CA - Billionaire Investors Have Been Rushing To Buy REITs

2023-07-22 09:00:00 ET

Summary

• Billionaires appear to be loading up on REITs.
• They differ from other investors in that they focus on the long run.
• I highlight three of my favorite investment ideas.

Many legendary investors apparently are loading up on real estate investment trusts ("REITs") at the moment.

Billionaire Jon Gray and Steve Schwartzman from Blackstone (BX) have acquired $30+ billion worth of REITs since the beginning of 2022. They recently said the following:

"We have nearly $200 billion of dry powder to take advantage of dislocation. With stock markets under pressure, we did agree to privatize two public companies in an otherwise muted deployment quarter, including... a logistics REIT in the UK...

We hold $16 billion of public stock in our private equity and real estate drawdown funds. When markets ultimately stabilize, we are well positioned for an acceleration in realizations."

Similarly, Billionaire Bruce Flatt, commonly known as "Canada's Warren Buffett," has acquired many REITs in recent years through Brookfield (BAM). They bought out three European office REITs (AOX, BEFB, HBRN) last year alone, and this came after he made the following statement in an interview in late 2020:

"Probably the greatest discount out there between what you would see as value and price is in REITs and real estate securities... I would say one of the great purchases today is real estate securities because you are buying them at a fraction of what you would trade them at in the private sector... REITs that have high-quality assets trade at enormous discounts to the tangible value of their assets."

Finally, billionaire Barry Sternlicht, CEO of Starwood, has been pounding the table about "bargains" in the REIT sector and recently said the following in a televised interview :

"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." Barry Sternlicht.

Brookfield, Blackstone, and Starwood are three of the best-regarded and most successful private equity firms in the world. They are all now investing in REITs and even willing to pay hefty premiums to privatize entire companies.

Blackstone just acquired yet another REIT a few months back, and it paid a whopping 41% premium to secure the deal!

What are they seeing that the market is missing?

I think that it is pretty simple.

It all comes down to your time horizon and investment focus.

Most investors in the public market are short-term oriented, and so they worry about short-term risks in today's highly uncertain environment. This is why REITs have crashed and are now so inexpensive:

But these billionaires, on the other hand, are long-term oriented and understand that near-term worries result in exceptional long-term opportunities.

They must know that rising interest rates are a headwind today, but they are patient enough to recognize that today's high interest rates likely won't last for long given that this tight monetary policy was meant to fight off inflation, which is now coming down already, and eventually rates will likely be cut again to stimulate our weakening economy.

That's what has happened each and every time over the past many decades, and the debt market is today already pricing lower interest rates with a significantly inverted yield curve:

Moreover, these billionaires also recognize that the high inflation of recent years significantly benefited real estate investors, as it led to rapidly growing rents and stopped a lot of new development projects, which should ultimately accelerate rent growth in the years ahead.

So one focuses on near-term risks, and the other focuses on long-term opportunities, and that explains why these private equity giants have been buying REITs even as most other investors were running away.

Let's look at a few examples to illustrate this point:

Example #1: Alexandria Real Estate Equities, Inc. ( ARE )

Alexandria Real Estate is a REIT that specializes in life-science buildings. Its properties are today experiencing significant demand in the post-covid world, as lots of money is being pumped into research and its current leases are deeply below market. This has led to 20%+ rent bumps as leases expire, which is the fastest growth in the company's history.

But despite that, its share price has crashed over the past year and it now trades at a historically low valuation as if the company was facing an existential crisis due to the rising interest rates. We estimate that its shares trade at a 35% discount to the net asset value of its properties and just 13x funds from operations ("FFO").

But the impact of rising interest rates actually isn't significant. The company has a strong BBB+ rated balance sheet with low debt and exceptionally long debt maturities at 13 years. This explains why the company expects its FFO per share to grow by 6.2% in 2023. The positive impact of rent growth is far greater than the negative impact of rising interest rates, and yet, the company is now heavily discounted.

This is a great example of a compelling opportunity for long-term-oriented investors who can ignore the near-term noise.

Example #2: Vonovia (FWB:VNA/ VONOY )

Vonovia is the biggest apartment landlord in Germany. It is today priced at its lowest valuation ever - a staggering 70% discount to its net asset value. In other words, its equity is now priced at 30 cents on the dollar - offering investors an exceptional opportunity to buy good real estate on the cheap.

The market worries that the surge in interest rates will cause its property values to collapse, but the reality is that its current NAV estimate reflects just €1,500 of implied building value per square meter, which is far less than what it would cost to build these properties and Germany is dealing with a severe housing shortage.

Therefore, it is unreasonable to expect property values to collapse. Over the long run, property values follow their replacement cost, especially if the supply of those properties is limited and demand for it is growing.

Meanwhile, rents keep growing gradually by 3-4% annually and VNA's management is busy selling assets to buy off debt at a discount, creating value for shareholders and removing the primary fear of the market.

Private equity players know that a few years out, VNA will likely trade a lot higher given that such discounts are extremely unusual.

Example #3: Tricon Residential Inc. (TCN)

Tricon owns a portfolio of single-family rentals in rapidly growing sunbelt markets. Today, its rents continue to grow at a rapid pace because not enough has been built in recent years and home ownership has become unaffordable for most people. Its same property NOI rose by 6.2% in the first quarter of 2023.

But its share price has been cut in half and it is now offered at a 35% discount to its NAV.

The interesting thing here is that, unlike other property types, there is real price discovery happening for housing even today. Transactions are down, but there are still many occurring all of the time. Therefore, their NAV is a lot more certain than that of other REITs and yet, their discount remains exceptionally large.

In short, you get to buy an interest in a conservatively-financed, well-diversified, and professionally-managed portfolio of single-family rentals with growing rents in strong sunbelt markets at 65 cents on the dollar.

Could market values drop a bit in the near term?

Sure... and that's why so few seem to care about buying these companies.

But will valuations eventually recover? I strongly believe so, and this is why these private equity players have been loading up on REITs.

They offer very significant upside and a high yield while you wait. Just to return to their NAVs, all three of these REITs would need to rise by 50-200%.

And these are not exceptions!

According to Janus Henderson, REITs are today priced at a ~30% discount to NAV on average, a level that's reminiscent of the great financial crisis.

Here, we think that this is a historic opportunity and we are following in the footsteps of the likes of Bruce Flatt and Barry Sternlicht and accumulating REITs at these exceptionally low valuations.

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