There aren’t often revolutions of thought in finance, but the move away from paying dividends and toward buying back stock has taken over the stock market over the past few decades. For most companies, dividends are taxed twice, once at the corporate level and then again at the shareholder level. Buybacks, on the other hand, increase each remaining shareholder’s claim on the company’s earnings and allows shareholders to choose how to sell stock to make the best decision for their own tax profile.
Though many businesses have seen the light and started prioritizing stock buybacks as a way to return value to shareholders, not many real estate investment trusts (REITs) have bought back material amounts of stock. That traditional argument about dividend tax efficiency doesn’t fly for REITs, which do not face double taxation of dividends.
That said, the market is perfect right now for REITs to start buying back stock en masse. Not only has the majority of the industry lost a ton of value this year, but it is getting harder and harder to expand as interest rates rise. These three REITs — Weyerhaeuser (NYSE: WY), Equity Commonwealth (NYSE: EQC), and Empire State Realty Trust (NYSE: ESRT) — have already started buying back stock and increasing shareholder value in the process.
Weyerhaeuser doesn’t own buildings and lease them out like most REITs. It is a timber REIT. In fact, Weyerhaeuser is the largest private timberland owner in North America.
Most years, it cuts down 2% of its forests; sells them through its operating units to be used in house construction, other wood-based building, and for wood fiber; and then pays a relatively low 2% “base dividend.” The fun part is the big years.
When timber prices go up, like they have over the last two years, the REIT has a lot of excess cash. If timber prices are high, that means buying more timberland will be expensive, so a lot of the cash gets returned to shareholders through debt paydowns, special dividends, and share buybacks.
In 2021, the REIT reduced debt by $375 million and returned $2 billion of cash to shareholders with buybacks and dividends. It also authorized an additional $1 billion in share buybacks. Through the end of Q2, the company has spent almost $260 million on share buybacks.
The stock is down about 15% year to date; that’s not a great performance, but it’s right in line with U.S. REITs in general, which are down 14.56% year to date.
That drop put its price-to-earnings (P/E) ratio at just 10.12, well below the five-year average of 38.28, and its price-to-funds from operations (a REIT specific cash flow measurement) is just 7.60. Weyerhaeuser’s stock is undervalued on paper because the price of timber has fallen significantly this year, but the stock valuation is around a quarter of the historical average and the timber price is at around half the peak. Even if you assume the REIT got the peak price for most of its revenue, the stock is still down too far comparatively. Add in management that is one of the best in the industry at returning value to shareholders and Weyerhaeuser could be a good buy here.
Equity Commonwealth is a unique company. It used to have a significant presence in offices, but has sold many of its holdings and is sitting on a huge pile of cash for super investor Sam Zell to put to work. Zell took control of the office REIT years ago and has since unloaded all but a few of its office buildings.
He hopes to eventually use the REIT as a vehicle to purchase industrial space (like warehouses) but since management has been unable to pull off any significant transactions, the stock has floundered and a lot of capital has been returned to shareholders.
In the first quarter of 2022, the company bought back $73.6 million worth of shares and the board authorized an additional $150 million of share repurchases. In 2021, the REIT bought back $174 million worth of stock.
It’s anyone’s guess when Equity Commonwealth will find and acquire a portfolio of industrial properties and move into its new phase, but management is unquestionably doing the right thing by returning capital to shareholders through buybacks. The REIT currently has a market cap of $3.1 billion, cash of $2.72 billion, and office buildings with a balance sheet value of $410 million. It’s trading for the value of its assets and as long as it does it makes sense to buy back stock.
Empire State Realty
Empire State Realty is another unique situation. The stock is down 10% year to date, which isn’t a big deal, because just about everything real estate is down this year. The interesting part is that the stock is down 60% over the last five years.
Empire State Realty owns the Empire State Building as well as other office properties primarily located in New York. It’s not surprising that the stock was hit hard by the pandemic. People started moving out of big coastal cities in droves and the REIT’s tourism business at the Empire State Building was also hit hard.
Today, it trades for less than one times book value and has a cash hoard of $430 million with investment opportunities few and far between. Since March 2020, it has repurchased 10% of its shares, a cumulative total of $256 million; $53.7 million of those repurchases were in the second quarter of 2022.
Empire State is a bet on a return to normalcy after the pandemic ends, but management is doing its part to increase shareholder value until that happens.