IIPR - 2 REITs To Buy In January 2024

2023-12-30 08:05:00 ET

Summary

• Most REITs rallied in December.
• But not all REITs participated in this rally to the same degree.
• Here are two REITs that remain very attractively priced.

REITs ( VNQ ) rallied after it was announced that the consumer price index had come down to the target range.

The market took this as further proof that the Fed's aggressive rate-hiking cycle had finally killed inflation and that further rate hikes wouldn't be needed.

On the contrary, many investors quickly changed their tune and are now expecting rate cuts in the near term.

Morgan Stanley just released their 2024 outlook and they are predicting that the Fed will make significant cuts to interest rates over the next 2 years as inflation cools down. They expect the Fed to start cutting rates in June and then again in every meeting from there on in 25-basis point increments. They expect the policy rate to be just 2.375% by the end of 2025.

UBS expects even sharper rate cuts. Just recently, they told CNBC that they expect the Fed to cut interest rates by as much as 275 basis points in 2024 as the world’s largest economy tips into a recession.

And it is not just Morgan Stanley and UBS.

In fact, this is starting to become the consensus expectation.

It is funny how quickly things can change. Just a few months ago, everyone talked about a "higher for longer" environment, and REITs were crashing.

Now, people are realizing that the inflation was perhaps temporary and these high-interest rates may not be sustainable after all.

As a result, REITs appear to now have begun their recovery:

But not all REITs participated in this recent rally, and some of them remain highly opportunistic.

Here are two examples that we are accumulating at the moment:

BSR REIT (HOM.U / BSRTF)

BSR REIT (HOM.U / OTCPK:BSRTF ) did not rise nearly as much as other apartment REITs. It only rose slightly even as its peers ( CPT ; AVB ; UDR ; IRT ) rose 15-20%.

I believe that this is because despite only investing in the US, BSR is actually structured in Canada and that's where it is primarily traded.

As a result, its stock is often detached from its peer group in the near term, and we think that this is an opportunity for us to buy more shares before the market recognizes this anomaly.

Today, it is still priced at a near 7% implied cap rate, which is truly exceptional for a portfolio of Texan Class B garden-style apartment communities. You would be happy to get a 5% cap rate in the private market for these assets.

On a price-per-unit basis, we are paying also only about $170,000, but the replacement cost of these properties would be about 50% higher.

We expect its net asset value per share to stabilize at around $18 per share, which means that we are getting a 35% discount.

The management is busy buying back shares to create value and I am glad to buy some more as well. Who doesn't want to buy apartment communities in rapidly growing Texan markets at 65 cents on the dollar?

Not long ago, BSR actually traded at a small premium to its net asset value. It was priced at 110 cents on the dollar before the surge in interest rates.

While I can't predict when BSR will close the gap to its net asset value, I think that it will happen over time and this could unlock up to 60% upside potential.

Also, keep in mind that I am using $18 per share as the NAV and this estimate has already been lowered quite significantly. It was at ~$23 at its peak and rents have risen further since then.

Finally, while you wait for the long-term upside, the dividend yield is nearly 5% and that's despite retaining nearly half of its cash flow for value-accretive share buybacks.

NewLake Capital Partners ( OTCQX:NLCP ):

NewLake Capital Partners ( OTCQX:NLCP ) is one of just a few Cannabis REITs. Its largest peer is Innovative Industrial Properties ( IIPR ).

But something curious happened with the recent rally. IIPR massively outperformed NLCP:

We believe that this has nothing to do with fundamentals.

It is simply because NLCP is not listed on a major exchange and as a result, market reactions are often delayed by poorer flows of capital.

But from a fundamental perspective, NLCP is actually superior to IIPR in many respects:

• It has zero debt and significant net cash.
• It only owns properties in limited license states.
• Its smaller size should allow it to grow at a faster pace.
• It trades at a lower valuation.
• It offers a materially higher dividend yield.
• The management is buying back shares.

So relatively speaking, NLCP remains very opportunistic today relative to IIPR.

Right now, its shares are priced at just 8x FFO, and offer a 10% dividend yield, and that still leaves enough cash flow for the company to buy back shares. That's especially attractive considering that the company has no debt and enjoys above-average annual rent escalations from its long triple net leases.

I believe that the shares could easily reprice at 12x FFO and that would result in up to 50% upside from today's share price. A drop in interest rates would be a strong catalyst.

Closing Note

Opportunities remain abundant in the REIT sector, but the window of opportunity is closing. The time to buy REITs is now before interest rates return to lower levels.

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