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5 REITs with Turnaround Potential

When investors think about turnarounds, they don't usually think REITs.

When investors think about turnarounds, they usually think about manufacturing, retail or service companies. One additional type of company that often is ignored is the real estate investment trust, or REIT, explains George Putnam, editor of The Turnaround Letter.

These companies own properties such as office buildings, hotels, shopping malls and apartment buildings. Some REITs specialize in a particular type of property; others have broad portfolios with a variety of buildings.

In real estate, the mantra is often “location, location, location.” However, in REIT turnarounds, like most turnarounds, it’s “management, management, management.”

Because REIT turnarounds often involve selling illiquid real estate, they can be measured in years, not quarters. However, for patient investors, they can offer substantial gains while often paying attractive dividends in the meantime. Listed below are five REITs that have stumbled but are showing signs of recovery and offer attractive return potential:

DiamondRock Hospitality (DRH) has a high-quality portfolio of urban hotels in major cities including New York City, Chicago and Boston.

While worries about competition from Airbnb, increasing supply and rising interest rates, along with tepid 2nd Quarter results, have led investors to check out of DiamondRock, the company continues to execute well despite investors’ fears, as well as selectively acquire attractive new properties like its successful Sedona purchase.

In many key cities, the company’s newly-renovated properties should help boost revenue growth. The debt level is relatively low, and the shares trade at a discounted price.

After the trustees were ousted in 2014, real estate legend Sam Zell took charge of Chicago-based office building REIT, Equity Commonwealth (EQC). Under Zell, Commonwealth has sold off nearly 75% of its former portfolio, leaving a smaller but higher-quality portfolio.

It has also reversed its high debt level to a net cash position (cash balance is $20/share) and repurchased shares. The newly-energized and opportunistic approach has already boosted occupancy levels and other operating results.

Next steps likely include either property acquisitions and special dividends or a complete liquidation. Management has a long-term perspective and so too should investors: the stock doesn’t pay a dividend, but the long-term upside appears attractive.

While the current valuation looks expensive, it is largely a result of the decline in earnings as income-producing properties have been replaced with cash.

Mack-Cali Realty (CLI) is one of the country’s largest REITs. Mack-Cali is undergoing a major transformation from holding dated suburban office space in the northeastern United States toward urban high-rise office and multi-family properties.

Senior management, now led by new CEO Mike DeMarco, who joined in 2015 as president, has cut significant costs, streamlined operations, raised occupancy rates and sold many properties.

The strategy is to redirect capital into new developments like the up-and-coming New Jersey waterfront across from New York City and other transit-based properties.

Recent difficulties in its to-be-sold properties, along with its high leverage, have held back recent results, but the long-term outlook still appears very promising.

Outfront Media (OUT), which focuses on outdoor advertising, was spun-off from the CBS Corporation (CBS) by an initial public offering at $28/share in 2014.

Its strategy is to expand its capabilities in digital billboards, maintain its strengths in transit ads and de-lever its balance sheet.

Outfront recently passed an important milestone with its big renewal for its entire New York City transit contract. With the stock trading at $24 (a discount to its IPO price) and producing a 5.9% dividend yield, Outfront shares look appealing.

Vereit (VER), formerly known as American Realty Capital Partners, was a high-flying REIT led by an aggressive acquirer that was brought down by an accounting scandal in 2014.

This left the company with excessive debt, a poorly-managed portfolio and no access to capital markets. The entire board was replaced — the new chairman previously led a Berkshire Hathaway (BRK.A) joint venture — along with the senior leadership.

The new CEO, Glenn Rufrano, brings extensive credibility and capabilities. In addition to cleaning up the books and governance, as well as changing the company’s tarnished name, he is selling undesirable properties, paying down or extending the maturities of its high debt load and restoring growth and profits.

Vereit still has significant issues, including the debt load, litigation costs and ownership of many non-traded REITs. Yet the company is on the road to becoming healthy again. Investors receive an attractive 6.6% dividend while waiting for the problems to be worked out.

George Putnam is editor of the Turnaround Letter.

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