VNQ - Billionaire Investor Says 'Buy REITs'

2023-04-15 09:00:00 ET

Summary

• Billionaire Barry Sternlicht is buying REITs.
• He explains that there are "unbelievable bargains" in REITs.
• I present why Sternlicht is so bullish and why you need to consider REITs.

Starwood Capital Group is one of the biggest and best-known private equity groups in the world. It was founded in 1991 by self-made billionaire Barry Sternlicht, and today they have about $120 billion of assets under management.

Barry Sternlicht is still to this day the CEO and Chairman of the company, and his track record puts him among the very best investors in the world, especially in the real estate sector.

So when he talks, we listen. Recently, he went on CNBC to share his thoughts on the current market conditions.

I expected to hear him talk about real estate markets in general and he did, but the main highlight was actually about real estate investment trusts, or REITs ( VNQ ). Here is what he said (emphasis added):

By the way, when credit comes back, you are gonna see REITs take off. REITs are on sale. There are some unbelievable bargains in REITs. We did the same thing during the pandemic. We bought a dozen stocks all over the world and we had a 70% IRR on that stuff. We are already buying some stuff in the public market because I do think that rates are going down.

He thinks that REITs are today offering a historic buying opportunity, just like they did following the early crash of the pandemic. REITs had dropped by 43% at their lowest point, but they then rapidly recovered and more than doubled investors' money in the following two years:

Today, we are again faced with a similar opportunity according to him.

REITs have crashed and they are heavily discounted. According to a recent study by Janus Henderson, REITs are currently priced at a 28% discount to their net asset value, which is reminiscent of the great financial crisis:

What this essentially means is that you get to buy good real estate at a large discount to its fair value.

Also, remember that the 28% discount is just the average of the sector.

Many REITs are actually priced at much larger discounts, reaching up to 70% in the most extreme cases. I am thinking here about Vonovia (VNA / VONOY ), the biggest apartment landlord in Europe.

Valuations are so low, of course, because the market fears that the surge in interest rates will cause REIT cash flows and property values to drop.

But as I have previously explained, it is not that simple.

For one, interest rates surged because of the high inflation, which actually benefits REITs since it leads to higher rents, lower supply, and higher property replacement cost.

For two, REIT balance sheets are today the strongest they have ever been, with LTVs as low as 30% on average. Most of it is fixed rate, and debt maturities are also long.

And finally, the environment will change again. Barry Sternlicht pointed this out in his interview (emphasis added):

"I think that inflation is going to drop hard. There is a CPI slide that I brought with me that shows why. It is about the rent component of CPI. If you make that one correction, it will take headline inflation to 2.6%. Just that one correction. You will probably see it in late Summer."

So, the adjusted headline inflation rate is already back at a low level, and we are now likely headed into a recession, which will force the Fed to cut interest rates (emphasis added).

"I think that we are going into a serious recession. The credit market is smart and it knows that this cannot last. You have very low consumer confidence. Very low savings rates. Very CEO confidence. Some serious layoffs coming in service industries.

I think that the credit market is right and Powell is wrong. I don't think that he is going to have a choice. He gets to lower those rates because inflation is coming down... I don't know why the Fed has this credibility today when they didn't get it yesterday."

If he is correct, this would be huge for the REIT sector.

Their market sentiment took a big hit because of the surge in interest rates.

Therefore, simple logic would tell you that a drop in interest rates would lead to their recovery.

Just to recover to where they were a year ago, lots of REITs would need to appreciate by 50-100%. Here are just a few examples:

• Essex Property Trust ( ESS ) has 74% upside to 52-week highs
• Boston Properties ( BXP ) has 148% upside to 52-week highs
• Alexandria Real Estate ( ARE ) has 71% upside to 52-week highs
• Prologis ( PLD ) has ~50% upside to 52-week highs
• Global Medical REIT ( GMRE ) has 78% upside to 52-week highs.

Now, there are, of course, some exceptions, and the main one is the office sector. It is likely to suffer for years to come, especially if we go into a recession.

But it is important to remember that 95% of REITs don't invest in office buildings. They invest in defensive property sectors like apartments, single-family rentals, industrial properties, etc., and these property types are doing very well. Starwood owns $10s of billions worth of properties, and here is what Barry Sternlicht said about the health of its assets (emphasis added):

"You have to back up. Other than the office asset class, real estate is actually performing really well. Apartments are full . Single family rentals are full . Hotels are REALLY full . There's no overbuilding.

What I would like viewers to understand is that the asset class, commercial real estate is actually in very good shape. We are not seeing declines in rents overall in almost anything.

Industrial is strong. Apartments are strong. We have a non-traded REIT and our underlying business is terrific.

What has happened to us is that interest rates have gone up, but if the credit market is right, they will go back down . But the long term effect of rising interest rates is that there is going to be much less supply. So we think that the rent growth will accelerate coming out of this. We will come out of this. We always come out of this. We have never had a recession that didn't end up with a recovery."

That would be a very bullish scenario for REITs because:

1. The inflation of recent years will not be canceled. Rents will remain persistently at higher levels, and on top of that, the low supply growth will also result in an acceleration of rent growth.
2. But interest rates will likely be cut substantially before most of the REIT debt needs to be refinanced.
3. Finally, valuation multiples are currently at historically low levels and so the upside could be very substantial when you consider that cash flows are now a lot higher, despite the lower share prices:

Barry Sternlicht is putting money where his mouth is, and Starwood has begun to accumulate shares of undervalued REITs.

And he is not alone.

Blackstone Inc. ( BX ), the biggest private equity group in the world, bought about $30 billion worth of REITs last year alone to take advantage of this opportunity. Just the other week, it announced yet again another REIT buyout. It is acquiring Industrials REIT in the UK at a 42% premium to its latest closing price. This is in line with the company's latest net asset value.

Barry notes that "there is $220 billion of dry powder in real estate equity funds looking to deploy it," so we will likely see many more REIT buyouts in the coming months since that's where you find today the best bargains.

Why would Blackstone, Brookfield ( BAM ), KKR & Co. Inc. ( KKR ), Starwood, and others buy private properties when they could buy REITs at large discounts relative to the value of their assets?

Closing Note:

Buying good real estate that's diversified, conservatively financed, professionally managed, and liquid, at a large discount to its fair value, has always been a good investment in the long run.

That's exactly what the REIT market is today offering.

Legendary investors like Barry Sternlicht from Starwood and Jon Gray from Blackstone are buying REITs, but I see few individual investors take advantage of this opportunity.

I am buying REITs hand over fist while they are discounted and expect large gains in the years ahead as they recover.

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