Published by Nicholas McCullum on May 17th, 2017
Real estate and dividend stocks are two of the most-cited strategies for creating passive retirement income.
The downside to owning rental properties is that it is not really passive. Any landlord who has had to call a plumber or an electrician during the middle of the night can attest to this.
For investors looking to capture the returns of the real estate sector while benefiting from the hands-off approach of dividend stocks, real estate investment trusts – or REITs, for short – are a very attractive investment vehicle.
EPR Properties (EPR) is one of the most well-known REITs thanks to its strong total return history and large size relative to other REITs.
EPR also has an outsized dividend yield. EPR currently has a dividend yield of 5.9%, giving it a place among the select group of stocks with 5%+ dividend yields.
Better yet, EPR Properties pays monthly dividends. This can help retirees and other income investors to budget over small time periods, and also creates a more reliable income stream.
This article will analyze the investment prospects of EPR Properties in detail.
EPR Properties is a triple net lease real estate investment trust that focuses on entertainment, recreation, and education properties.
Triple net lease means that the tenant is responsible for paying the three main costs associated with real estate: taxes, insurance, and maintenance. Operating as a triple net lease REIT reduces the operating expenses of EPR Properties.
EPR Properties is well known for its total return history. EPR’s publicly-traded common stock has outperformed all other meaningful competitors over the past decade (which includes the financial crisis of 2007-2009).
Source: EPR Properties Investor Presentation, slide 4
Looking back further than just the past decade, EPR’s total returns have been very impressive.
Since the REIT became a publicly-traded entity in 1997, EPR Properties has delivered total returns of more than 1,000% to its shareholders – more than three times the total returns of its competitors, as measured by the MSCI U.S. REIT Index.
Source: EPR Properties Investor Presentation, slide 5
EPR Properties has driven these total returns by focusing on the ‘white space’ between diversification and specialization.
Most REITs are either highly diversified or highly specialized (for example, STAG Industrial (STAG) focuses solely on single-tenant industrial properties).
Remarkably, EPR Properties is both. The company is highly specialized in each of the Entertainment, Recreation, and Education sectors, while having a healthy degree of diversification among them.
Source: EPR Properties Investor Presentation, slide 6
More specifically, the $5.5 billion+ portfolio of EPR Properties is broken down as follows:
- 49% Entertainment
- 25% Education
- 23% Recreation
- 3% Other
The company’s portfolio is highly diversified within each segment, with 338 locations leased to 250+ tenants in 42 states, DC and Canada.
Source: EPR Properties Investor Presentation, slide 11
To get a sense of the actual operations of each segment, consider the following table (which follows the same color scheme as the above pie chart).
Source: EPR Properties Investor Presentation, slide 12
EPR’s Entertainment segment owns theaters, retail centers, and family entertainment centers.
The Recreation segment owns waterparks, golf courses, and ski hills.
Lastly, the Education segment of EPR Properties is in the business of owning public charter schools, private schools, and early childhood education locations.
Each of the three operating segments of EPR Properties benefits from substantial geographic diversification within the United States and Canada, shown below.
Source: EPR Properties Investor Presentation, slide 13
Although an established REIT with a market capitalization of $5.2 billion, EPR Properties still has many opportunities to drive its growth.
In the past, the REIT has grown by making regular property acquisitions in each of its operating segments.
In recent years, the amount of new investment allocated to its two smaller segments (Education and Recreation) has increased notably. This may be a sign that EPR Properties is attempting to diversify away from its dominant Entertainment business.
Source: EPR Properties Investor Presentation, slide 7
The reason why the Entertainment segment is such a large component of the greater EPR Properties business is because initially, EPR Properties focused solely on this area of the real estate market. As the trust grows, it has been diversifying its real estate portfolio.
The steady real estate acquisitions made by EPR Properties has translated to fundamental growth in the REIT’s underlying business.
The company has grown its funds from operations (FFO), revenue, and net income at satisfactory rates over the last several years.
Source: EPR Properties Investor Presentation, slide 44
As a REIT, EPR Properties is required by law to pay the majority of its income to shareholders as dividend payments. Thus, the trust has limited capital to reinvest for internal growth. EPR raises capital to fund growth by issuing debt and equity securities.
EPR’s growth prospects remain bright because of its leadership in the segments that it operates in. The company has a flexible balance sheet (more on that later), which means it has the capability to issue new securities to raise capital and acquire properties.
Competitive Advantage & Recession Performance
The competitive advantage of EPR Properties comes from its expertise in each of its three operating segments. It is one of the few REITs with the size and expertise to close on large real estate deals in the Entertainment, Recreation, and Education sectors.
EPR also benefits from its highly decentralized management structure. Each segment of the REIT (Entertainment, Recreation, and Education) operates independently and reports to the company’s senior executive team.
Source: EPR Properties Investor Presentation, slide 8
This benefits the REIT in two ways.
First, the decentralized structure helps to reduce operating expenses, giving EPR a cost-based competitive advantage over its peers.
Secondly, it allows each operating silo to develop substantial expertise. If your team is focused on solely finding deals in the education real estate segment (as an example), you have a much greater probability of identifying deals than if you are searching for all real estate.
As an owner of entertainment and recreation properties, EPR might not be as recession-resilient as, say, a healthcare REIT. The tenants of EPR may experience financial difficulties if customers cut spending when disposable income becomes tight.
With that said, EPR stands to benefit from its strong balance sheet. 62% of EPR’s assets are financed with common equity, with the majority of the remainder (31%) financed with unsecured debt.
EPR Properties also has most of its debt financed in fixed-rate instruments, which will benefit this REIT in the current rising interest rate economic environment.
More details about the balance sheet of EPR Properties can be seen below.
Source: EPR Properties Investor Presentation, slide 42
For EPR, there are two main concerns that may need to be addressed during a recession.
The first is that a company will be unable to meet its interest obligations, or unable to refinance debt as it matures.
EPR is insulated from this risk because of its well-laddered debt maturity profile. The REIT has just $140 million of debt maturing in 2017, and the remainder is well dispersed beyond that.
Source: EPR Properties Investor Presentation, slide 43
The second main risk is tenant-related. As mentioned, EPR might experience trouble if its tenant do.
There is also the additional risk that EPR will not be able to find new occupants for its properties as its leases expire.
EPR has mitigated this risk by creating a well-laddered lease maturity profile. Fortunately for investors, a great deal (40%+) of EPR’s leases are very long-lived and expire beyond 2027.
In the more near-term, EPR’s lease expirations over the next 10 years average only ~3% of total revenues each year.
Source: EPR Properties Investor Presentation, slide 16
Although EPR is likely not as recession-resistant as a healthcare REIT like Omega Healthcare Investors (OHI), EPR has mitigated its business-specific risks accordingly.
Valuation & Expected Total Returns
Expected total returns for EPR shareholders will be composed of valuation changes, dividend yield, and growth in the trust’s per-share funds from operations.
The valuation of REITs cannot be assessed using the traditional price-to-earnings ratio because their earnings-per-share are depressed by the substantial depreciation and amortization charges associated with owning real estate.
The easiest (and perhaps most useful) valuation method for real estate trusts it to simply consider their dividend yields. By comparing EPR’s current dividend yield to its historical average, we can get a sense of the REIT’s current valuation.
EPR Properties currently pays a monthly dividend of $0.34 per unit, which yields 5.9% on today’s stock price of $69.44.
The following diagram compares EPR Properties’ current dividend yield to its historical average.
Based on the above diagram, the current dividend yield of EPR Properties is roughly in-line with its historical averages. Thus, it is unlikely that valuation changes will have a material effect on this stock’s expected total returns.
With that said, EPR’s current dividend yield is very attractive and will be a boon to investor returns. Further, it is highly likely that the REIT will continue to grow its payout over time. The trust has compounded its payout at ~7% per year over the last several years.
Source: EPR Properties Investor Presentation, slide 45
The remainder of EPR’s shareholder returns will be caused by growth in the company’s earnings power as measured by funds from operations (FFO) per unit.
Since 2012, EPR has grown its FFO/unit by approximately 7% per year, on average. The REITs growth may moderate slightly as it grows in size. I conservatively expect FFO/unit growth of about 5%-7% per year (on average) moving forward.
Altogether, the expected total returns for EPR shareholders will be composed of:
- 5.9% dividend yield
- 5%-7% growth in funds from operations per unit (on average)
For total expected shareholder returns of 10.9%-12.9% per year, before accounting for changes in the REIT’s valuation.
EPR Properties looks to be a very attractive investment right now.
The REIT has a dominant position in the ownership of movie theaters, golf courses, ski hills, and educational institutions. These are relatively small sub-segments of the real estate industry, and give EPR the benefit of being ‘a big fish in a small pond.’
EPR Properties is also very shareholder-friendly. The company’s 5.9% dividend yield and monthly dividend payments are very attractive for investors seeking current income.
Based on all these factors, EPR Properties appears to be an excellent choice for either income investors or total return investors that are looking for some exposure to the real estate industry.