Like most real estate companies, EPR Properties (EPR +0.50%) is feeling the pressure of rising interest rates. They've increased its borrowing costs while weighing on its stock price. That has pushed up its cost of capital, making it more challenging to finance new investments to grow its experiential real estate portfolio.
The good news is that the REIT doesn't need outside funding to continue growing at a decent rate. It could produce an attractive total return over the next two years even if market conditions don't improve.
NYSE: EPR
Key Data Points
Focused internally
REITs typically rely on issuing new debt and equity in the capital markets to fund their expansion. However, with EPR Properties' share price currently down more than 50% from its all-time high, issuing stock to fund new investments isn't attractive. Meanwhile, the surge in interest rates has made borrowing money more expensive.
With the external capital markets largely shut off, EPR Properties has shifted to internal funding sources. Despite its high dividend yield (currently around 8%), the REIT has a very conservative dividend payout ratio. It expects to generate $5.10 to $5.18 per share of funds from operations (FFO) this year. With dividend payments totaling $3.30 per share, it's retaining a meaningful amount of cash flow (over $100 million per year) to fund new investments.
The company is also recycling capital by selling assets to fund new investments. It sold two vacant theater properties in the third quarter and two early childhood education centers for $26.6 million, recognizing a $2.6 million gain. That brought its 2023 total to $35 million. The company expects to sell between $45 million and $60 million of assets this year.
These two sources of cash have enhanced EPR's liquidity. It ended the third quarter with $173 million of cash and no borrowings on its $1 billion credit facility. That gives it lots of funding capacity to make new investments.
Built-in growth
EPR Properties has the financial flexibility to make about $200 million to $300 million of new investments annually without tapping external capital markets. The company has already invested $135 million through the third quarter. It spent $43.7 million to acquire a fitness and wellness property while investing the rest into development and redevelopment projects. It anticipates spending $225 million to $275 million on new investments this year, which includes about $63 million of committed spending on development and redevelopment projects in the fourth quarter.
Those investments are part of the $235 million it has committed to development and redevelopment projects over the next two years. These are very high-return projects, with real estate cap rates above 8%. This investment pipeline therefore gives the REIT lots of visibility into its earnings growth potential over the next two years. CFO Mark Peterson provided investors with a glimpse at how fast it could grow through 2025 on its third-quarter conference call. He stated:
Over the next couple of years, given our low dividend payout ratio and modest debt maturities, we believe we can use excess cash flow, disposition proceeds, and some of our line capacity to increase investments a modest amount and still grow FFO as adjusted per share, excluding the impact from cash-basis deferral collections, by around 4% each year while maintaining our targeted debt-to-adjusted EBITDA range of 5 to 5.6 times. When this growth is combined with a well-covered dividend yield of nearly 8% currently, we believe that EPR offers shareholders a compelling investment opportunity.
When adding in the 8%-yielding dividend, that modest 4% annual growth rate positions EPR Properties to produce total returns of 12% annually, assuming no change in the trading multiple of its stock. There's upside to that if the market values its shares higher. If that happens, the company could start using its stock as currency to accelerate its investment rate, enabling it to grow even faster.
Decent growth despite the headwinds
High capital costs have made it too expensive for EPR Properties to use outside financing to expand. However, the REIT has enough internally sourced financing and committed high-return investment opportunities to grow at a decent rate over the next two years, so it can still produce an attractive total return. Meanwhile, it has ample upside potential as market conditions improve, and it can access outside capital at an attractive rate to accelerate its growth. These factors make EPR Properties look like an excellent investment opportunity right now.
