There it is, right on page 11 of the firm’s latest SEC 10K filing.

We have qualified as a REIT for U.S. federal income tax purposes. As a REIT, we generally will not be subject to U.S. federal income tax. Under the Code, REITs are subject to a requirement that they distribute on an annual basis at least 90% of their taxable income to shareholders.

In short, this company (and others like it) is fully exempt from corporate income taxes at the federal level. That’s a pretty nice perk. Most businesses pay a fixed percentage to the IRS and then maybe give a piece of whatever is left to shareholders — who are then subject to dividend taxes on whatever is shared.

As pass-thru entities, real estate trusts avoid this double taxation. For the record, Master Limited Partnerships (MLPs) like Antero Midstream receive this same preferential treatment. So do business development companies (BDCs), an incentive from Uncle Sam to spur investment in small private businesses.

Without a large chunk of their profits lopped off the top, REITs typically disseminate some of the market’s richest dividend yields. But there is a tradeoff to this special arrangement. If a business must legally distribute 90% of its taxable profits each year, then it can’t retain much to invest in new expansion projects or make acquisitions.

These companies frequently tap the capital markets to keep growing cash flows to obtain fresh funding. That makes them sensitive to rising borrowing costs. And with the Federal Reserve raising rates relentlessly in 2023, that vulnerability has been on full display.

The S&P real estate sector lost nearly one-quarter of its value from January through October. But as you can plainly see, it has rallied sharply since then – bouncing 18% in just over a month. Buyers have returned in droves. Raymond James and other brokerages have revised their targets. Morgan Stanley just named real estate a top investment focal point for 2024, right up there with semiconductors.

So what’s going on?

Well, for starters, interest rate headwinds have suddenly become tailwinds. It stands to reason that the stocks most punished when the Fed zigs will be the most relieved when it zags. We’re already getting a taste of this.

Americold Realty (Nasdaq: COLD) has rebounded 19% over the past two weeks. Sun Communities (NYSE: SUI) has climbed 30%, rising from $103 on October 25 to $132 today.

And rates haven’t yet declined even once; this is just the expectation that this historic tightening cycle is finally ending. The odds of another rate hike at the December meeting (which stood at 14% a few weeks ago) have diminished to zero.

And cuts won’t be too far behind.

The Pendulum Swings

We are now winning the fight against inflation. It took extreme measures, but the tide has finally turned. The October CPI report showed the price growth for goods and services decelerating to just 3.2%, down from 3.7% in September. Many categories are declining, from school supplies to used cars to kitchen appliances.

The Producer Price Index (PPI) and other barometers point the same way: inflation has been tamed and is now easing back within the Fed’s comfort zone. That means rate tightening should soon give way to loosening. Historically, once rates peak, the next downcycle usually starts within four to six months.

Charles Schwab’s chief fixed income strategist sees the beginning of rate cuts happening by next quarter. Goldman Sachs believes it will happen in the second quarter. But while economists differ slightly in the timing, they almost unanimously agree that rates are headed lower.

A recent Bankrate poll found that 94% expect the Fed to lower rates in 2024.

The biggest question is just how much cutting we’ll see. The market is currently anticipating three quarter-point declines, 75 basis points total. But to revive the sluggish economy, it might take more monetary medicine. UBS Investment Bank forecasts 275 basis points, nearly three full percentage points. I think we’ll land somewhere in the middle. But politics may enter into the equation as well. Rate cuts stimulate both the market and the economy – and 2024 is an election year.

In any case, the bond market (which is far more sensitive to rate vibrations than the stock market) has already reached an inflection point. Under the expectation of falling rates, the 10-year Treasury bond has rallied sharply, driving yields from nearly 5.0% in late October to 4.2% today.

Get Ready For More REIT Deals…

You can understand why investors are flocking to the real estate sector. Profits in this group are largely determined by the difference between a company’s weighted average cost of capital and how much it can earn on that capital. The latter is usually expressed as a cap rate or net operating income (NOI) from a property as a percentage of its value.

Borrowing at 6% and deploying at 7% doesn’t leave much. A drop in borrowing costs widens that spread. It also makes REIT dividend yields more appealing compared to other interest-bearing securities. And perhaps most importantly, from our perspective, it lowers the hurdle at which accretive deals can be made.

Cheap money greases the M&A wheels. And commercial real estate has been a very busy space. According to S&P Global, there were 10 publicly-traded REIT takeovers last year valued at $83 billion, not far from the record of $99 billion the year before.

These rent-earning assets (which span the spectrum from apartments and warehouses to retail shops and self-storage facilities) are being privatized before our eyes. It wasn’t that long ago that Store Capital, Warren Buffett’s favorite REIT, was swallowed up by Oak Tree for $14 billion. Blackstone has closed a series of purchases over the past 18 months, including the $13 billion takeover of American Campus Communities.

Incidentally, my High-Yield Investing portfolio was on the receiving end of both deals. Trust me, there are more of these transactions in the pipeline.

How We Can Profit…

Just last week, a candidate on my watch list, Healthpeak Properties (Nasdaq: PEAK), announced plans to merge with Physicians Realty Trust (NYSE: DOC) in a $21 billion transaction.

I think this could be the next sub-sector to heat up. While some corners of the CRE universe (like office towers) face macro challenges, you don’t find too many half-vacant hospitals and nursing homes these days. It’s a well-known fact that healthcare now accounts for nearly one-fifth of U.S. GDP. According to the Centers for Medicare and Medicaid Services (CMS), per-capita spending now stands at $12,900, or a total of $4.3 trillion. That’s triple what was spent just three decades ago.

Even by government standards, $4.3 trillion is an astronomical sum – and it won’t shrink anytime soon. CMS now forecasts that healthcare spending will climb to $6 trillion by 2028… Another 2 trillion more per year.

That’s a depressing thought for anyone paying for private health insurance. But from an investment standpoint, this is a long growth runway brimming with opportunities.

Like Community Healthcare Trust…

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New Portfolio Addition

Community Healthcare Trust (NYSE: CHCT)

Company Name:	Community Healthcare Trust (NYSE: CHCT)
Industry:	Healthcare REIT
Market Cap:	$764 M
Annual Revenue:	n/a
52-Week Price Change	-20.5%

Community Healthcare made its market debut on the NYSE in May 2015. Prior to the IPO, the company had just $2,000 in cash on its balance sheet. Today, it owns a sprawling portfolio of 191 properties in 34 states. These facilities are leased to doctors, urgent care centers, behavioral therapists, hospital systems, and other healthcare providers.

CHT has a broad portfolio encompassing everything from dialysis clinics to radiation treatment centers to long-term care facilities. They are occupied by a diverse base of nearly 300 tenants, including well-known operators such as DaVita, Tenet, Fresenius, and HCA. Management prefers outpatient facilities (a faster-growing segment). And there is a strategic geographic focus on small suburbs outside of big urban markets.

Like Rogers, Arkansas, Lakeland, Florida, and Waukegan, Illinois.

Compared to major metro markets, these community centers are “lightly marketed” and often sell at lower valuations, meaning better returns for the landlord. CHT has built this $1+ billion portfolio by acquisition and doesn’t engage in bidding wars. Most of its purchases were closed at prices providing 10% or better cap rate returns. These leases typically carry escalators that automatically bump rental rates by 1% to 2% annually.

The company invested $103 million in new acquisitions in 2021 and $107 million in 2022 and is on track for a similar outlay in 2023. It closed on another seven properties last quarter, totaling 177,000 square feet – boosting the portfolio total to 4.2 million. These buildings are almost fully occupied (99.8%) by experienced healthcare operators under multi-year leases.

Seven more purchases are on the docket for next year at an aggregate price tag of $166 million. This incoming real estate will generate approximately $15 to $16 million in annual rental income for a cap rate of up to 9.75% ($16m/$166m).

Like many REITs, CHT routinely sells additional shares to obtain fresh funding. Most recently, it issued 552,000 shares at a price near $33 – for proceeds of $17.8 million. While these offerings are somewhat dilutive, management has put the cash to good use. Since 2015, the asset base has expanded from $143 million to $955 million – an increase of 568%.

CHT collected $28.7 million in rent checks last quarter, a healthy 15% increase. After expenses, it generated $16 million in adjusted funds from operations (AFFO), or $0.63 per share. That pool of cash (untouched by the IRS) supports a generous dividend that rises not just annually, but every 90 days.

CHT made its first dividend payment in August 2015 of $0.142 per share. And it has risen every quarter since then – an impressive streak of 33 consecutive quarterly hikes. Over that span, the distribution has tripled to $0.455 per share. The annualized payout of $1.82 per share equates to a yield of 6.5% — more than three times the market average.

But that growing income stream is just icing on the cake. The 65+ age group has expanded by 35% over the past decade – five times the pace of the overall U.S. population. Roughly 10,000 baby boomers are reaching this age every day. By 2030, this fast-growing demographic will have nearly 75 million people. And per-capita medical spending for retirees is more than double that of the average worker.

That unwavering demand bodes well for the future rental rates (and thus real estate appraisal) of CHT’s growing portfolio of healthcare facilities.

Action to Take

CHT has a stable balance sheet. But the debt/real estate value ratio has widened from 31% to 38% over the past year. And since some of these loans are variable, debt service costs have risen.

But the market has more than compensated, driving the stock from the mid-$40s down to the upper-$20s. This well-run business is now valued at just 11 times cash flows, an attractive multiple. Keep in mind that it has now distributed well over $100 million in cumulative dividends since 2015.

As a member of the S&P SmallCap 600 Index, CHT has the backing of institutional holders like Vanguard and T Rowe Price. But somebody might want to add these assets to their collection.

Given the consolidation in the healthcare REIT space, and considering the firm’s focus on rural markets that yield premium returns, I see CHT as a good complementary fit for a larger player like Omega Healthcare (NYSE: OHI) or Medical Properties Trust (NYSE: MPW). Private equity has taken an interest in this sector as well.

In any case, with interest rates easing back, I think CHT is poised to rebound and deliver market-beating gains in 2024. I will add the stock to my portfolio on Thursday, December 7th.

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Portfolio Updates

Dundee Precious Metals (OTC: DPMLF) – The likely transition from rate tightening to loosening has been bullish for precious metals. In fact, the prospect of a weaker dollar has sent gold spot prices running to $2,135 per ounce – a new all-time peak.

Dundee brought 74,102 ounces to market last quarter, an increase of 16% from a year ago (along with 7 million pounds of copper by-product).

With record production from the Ada Tepe mine in Bulgaria, the company has reaffirmed its optimistic full-year targets. And with costs in check, it has now churned out $180 million in free cash flows over the past nine months, versus $133 million at this point last year.

Some of that cash is being used to fund exploration and development activities in Serbia and elsewhere around the globe. But management dutifully returns the excess to stockholders. The company also ended last quarter with $562 million in cash on the books.

Action to Take: Stronger volumes and better pricing have translated into powerful bottom-line improvements. Dundee’s high-grade, low-cost deposits remain a viable target for senior producers looking to bolster their production and reserves. I continue to rate the stock a “Buy.”