Whitestone REIT (NYSE:WSR) is a deep-value real estate investment trust that has attractive, long-term growth prospects for its funds from operations. The trust is primarily concentrated in a handful of markets in Texas and Arizona and positive leasing spreads are a catalyst for income and dividend growth moving forward.

Whitestone REIT has the potential to grow organically as well as via an acquisition pathway and the trust has a very low payout ratio and is growing its dividend.

The stock is not overly expensive and thus continues to be a compelling dividend and yield wager for passive income investors that look for a promising niche REIT investment.

My Rating History

Whitestone REIT got my Buy stock classification in April primarily because of strong funds from operations outlook. The trust is profiting from favorable lease spreads which is a result of strong demand for retail lease space.

Since Whitestone REIT raised its dividend by 3% in the second quarter, I think that the trust offers passive income investors dividend growth and capital appreciation potential.

Concentrated Real Estate Portfolio, Favorable Market Dynamics

Whitestone REIT is a real estate investment trust that owns and operates open-air retail shopping centers in Phoenix, Austin, Dallas-Fort Worth, Houston, and San Antonio.

The markets in which Whitestone REIT operates are characterized by strong rent fundamentals, meaning they have strong economies, are seeing growing populations, and have above-average household incomes. All of these factors contribute to making these core markets attractive wagers on above-average rental growth as well. Rent trends in each of Whitestone REIT's markets are pointing upward and the trust is profiting from positive leasing spreads in its business.

With a much-muted outlook for new strip center supply in the coming years, the odds are in favor of Whitestone REIT enjoying sustained rental growth for its retail centers.

A main driver of Whitestone REIT's operational trends is the trust's ability to hike its rents. Positive leasing spreads are the main reason why I think that Whitestone REIT has outperformance potential, an idea I also raised in my piece on Kimco Realty Corporation (KIM).

Lease spreads reflect the difference between present lease rates and new rates agreed upon during renewal negotiations. In short, they are the difference between old and new rents on a lease and indicate how much negotiation power a landlord has.

In the first quarter, Whitestone REIT's lease spreads amounted to a whopping 17%, less than in the last couple of quarters, but a decent figure nonetheless.

NOI Trend, Low FFO Payout Ratio

Whitestone REIT earned $23.9 million in net operating income on a same-store basis in 1Q24, reflecting 3.1% YoY growth. The trust's net operating income could primarily grow through acquisitions moving forward and rental increases given the strong lease environment for retail-focused real estate investment trusts.

Since Whitestone REIT is also focused on a small number of high-performance markets, particularly in Texas, I think that the trust has the potential to deliver above-average NOI and FFO growth in the future.

Whitestone REIT more than earns its dividend with funds from operations and the trust is growing its dividend again. In 1Q24, the real estate investment trust earned $0.23 per share in funds from operations and paid out $0.04 per share per month which calculates to a dividend payout ratio of 52% which was only slightly lower than the twelve months dividend payout ratio of 55%.

The low payout ratio allows Whitestone REIT to invest in the growth of its property portfolio while also rewarding passive income investors via a juicy dividend. The trust raised its dividend 3% in the second quarter and presently pays investors $0.0413 per share per month which gives the stock a leading dividend yield of 3.7%.

FFO Guidance And Multiple

Whitestone REIT foresees between $0.98 and $1.04 per share in core funds from operations this year, reflecting an 11% YoY jump. The trust presently has a market valuation of $622 million and its stock is selling for $13.22 per share.

Working with the most recent forward-looking funds from operations estimate, Whitestone REIT's stock is selling for a 13.1x FFO multiple. In the last twelve months, the trust's stock has sold for prices ranging between $9.07 and $13.49, implying funds from operations multiples of 9.0-13.4x. Thus, Whitestone REIT is valued at the high end of this range.

Kimco Realty guided for $1.58 per share in funds from operations, reflecting an FFO multiple of 12.2x this year's estimated FFO. The forecast for Kimco Realty also implies no FFO growth this year at all.

Since Whitestone REIT can grow its funds from operations more strongly than a more mature, more diversified real estate investment trust, I think that the risk/reward relationship here is a positive one.

Why The Investment Thesis Might Not Work Out As Anticipated

Small real estate investment trusts with exposure to only a handful of local real estate markets have upside potential if these markets continue to perform well, but also have a considerable amount of downside in case the markets in which Whitestone REIT operates in are headed for a real estate recession. Thus, the concentrated exposure to markets such as Phoenix, Houston, or Austin is a double-edged sword and could either work in favor or against passive income investors.

Furthermore, WSR has no established, long-term dividend growth record which makes it a riskier investment than Kimco Realty, for instance.

My Conclusion

In my view, it can make sense for passive income investors to venture off the beaten path and invest some of their portfolio assets into smaller, less-covered real estate investment trusts that make compelling value propositions not exclusively due to their dividend yields, but due to their growth profiles.

Whitestone REIT could potentially allow passive income investors to leverage the strength of small REITs, which is their ability to scale real estate portfolios and funds from operations more quickly. This makes Whitestone REIT a primary play on capital appreciation, though the 3.7% yield is definitely not something to scoff at.

Besides the solid yield and leasing spread catalyst, passive income investors have a shot at producing attractive total returns with an investment in Whitestone REIT if the trust's core markets can sustain their rental growth trends. Buy.