By: Dividend Sensei
Real Estate Investment Trusts or REITs have proven to be a great way to both grow your income and wealth over time. In fact over the last 20 years REITs have been the best performing asset class.
Best of all, thanks to a recent REIT bear market the sector remains attractively priced today. Which is why I want to highlight American Tower (AMT), one of the fastest growing REITs in the country. Let’s take a look at why this specialized tech REIT likely has what it takes to provide safe and fast dividend growth, as well as potentially 18% annualized total returns over the coming decade.
American Tower: One Of The Fastest Growing REITs In America
American Tower was founded in 1995 but converted to a REIT in 2012. It owns about 170,000 telecom towers, with 41,000 in the US and the rest overseas. 98% of its revenue comes from leasing the use of its towers to telecom companies.
The beauty of American Tower’s business model is from two main factors, incredible scalability and highly profitable and stable cash flow. For example the typical telecom tower costs $275,000 to construct in the US and about $150,000 overseas. Maintenance runs about $600 per year for international towers and $1,250 for US towers. However, once a tower is built it can accommodate up to five telecom tenants and it costs nothing to lease up a tower from one client to five. This means that once a tower gets two tenants its annual return on investment hits 13%, and at three tenants it hits 24%. And overseas where towers are cheaper to construct just three tenants equates to a 32% annual return on investment. At the end of 2017 the REIT had an average of 1.9 tenants per tower across its portfolio. This means the REIT has plenty of scalability left to boost the profitability of its tower portfolio. Thus it’s able to grow its revenue quickly, but its adjusted funds from operation or AFFO/share even faster. AFFO is the REIT equivalent of free cash flow and what pays the dividends. In the most recent quarter the REIT converted 7.1% revenue growth into 13.1% AFFO/share growth which has allowed it to continue growing its dividend at a very impressive rate.
Meanwhile towers are usually under 10 years non cancellable contracts with 3% annual rental escalators that offset inflation. Better yet, once a telecom company installs its equipment on a tower it usually costs about $40,000 to remove it. Since rents tend to run $20,000 to $30,000 per year, very few customers will bother switching to a rival. This is why AMT enjoys an annual churn rate of 1% to 2% when contracts expire. All of which means the REIT enjoys extremely stable, recurring and increasingly profitable cash flow over time. For example in the most recent quarter the REITs’ Adjusted EBITDA margin was 61% and its AFFO margin was 47%. American Tower is able to convert nearly half its revenue into cash that can be paid out in the form of dividends, which have been growing at a five year average of 24% and have been raised 25 consecutive quarters (last hike was 20% YOY).
In the US mobile internet traffic grew at 92% annually between 2006 and 2016 and is expected to grow at 35% annually through 2021. Thanks to the introduction of 5G US mobile data is expected to continue growing exponentially for decades beyond that. This is because 5G will bring with it not just more video streaming on smartphones, but also broadband speed wireless internet and the internet of things or IOT. This will connect an estimated 513 million devices to the internet by 2020. IOT data growth alone is expected to increase 85% annually between 2015 and 2020. All that data is going to require a lot of new towers (about 25,000 in the US alone) and likely keep American Tower’s business booming for decades to come.
Meanwhile AMT is dominant in major fast growing emerging markets like Brazil, Mexico and India. Brazil and Mexico account for 50% of Latin America’s population and 70% of consumer spending power. The rapid adoption of smartphones and the ongoing switch to 4G in those countries should fuel rapid growth for the REIT. Meanwhile India’s more than 1 billion people and more than 7% GDP growth mean hundreds of millions are expected to soon join the middle class. That’s why India’s mobile data is growing at 100%, a growth rate that is expected to be sustained for several years.
The bottom line is that American Tower is the leader in global telecom towers, and has a massive long-term growth runway created by the exponential growth in wireless data. And thanks to the immense scalability of its business model (gets more profitable over time) analysts expect AMT to remain one of the fastest growing REITs in America. That spells immense dividend growth and long-term total return potential for income investors.