REITs have not thrived since investors started to fret about rising interest rates a year and a half ago. FAM Real Estate Investment Trust has fared even worse thanks to a controversial decision by its board of trustees.
But there are two reasons to buy this little-known REIT, which at today's price offers investors a safe 9-per-cent yield and the prospect of a decent capital gain.
The first reason is that it's becoming clear that talk of rising rates is very premature.
Look at the U.S. Federal Reserve, which has been warning of rising rates for 18 months but has yet to pull the trigger. Why? Because there's not much economic growth in the developed world. Sure, the United States is faring a little better than Europe or Canada, but the recovery is lumpy at best.
There's also no sign of inflation. In fact, the fear now in many parts of the world is of deflation, which would argue for lower interest rates. The U.S. 10-year treasury yield sits below 1.7 per cent, hardly indicative of fears of inflation.
This should keep borrowing costs for real estate investors low as well. And since that was one of the reasons REIT shares fell, it stands to reason that as investors begin to accept that lower rates are here to stay for a while longer, if not a lot longer, REIT shares should start to move up.
Investors looking for income and faced with paltry bond yields will have to start buying income elsewhere, and REITs are good candidates.
FAM is a particularly good candidate in my view because the unit price is even lower for what I think are temporary reasons.
The REIT was spun out of another listed firm that owned a contract to manage FAM. When that company was sold, some analysts and investors were not happy with the plans of the new manager, Slate Properties, which included dropping some of its properties into FAM in exchange for units.
Notwithstanding the outcry, shareholders voted in favour of the deal and the stock price has started to recover a little.
Slate's principals, now the insiders at FAM, have bought a lot of stock in the market and in addition to this, as part of the deal, Slate was given shares valued at $9, less than the current share price. So if one assumes that $9 is a conservative value for the stock, there's room for the shares to appreciate in value.
Another thing to like about the stock is that FAM has very good assets. Until the takeover by Slate, it was very capably managed by a first-rate chief executive who spent most of his life as a real estate analyst. This experience influenced him to build a very diversified asset base and to avoid sectors of the real estate market that are too crowded and competitive.
He leaned toward niche properties, including a data centre that's currently under construction that will, once built, contribute nice cash flow to the company for possible dividend increases.
He also used relatively modest amounts of debt, so the balance sheet is flexible and conservative.
Some analysts who were skeptical about the Slate deal have come around.
Rob Sutherland at Euro Pacific calls FAM one of his top picks. He's especially keen on the data centre investment, which, if it develops beyond current plans could add 60 to 90 cents to his estimate of net asset value.
"It's an absolute cash cow," he says.
As for the new management team, "they're incentivized by their fees and stock ownership to do what's right."
Mr. Sutherland also doubts rates will rise soon, pointing to oil prices as yet another reason to think there's no inflation in the air.
So while FAM is not a household name, it has most of the hallmarks of a good investment: a conservative balance sheet that offers protection, a diversified asset base with some interesting niche avenues for growth, a handsome dividend with room to rise, insider buying and a stock price that got cheap briefly but is on the mend. It's tough to go wrong when a stock has these things going for it.
Fabrice Taylor, CFA, publishes the President's Club investment letter, for which he and The Globe and Mail have a distribution agreement. He owns shares of FAM.