst case scenario would likely take a few years to overcome in a slow growth turnaround period. During which we might see Monmouth return to previous nasty habit of several years with no dividend growth.

Source: Simply Safe Dividends

The other worry I have about Monmouth is the slightly over-leveraged balance sheet. The industrial REIT industry is facing a potentially challenging year or two. That’s thanks to rising interest rates and falling cap rates on new properties.

Source: Monmouth Investor Presentation

Monmouth’s relatively higher debt levels are not dangerous as of now. But they might limit its future borrowing ability, making it more dependent on fickle (and currently bearish) equity markets to fund its growth.

The problem here is that industrial property cap rates have been declining for years due to rising property values. If they fall too low it can be harder for all industrial REITs to grow profitably. That’s especially true for smaller ones that lack massive scale and large access to cheap growth capital.

Industrial Property Cap Rates

Source: Monmouth Investor Presentation

As you can see, cap rates for industrial properties are cyclical, rising and falling with the economic environment. During recessions, when vacancies rise and the industry struggles, cap rates increase. This makes it easier for REITs to invest profitably.

The second longest US economic expansion in history, (which will hit 10 years in June of 2019), has also seen interest rates near zero for much of the decade. This has led to rising property values and declining cash yields.

For example, back in 2010 STAG Capital was able to acquire properties for cap rates as high as 9.2%. By 2016 that had fallen to 7.9%, by 2017 7.4%, and now in 2018 management is guiding for 7.0%. And keep in mind these are mostly secondary markets, which have lower prices and higher cap rates.

Monmouth on the other hand, has historically targeted prime market properties, specifically: brand new buildings, with the strongest tenants, and the longest leases. While this gives it the best property portfolio in the industry, it also means the REIT has to pay more for growth. For example, in 2017 the average cap rate for its 10 acquired properties was 5.9%.

The concern here is that because they are small REITs, STAG and MNR might lack the scale to keep their cost of capital low enough. At least low enough to generate the kinds of strong gross cash yields on investment (cash yield on new property minus cost of capital) to fuel their projected growth rates.

STAG Industrial

Estimated Cash Cost Of Capital


2018 Cap Rate


Approximate Gross Cash Yield On New Investment


Sources: earnings releases, FastGraphs, Gurufocus, management guidance

In 2017 STAG’s higher share price allowed it to enjoy a lower cost of equity. When combined with higher cap rates this generated a gross cash yield on acquisitions of about 3.0%. That is expected to decline to 2.3% this year, due to a lower share price, and management’s focus on more prime market properties with longer lease durations (which cost more to buy).

Monmouth Real Estate

Estimated Cash Cost Of Capital


2017 Cap Rate


Approximate Gross Cash Yield On New Investment


Sources: earnings releases, FastGraphs, Gurufocus, management guidance

And while Monmouth enjoys a slightly lower cost of capital due to its slightly higher share premium, the gross cash yield on new properties was rather low in 2017.

The good news is that according to STAG higher long-term rates will EVENTUALLY drive cap rates up, thus preventing a liquidity growth trap in which industrial REITs are unable to grow profitably.

However, this might not be for several months or even a year or more. It depends on the rate at which long-term rates rise, as well as numerous other factors.

But there are reasons for optimism. Monmouth says that in their latest quarter (Q1 of Fiscal 2018) they were able to acquire two new properties for $52.1 million. These were leased to FedEx and Amazon for 15 and 10 years, respectively. The cap rate on these buildings was 6.1%, 0.2% higher than last year. This potentially indicates that perhaps the prices for top grade industrial properties may be near its top and set to start falling relatively soon.

Still we can’t forget that there are two parts to the profitability formula, cap rates, but also cost of capital. STAG and Monmouth have enjoyed the lowest interest rates in history, which has allowed even small REITs like these to still borrow very cheaply. For example STAG’s average borrowing costs are 3.5% while Monmouth’s longer duration bonds, (average of 11.5 years), have an average interest rate of just 4.2%.

With long-term rates now rising it’s unlikely that either REIT can expect to see borrowing costs fall any lower, but rather start drifting higher. This could largely offset any near-term increase in cap rates caused by higher interest rates.

So if cap rates move up a bit, and borrowing costs move up by the same amount, doesn’t that mean that the profitability of new properties will remain the same? Not necessarily, at least not in the short to medium-term.

This is because REITs have been incorrectly used as a “bond proxy” by yield-starved income investors for so long, the sector is currently highly rate sensitive. This means that when 10-year yields rise, so do REIT yields, indicating falling share prices, and thus higher costs of equity.

Source: Hoya Capital Real Estate

The amount of sensitivity is determined in part by the duration of a REIT’s leases. This is because the longer the lease, the more inflation sensitive a REIT’s cash flows are thought to be. In reality, rental escalators usually have inflation baked into their formula. But in the short term, perception is reality, at least on Wall Street.

The good news is that industrial REITs have below average rate sensitivity, at least compared to other kinds of REITs. However, Monmouth’s very long lease durations mean that its sensitivity may be the highest among its peers.

This indicates that, at least until industrial cap rates start moving higher, and REIT rate sensitivity declines, (it’s cyclical and mean reverting), both STAG and Monmouth might see slower than expected growth.

For example, STAG industrial is guiding for about $450 million in net acquisitions in 2018, down from $545 million in 2017. For a REIT with a goal of growing its portfolio 25% a year, this slowdown is a potentially troubling sign. Management says that the slower growth will be mainly from growing dispositions as lower cap rates mean it can recycle capital very profitably, (12% unlevered returns on property sales in 2017).

Monmouth too is likely to not repeat 2017’s record year of growth, because its current growth pipeline is just $135 million. That’s compared to $287 million in acquisitions last year.

The good news is that over the long term, interest rates don’t actually hurt: REIT growth, dividend safety or total returns. In fact, because rates usually rise during times of economic prosperity, REIT fundamentals tend to do best in a rising rate environment. And both STAG and Monmouth have long histories (since 2003 and 1968, respectively) of growing during all manner of economic and interest rate environments. Thus, I have full confidence that these quality management teams will be able to keep growing and generating: generous, secure, and rising dividends over time.

But until the market starts focusing on those positive economic, industry, and individual REIT fundamentals, investors need to brace for a potentially painful year. Both in terms of share price, and potentially slower than expected growth rates for these REITs.

Bottom Line: These 2 Undervalued, Fast-Growing Industrial REITs Make Potentially Great Long-Term Buys At Today’s Prices

Don’t get me wrong, I’m not calling a bottom for REITs. For all we know, the sector might end up lagging the broader market for the next year or more, due to rising rate concerns.

What I do know is that industrial REITs like STAG and Monmouth have a bright future, and strong long-term total return potential. I have full confidence in their skilled management teams to continue adapting to various challenges, as they have successfully done in the past.

Which means that at today’s prices, long term, high-yield income growth investors are likely to do well adding these two stocks to their diversified income portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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