Crown Castle: A Fortress of REIT Dividends

I’m the first to admit that, when it comes to real estate investment trusts, a low-yielding dividend is not very exciting. However, over the years, I’ve found that there can be considerable value in owning shares in such companies.

It might not seem much at first glance, but as investing resource Sure Dividend explains, “ Total return is one of (if not the) most important financial metrics around. ”

As a refresher, I’ll remind you that the term “total return” includes capital gains, dividends, and distributions realized over a given period of time. While many readers on Forbes.com– myself included – are income-oriented investors, there are many who consider total return to be just as important, if not more so.

Of course, either way, it’s also valuable to understand the times. What up-and-coming or long-term trends can you attach your portfolio to?

Glad you asked, because here’s a big one…

Increasing data consumption is driving the need for denser networks of cell towers and what they call “small cells.” These are low-powered radio-access devices that feature transmission ranges of anywhere from 10 yards to 1.24 miles).

Fed by fibers that attach to nodes, which are then fixed to utility and telephone poles, they allow wireless carriers to not only handle increased traffic… but boost their own profits as they d

Their profits and the companies they rely on.

That’s why, at the beginning of the year, I explained how we were overweight in data center and cell tower REITs. And although shares in American Tower (AMT) and Crown Castle (CCI) had become a tad pricey at the time, we believed there was room for continued multiple expansion.

Today, based on continuing data, we’re much more bullish on Crown Castle thanks to its simpler and solid commitment to U.S. exposure, not to mention its higher – yet stable – dividend yield. We’re also impressed by its full toolkit of macro towers, small cells, and fiber-filled cables. Looking at the big picture, we expect shares to outperform in 2019.

The Business Model

Crown Castle was founded in 1994 and converted to a REIT in 2014. This cell tower REIT owns one of the largest collections of telecom towers. And, in recent years, it’s been diversifying into those fiber optic cables and 5G enabling small-cell nodes we mentioned above.

One of the things I like most about Crown Castle (as well as American Tower) is the fact that its towers are incredibly scalable. This means that once a tower is built, it costs just $1,000 per year to add new telecom tenants, which greatly increases the cash yields on investment.

Also consider how the average telecom tenant pays $25,000 to lease space on a tower. So after deducting expenses, each additional client represents $24,000 in additional gross income per location. With two tenants on a tower, the cash yield on invested capital is about 7%; but when that rises to 2.6 the average cash yield more than doubles to 15%.

In other words, this is big business, as evidenced by what Hoya Capital Real Estate has to say on the subject:

Cell tower REITs own roughly 50-80% of the 100-150k investment-grade macro cell towers in the United States. For this reason, while cell towers may constitute only a tiny portion of total real estate asset value in the United States, they constitute a disproportionally high importance in the market capitalization-weighted investible real estate indexes; and in fact, American Tower and Crown Castle are the two single largest REITs. Strong performance from cell tower REITs over the past two years have explained much of the underperformance of the traditional “core” real estate sectors.

In that same article, it further expostulates that:

Carriers are incentivized to invest capital in alternative technologies like small-cells and DAS to try to reduce the competitive position of cell towers. Perhaps the most significant risk relates to the fact that these REITs own just 30% of the land under their structures and lease the other 70% through (typically long-term) ground leases.

The Balance Sheet

While we’re quoting facts and figures, let’s not forget that Crown Castle’s retention rate has been 98% to 99% on expiring leases over the past five years.

Though it’s hardly resting on its laurels. To date, the REIT has invested approximately $13 billion of capital into establishing fiber footprints in prime locations across the top U.S. markets. According to CEO Jay Brown on a recent earnings call, “These investments are already yielding 8% and have significant available capacity to further increase the return as [Crown Castle] adds new small cell and fiber solutions customers.”

Brown added that commentary from the White House and FCC indicates that both institutions are “committed to ensuring the U.S. wins the race to be the world’s leader in providing 5G.” For him, that “underscores the belief that the U.S. is the best market in the world for infrastructure ownership.”

It also underscores our conviction that Crown Castle is the REIT to beat.

This powerhouse has definitely built a business model with ample flexibility. In February, it issued $1 billion worth of unsecured notes with 10 and 30-year maturities, utilizing the proceeds to repay outstanding debt. (It extended the weighted average maturity of outstanding debt to approximately 6.5 years.)

At the same time, it established a $1 billion commercial paper program to use as a short-term funding source. The company said it “intends to finance the business with approximately five turns of leverage longer-term, consistent with [its] commitment to maintaining an investment-grade credit profile.”

All in all, Crown Castle sees itself as remaining “well-positioned to generate approximately 7% growth in AFFO [adjusted funds from operations] per share in 2019.”

And we don’t disagree.

The Latest Earnings Results

In Q1-19, Crown Castle had an excellent quarter, with site rental revenue increasing 6% , adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) increasing 8%, and AFFO increasing 9% over Q1-18.

Going back to the very knowledgeable Hoya Capital Real Estate for a moment, it explains:

Cell tower REITs trade at an estimated 30-50% premium to private market-implied net asset value, meaning that external acquisitions, though somewhat limited, are easily accretive to earnings.

Cell towers continue to be one of the few remaining growth engines of the REIT sector and, considering the positive operating environment forecast for 2018-2020, don’t appear to be slowing down anytime soon.

Using FastGraph data, Crown Castle should grow by 7% in 2019 – whereas American Tower is expected to shrink -3.0%.

And its estimated AFFO payout ratio for the year is 78% – compared with American Tower’s 49%.

This explains why one has a much higher dividend yield than the other. It also explains Brown’s optimism on that earnings call. But just for good measure, here are a few more snippets of what he said:

• “By the end of 2019, we think we’ll put about double the number that we had in 2018.”
• “For small cells, we’ve continued to see lease-up on those assets that’s in line with our expectation of being able to exceed our cost of capital with that second tenant and then continued upside as we share the assets across customers into the future.”
• “These assets are going to lease up over time. When we build them in the best markets, we’re continuing to expand and grow the pie.”
• “The vast majority of the activity would be focused on the top 30 markets currently in the U.S. That’s the focus of the wireless operator.”

Our official recommendation is to buy Crown Castle on a pullback, recognizing that shares are soundly valued right now based on traditional REIT metrics. However, given the potential growth story, I’ll admit I’m still nibbling on shares as a means to justify my massive AT&T bill. I pay for six devices in my household, and I’d like a little return on that customer account.

I’m also beginning to increase exposure within my children’s portfolio, recognizing that they don’t need the income today and will likely benefit from the price appreciation when they’re out of college.

I own shares in CCI.