Renewable power is on fire today, and Hannon Armstrong (NYSE: HASI) is a key player in the space. But there's so much more to understand about this real estate investment trust (REIT) before you buy it. The nuances, meanwhile, could have a big impact on where this unique REIT ends up over the long term.
A little different
A traditional REIT buys physical properties and collects rents from tenants. This is not what Hannon Armstrong does, because it is technically a mortgage REIT. So it is providing loans to customers that, in this case, are using renewable power assets as their collateral. This is a very important nuance.
Right now, more conservative companies are warning that the returns on renewable power projects are troublingly low because of heightened bidding activity. In other words, investors attracted to this hot sector are, perhaps, making irrational bids to ensure they get a seat at the table. In the process, they are locking in thin margins. Directly owning a renewable power asset in such an environment doesn't sound like a great plan.
Hannon Armstrong sidesteps this issue by making loans to the owners of renewable power assets. And, perhaps more important, it makes sure that the contracts backing the physical assets are sufficient to ensure those loans get repaid. It is a unique, interesting approach to the sector, with a $3 billion pipeline for growth, according to the REIT. That is projected to power 7% to 10% distributable growth over the next few years, with dividends expected to grow between 3% and 5% annually. Those are pretty solid numbers.
Is this a problem or a benefit?
Here's the fly in the ointment: Hannon Armstrong's stock is up a huge 176% over the past three years. That's taken the REIT's dividend yield from over 6% to the current 2.3%. It would be very hard to call this REIT cheap today, which makes sense given the renewable power sector's prominence right now in the market, and in politics and the media more generally. There's no question that the world is going green, and stock investors want to get in on the action.
So, even though Hannon Armstrong isn't buying inflated physical assets, that doesn't mean investors aren't at risk of overpaying here. But there's an important point to consider: Hannon Armstrong is a REIT, which means that it distributes much of what it earns to shareholders in the form of dividends. In order to fund growth, it needs to access the capital markets. That includes selling shares of stock. To put a number on that, the REIT's share count has nearly doubled over just the past five years.
This means the high stock price can help Hannon Armstrong raise low-cost capital to fund its long-term growth plans. And that's the dilemma for investors right now. The REIT is not cheap, but it is likely to keep growing at a desirable pace over the next few years. Along the way, it intends to reward income investors with dividend growth of as much as 5% a year. The tradeoff is a fairly modest yield, historically speaking, if you buy in today.
Answering the question "Where will Hannon Armstrong be in three years?" is actually pretty simple: It will be bigger. The harder question is whether investors will want to own the stock, given the fast run-up in price. Those seeking to maximize current income will probably want to look at other REITs.
Investors seeking a way to invest in the clean energy transition, meanwhile, might find this mortgage REIT's unique approach very interesting. Just go in knowing that you are paying up for this opportunity, which is both potentially good and potentially bad.