BXP - 2 REITs To Sell & 2 REITs To Buy

2023-11-20 08:05:00 ET

Summary

• There are lots of capital recycling opportunities in the market right now.
• We highlight two REITs that we would sell.
• And simultaneously, we look at two better alternatives.

Times of intense market volatility often lead to some interesting capital recycling opportunities that may allow you to upgrade the quality of your portfolio without sacrificing its future upside potential.

In today's article, we will review two such capital recycling opportunities, highlighting 2 REITs (VNQ) that I would sell and 2 better alternatives that I would consider buying.

Boston Properties (BXP): Sell

BXP is a blue-chip office REIT that's gaining a lot of attention right now because its share price has crashed and it is now priced at a historically low valuation and high dividend yield:

Despite this crash, the company is actually doing fairly well. It has a good balance sheet, it owns high-quality assets, and its management is well-aligned with shareholders.

So I agree that BXP may be getting attractive at these levels.

But here's why I would sell it if I owned it today. Alexandria Real Estate (ARE) is a far superior REIT in my opinion, but it is down just as much and its valuation is today quite similar:

But from every perspective, ARE is a far superior REIT.

Better assets: ARE owns life science buildings, which may look like offices from the outside but are far safer, require less TI and capex, and enjoy better growth prospects. They are less impacted by the growing trend of work-from-home and are also far more resilient to recessions. Moreover, ARE's rents are today deeply below market, offering a clear path to future growth, and most of its leases are triple-net, limiting capex requirements, and include 3% annual rent escalations.

Better balance sheet: ARE has lower debt and longer debt maturities. Moreover, the recent surge in interest rates has had an even greater impact on office buildings. Lenders know that the office sector is going through severe difficulties and they are now asking for larger spreads and/or safer terms.

Better management track record: Finally, ARE has done far better than BXP over the long run and I don't expect this to change. On the contrary, I expect a lot more outperformance in the future given that ARE is down just as much, but owns better assets and has a stronger balance sheet.

So I just don't see the point of buying BXP.

The office sector is going through severe difficulties and I think that BXP should trade at an even lower valuation relative to ARE.

My capital is limited so I would much rather buy shares of ARE than BXP.

UMH Properties ( UMH ): Sell

There is another similar capital recycling opportunity in the manufactured housing sector.

Over the past 6 months, our manufactured REIT investment UMH Properties has massively outperformed its close peer Sun Communities ( SUI ):

As a result of this, they are now both down an equivalent amount since hitting all-time highs in early 2022:

But since then, SUI has grown its FFO per share by about 10% even as UMH failed to grow.

As a result, both REITs are now priced at similar valuation multiples:

The interesting thing here is that despite trading at similar valuations, SUI is actually far superior in terms of quality:

• SUI owns properties that enjoy a ~95% occupancy rate, whereas UMH only has an ~88% occupancy rate. UMH buys lower-quality communities at cheap prices and it then attempts to turn them around. In comparison, SUI focuses on the higher-quality spectrum, and its properties enjoy far greater barriers to entry. As an example, 1/5 of its revenue comes from marinas that enjoy a long waitlist for potential tenants.

• SUI has a far stronger balance sheet with a BBB investment grade rating, lower leverage, and no major maturities until 2026.

• SUI is better managed. They are clearly focused on FFO per share growth and have one of the best track records in the entire REIT sector. UMH has a pretty good track record as well, but it is not as good as that of SUI, and after meeting the management earlier this year, we have lost confidence in their growth strategy.

• SUI is far larger in size, which typically also justifies a premium since it results in better diversification, greater economies of scale, and better access to capital.

• Finally, we prefer SUI's approach to retain nearly half of its cash flow for growth because capital is today expensive and this allows them to self-fund their growth. UMH, on the other hand, isn't retaining enough cash flow and is issuing new shares, claiming that its investments will "eventually" become accretive. This may be the case, but SUI's story is far less complex and we predict that this will allow it to recover faster than UMH.

So put simply, SUI is a higher quality REIT that is priced at a comparable valuation following its recent underperformance, and for this reason, we have decided to sell our position in UMH in order to reinvest the proceeds into SUI.

Historically, it made sense to favor UMH because there was a significant valuation spread and we didn't have the same concerns over the management.

But following SUI's recent dip, we think that it presents superior risk-to-reward for investors. Finally, I would add that Land & Buildings, which is a famous REIT activist investor, also recently initiated a position in SUI according to their latest 13F filings. It appears that they also took advantage of the recent dip as well.

It is similar to that of UMH in that we expect a significant upside in a future recovery. Even just getting halfway to its previous peak would unlock a 50% upside from here and while you wait, you earn a 3.2% dividend yield and the REIT is in a strong position to keep growing in the coming years. The dividend yield is relatively low, but keep in mind that this is because they retain about half of their cash flow to reinvest in growth and use little leverage.

Bottom Line

Overall, I still give a Buy rating to all four of these REITs.

But I think that ARE and SUI offer better risk-to-reward than BXP and UMH and therefore, we see no point in owning them.

We once used to own BXP and UMH, but we do not anymore.

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