In summary, I believe REITs offer better risk-to-reward in today’s environment because of 8 reasons:
- (i) They are at least somewhat slack-resistant: REITs have enjoyed nearly double the downside protection during previous recessions on average;
- (ii) They offer superior inflation protection: rents are growing rapidly and so is the value of their assets – all while their debts are magnified;
- (iii) They provide a hedge against rising interest rates: REITs today have the lowest debt in their history and very long debt maturities. Therefore, the negative effect of higher interest rates will be much less than the positive effect of inflation. This is why REITs tend to outperform in times of price hikes;
- (iv) Isolated from Geopolitical Risks: Today, there are increasing tensions between East and West. Russia’s invasion of Ukraine and China’s zero-tolerance approach to COVID-19 are prompting many companies to leave some markets and rethink their supply chains. This leads to costs and loss of profits. Real estate funds are not directly affected by these geopolitical risks;
- (5) They have Attractive Growth Prospects: Most of the real estate sectors have been intertwined over the past decade, and even more so in the recent past due to all the supply chain problems caused by the pandemic. As a result, rents are rising rapidly and they have the opportunity to build new properties at high rates of return;
- (6) We Earn Dividends While We Wait: There are many high quality REITs with returns of 6-7% in today’s market. By earning a high income, we are less dependent on market estimation in the event of a lost decade as some expect. We only need 3-4% annual growth to reach double digit annual returns;
- (7) Ratings are highly discounted: Today, REIT stock prices are still barely back to where they were before the pandemic two years ago, but we all know real estate has skyrocketed since then. As a result, REITs are now trading at significant discounts on the principal value of their holdings;
- (8) The end of the pandemic is a clear catalyst: The main reason for discounting REITs is the pandemic. It has caused market sentiment to suffer due to the misperception that REITs own a lot of office buildings when in reality, only about 5% of REITs specialize in offices. As we slowly move past the pandemic, investors will increasingly return to REITs to diversify their portfolios and seek protection from inflation and recession.
Here’s how REITs have historically performed during periods of high inflation:
However, most of them today have a huge discount …
But before you rush to buy just any REIT, remember that not all of them are created equal. There are over 200 of them, and while we’re optimistic about the sector as a whole, we’re really only investing in an average of 1 out of 10 in high-yield property owners.
Some real estate sectors face challenges. Some management teams are conflicting. And some budgets are better prepared for higher rates than others. Being eclectic is key in this sector:
The market is collapsing, this is what I buy:
Today, residential real estate is highly desirable. They provide inflation protection, recession resistance, and rents are growing fast because we haven’t built enough apartments over the past decade and not many people can afford to buy a home, especially after the recent hike in interest rates. Most major real estate investment trusts such as Mid-America Apartment Communities, Inc. (MA) and the Independence Realty Trust (IRTAttractive, but our top pick is BSR REIT, a small business that mainly owns communities in fast-growing Texas cities like Austin and Dallas.
Over the past year, the value of its portfolio has increased by 66% as it has been able to pay significant increases in rents. This year, we expect more of the same as the company has yet to renew all of its lease contracts and is able to push for more rent increases. In the first quarter, new leases were signed with a higher rent rate of 17.4%, twice the rate of inflation!
Today, though, the company is priced at a 25% discount to the base value of its assets. By the end of the year, the discount will likely expand to close to 30-40% if the company’s stock price does not rise.
It is rare that you will be able to purchase such a coveted asset at a steep discount. The REIT market typically rates these companies at a significant premium.
While we wait for the upside, we are earning a 3% monthly return which is well covered by a 63% payout and is set for further growth in the coming quarters.
Germany’s largest real estate investment is priced at its lowest since late 2020, despite strong growth in 2021 and strong guidance for 2022.
We believe the shares were undervalued at €16, recently dropping to €12.50. At the same time, the euro has also lost its value relative to the US dollar, making it cheaper for US investors.
This decline is of course caused by the Russian invasion of Ukraine, which caused a great deal of uncertainty in Europe. A recession may be imminent, energy prices are rising, and inflation is only accelerating. It is undeniable that the Russian invasion of Ukraine creates new risks that we did not take into account.
However, the best opportunities emerge in times of crisis, and this is a good example of that. This may lead to disappointing results in the next 12 months, but it will not affect the long-term trajectory of the company, and therefore, we believe the market is overreacting.
What the market seems to be ignoring is that German real estate is seen as a “safe haven” asset class in Europe. Therefore, this crisis is likely to benefit DIC in the coming years as many investors are increasingly turning to German real estate investments and using DIC’s asset management services.
We believe its fair value is nearly double the current stock price and that you are also earning a 6% return while you wait for growth and post-war recovery.
NewLake Capital Partners, Inc. (OTCQX: NLCP):
The entire cannabis sector today is out of service. Large operators such as Trulieve (OTCQX: TCNNF) saw their stock price fall by as much as 75%. Interestingly, cannabis REITs have fallen with it, despite publishing record results.
It’s important to understand that unlike cannabis growers and distributors, REITs get fixed rent checks on long-term leases with annual rent pitfalls agreed on the first day. Like the fees that are pre-fixed.
It’s a much more flexible business, and therefore, you expect them to get away with selling out, especially since their results are stronger than ever.
But this would assume that the market is completely rational, which of course is not. The largest REIT for hemp, innovative industrial properties (IIPR), down 60% in less than a year. Some of his close peers are even lower.
Our favorite real estate fund is NewLake Capital Partners.
It is similar to IIPR, but has several advantages that should lead to better returns over time:
- Focuses on limited licensing states, which reduces risk;
- It is smaller in size, which leads to faster growth as it acquires new properties;
- Not yet invested all of the proceeds from the IPO, providing a predictable path to growth;
- You have just started using debt and have an authentic balance sheet;
- It’s even cheaper than IIPR, with a price of 11.5x FFO and a dividend yield of 6.5%.
REITs with such strong fundamentals and growth prospects usually trade with materially higher valuations and lower returns. The main reason NLCP is so cheap is that cannabis is currently not preferred, but the market narrative will change again, and now is the time to buy stocks at a cheap valuation. Expect a 50% hike, and while you wait, you get a generous income.
These are just 3 REITs among the many others we’re compiling at the moment.