Luxor Capital Is Betting Big on This REIT

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In a 13G filed with the SEC, Christian Leone’s Luxor Capital has disclosed ownership of more than 17 million shares of American Realty Capital Properties (NASDAQ: ARCP), a $2.3 billion market cap real estate investment trust which focuses on investments in retail and office real estate. This gives the hedge fund 9.2% of the total outstanding shares, and is up from the position of 4.1 million shares which it had reported as of the end of March (find Luxor's favorite stocks).

We can see from our database of quarterly 13F filings, which we track to develop investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year) that Luxor had not owned any shares of the stock at the beginning of 2013.

When evaluating REITs, we focus on funds from operations (FFO) as opposed to earnings/net income. This is because certain GAAP expenses (such as depreciation) are not as relevant for these companies; in fact, the value of real estate assets usually increases over time. Last quarter, FFO was over $24 million, compared to a slightly negative figure in the first quarter of 2012.

If we annualize that, and use a full-year FFO figure of $100 million, then we get a P/FFO multiple of 23. If instead we perform the entire exercise with adjusted funds from operations (or AFFO), where American Realty Capital Properties made additional addbacks, primarily related to acquisition and transaction related costs, the P/AFFO multiple comes out to 19.

REITs receive favorable tax treatment from the IRS, conditional on distributing a large share of taxable income to their shareholders, which often results in high dividend yields. American Realty Capital Properties began paying monthly dividends in October 2011; it currently has an annual yield of just over 6% at current prices. Billionaire Steven Cohen’s SAC Capital Advisors had also been buying the stock in the first quarter of this year (check out Cohen's stock picks).

Other real estate investment trusts with an emphasis on retail and/or office properties are National Retail Properties (NYSE: NNN), Douglas Emmett (NYSE: DEI), Lexington Realty Trust (NYSE: LXP), and Brandywine Realty Trust (NYSE: BDN). Douglas Emmett, with a current yield of 2.9%, is the only one of these four to pay a yield less than 4%. The company, which primarily owns office properties in California, did cut its dividend nearly in half at the end of 2008 and is still just short of what its quarterly payments used to be after a pattern of increases in the past few years.

Lexington Realty reduced its dividends to less than $0.02 per share after paying over $0.30 per share for about 10 years; even after recent increases, quarterly payments are well below these levels at $0.15 per share. So, while it has the highest yield of this peer group at 5%, income investors should be aware that the company is vulnerable to economic shocks.

National Retail Properties and Brandywine each carry yields in the 4.3%-4.4% range. The $2 billion market cap Brandywine follows the same pattern we’ve seen for companies which were around pre-crisis: quarterly dividend payments are roughly a third of what they were in late 2008, and so, investors should weigh the high yield of the stock against the risk of any events which could lead to dividend cuts.

Interestingly, National Retail Properties has actually managed to increase its dividend payments over this time. The stock’s beta is 0.2, which suggests, in quantitative terms, that it has little exposure to the overall economy, but given the company’s business, we are skeptical and would need to look into the stock further before recommending it as an income or defensive pick.

We think real estate investment trusts should only be used as high-yield stocks to supplement the returns on an income portfolio focused on more conventional companies, particularly given their general sensitivity to market conditions. National Retail Properties does seem worthy of checking out, however, and while American Realty Capital Properties does have a short history of paying dividends, the yield is high and so, some investors may want to look into how it would fare in rough times. 

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This article is written by Serkan Unal and edited by Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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