A good time to invest in REITs
Many high quality stocks became freshly cheap during the market correction. A fundamental fact of the stock market that has been true for centuries is that when the market goes down, the good is dragged down with the bad. ETFs and other group transactions have exacerbated this phenomenon.
Right now, we’re looking at the S&P down about 10% this year. In a rational world that consists of massively declining fundamental failures and perhaps a little rising fundamental successes. However, so many trades are made at the index level these days that price discovery is halted. The passive part has exceeded the active part.
So when this shitty company completely fails, it directly pulls the good companies down because they are bought and sold together in a basket. It’s not fair, but it creates huge opportunities for those who pay attention.
One can pick up large companies that have been unfairly slaughtered and at this significantly lower cost, the benefit is substantial. REITs are a clear example of strength reduced by weakness.
Fundamental success of REITs overshadowed by broader equity issues
In 2022, there is a key difference between REITs and the rest of the market. While most of the market is affected by inflation, REITs benefit from it. It’s really not that hard to figure out.
- If you’re a homeowner, you know how much your home has gone up in value
- If you’re a tenant, you know how much your rent bill has gone up.
REITs own real estate, so the same thing happens to them. Their land values are up and rental income is up. Thus, the net asset value increases and the profits (funds from operations) increase.
Despite the clear tailwind, REITs are down almost as much as the S&P with the Vanguard Real Estate ETF (VNQ) down 7.8% year-to-date.
Given the combination of earnings growth and falling prices, the median FPI is now trading at 16.3x FFO. That is an FFO yield of 6.13%. In contrast, the earnings yield on the S&P is only 3.99%.
Although the S&P price also fell, this was largely in line with reduced growth estimates.
In a nutshell, inflation presents a challenge for the S&P that caused it to sell. This sell-off in turn dragged REITs down as large-cap REITs also feature in S&P 500 indices and ETFs such as the SPDR S&P 500 Trust ETF (SPY).
Perhaps due to the fact that the passive share now exceeds the active share, the decline in REITs occurred when they were actually benefiting from inflation.
For REITs, this is a tailwind that, due to market forces, has been priced in as a headwind. I love this setup and am more optimistic than I have been in a long time.
One by one I watched the REIT earnings reports roll in and each one was as strong as the last. All 19 companies in the Portfolio Income Solutions portfolio are showing growth.
Given that it was the tech sector that contained some of the top drivers, it has fallen more than the broader market, down about 15% year-to-date.
Tech REITs were dragged down by Nasdaq weakness and fell more than most REITs. Cellular infrastructure REITs, American Tower (AMT), Crown Castle (CCI) and SBA Communications (SBAC) are down 18%, 17% and 16%, respectively.
Data center REITs, Equinix (EQIX) and Digital Realty (DLR) are down 17% and 23%, respectively.
Each of these companies performed well fundamentally, with the exception of Digital Realty, which showed some weakness in relocation spreads.
This shows that the market is at least partially reacting to fundamental data, as DLR is the most bearish and the Uniti Group (UNIT), which has announced new growth paths, is the least bearish among this group.
However, the overall bearish trend seems to have been driven by the correlation with the Nasdaq. I see this as an obvious opportunity because the fundamentals are completely different.
Much of the reason the Nasdaq has fallen so much is that the whole concept of maybe someday being profitable in the future just doesn’t work in a rising rate environment.
Tech REITs are profitable today and trade at quite reasonable multiples. Lower prices are a gift and a great entry point for those who aren’t already there.
More Correlational Drops
All casinos are the same, right?
Well, that’s what the market seems to think. Macau is a problematic market, with China acting somewhat combatively towards casino operators. This is made even more difficult by their zero tolerance COVID policy which is even today in this post-vaccine world halting operations.
Given this risk, I think it makes sense that Wynn (WYNN) and other Macau-based casino operators are down.
What doesn’t make sense is that it dragged casino REITs down. VICI (VICI), Gaming and Leisure Properties (GLPI) and MGM Growth Properties (MGP) are down 9%, 8% and 9%, respectively.
This is about as much as Macau operators and the most important thing here is that these REITs have almost no exposure to Macau. The properties are American and the tenants who pay the rent are mostly based on American income.
Each of these REITs have increased earnings during the pandemic and are on track to continue increasing earnings in 2022. The market is pricing in risk in Macau that simply does not exist and I intend to to take full advantage of.
If you’ve ever been curious about REIT investing and just haven’t pulled the trigger, now might be the time. Market prices are cheap and the fundamentals are strong. Broad exposure such as the Vanguard Real Estate ETF looks reasonably good right now, but I think you can do even better by picking the most opportunistic individual stocks.
In this article, we’ve discussed the poor valuation of tech and casino REITs, but it goes way beyond that. There is drastic mispricing in most of the 21 REIT property types and impressive growth is being ignored entirely by the market. Today’s cheap prices offer higher dividend yields and higher expected total returns.