SRVR - Important Warning For REIT Investors

2023-05-29 08:05:00 ET

Summary

• A lot of investors appear to think that REITs will drop lower.
• They believe that their valuations aren't low enough.
• Do they have a point? We take a closer look and issue a warning to those REIT investors who are trying to time the market.

Recently, I wrote an article that made the case for investing in REITs ( VNQ ). The title is " Buy REITs When There's Blood In The Streets " and it explains that:

• REIT share prices have dropped by 30-50% in most cases.
• Even as their cash flows have kept on rising.
• Balance sheets are the strongest they have ever been.
• Most REITs have guided further growth in 2023.
• As a result, REITs are today priced at some of their lowest valuations ever. According to some studies , valuations are now reminiscent of 2008-2009 with REITs trading at a ~30% discount to NAV on average:

So in short, valuations are low, balance sheets are strong, and cash flows are rising.

That's very compelling to me.

It essentially means that you get to buy high-quality real estate that's conservatively financed and professionally managed at a steep discount to its fair value. You earn high cash flow while you patiently wait for growth and upside. A great risk-to-reward if you ask me.

But a lot of you appeared to disagree.

The article received a very bearish response with 100+ comments, many of which were very hesitant about REITs. Here are some examples:

"No blood yet, only a scratch."

"REITs are going to get slaughtered over the next few years. The bubble in all things real estate is massive, and when that bubble pops, it's going to be one for the record books. There are a whole lot of REITs that exist now, that won't exist 2-3 years from now. That's just the facts."

"Slaughtered... The free money flow has stopped... Paying up for properties is over..."

"continued high rates make REITS bad investments. Continue to go down or tread water. Divvy of 4 5 6% unappealing with risk of continued capital loss"

"Problems in CRE have just started. It's a long long way to the bottom. Pass."

"Not enough blood yet, I’ll buy when people start crying."

"More blood to flow..."

"Better to invest on the way up rather than the way down."

"I am definitely waiting until at least the FED pause. I've been saying for over a year that REITs will be on sale for a very long time and the sales will get better and they have. I still believe there will be better prices coming because I expect 1..2 rate increases and a recession. I am so much happier with my cash making 5% 100% risk free."

"wait until the bleeding stops"

(There are many more. You can read all comments by clicking here. )

I wanted to write this quick follow-up article to those of you who share this same negative sentiment towards REIT.

Here is my warning to you:

You cannot time a bottom.

A lot of investors appear convinced that REITs have further to fall and that therefore, now isn't the time to buy just yet.

This implies that you are somehow able to predict what the market is going to do in the short run, which has been proven to be impossible time and time again. Here is the average performance of individual investors who attempt to time the market:

It is so difficult (impossible?) to time the market because it is a forward-looking machine and you simply cannot know what it has already priced in or not.

Today, many investors will point to rising rates or a coming recession as a reason to stay away from REITs or other stocks... but again... the market is a forward-looking machine. It knows this. It is not a secret to anyone if you are posting about it on Seeking Alpha. Therefore, the market has already taken it into consideration when pricing the stock.

As a reminder, REITs are already down by over 30% on average and this drop happened even as REIT cash flows and dividends kept on rising. Therefore, the drop is actually closer to 35-40% when adjusted for the higher cash flows:

So that's not enough for you?

Second reminder: REIT valuations are now reminiscent of the great financial crisis with huge discounts to net asset values and low cash flow multiples.

Here is a table of today's average valuations:

I would add that this is just the average valuation of the sector. Some individual REITs are even cheaper. To give you an example: Alexandria Real Estate ( ARE ) is a blue-chip REIT that focuses on life-science buildings. Its share price has crashed by 50% since the beginning of 2022 despite enjoying rapid growth and having a fortress balance sheet.

As a result, it is now priced at an estimated 40% discount to its net asset value - even as it is hiking its rents by 20%+ as leases expire.

Look at the contrast between the crash of its share price and the growth of its rents:

So here's another question for you:

Is that not cheap enough for you? And if not, then what would be cheap enough? A 50% discount? 60% discount?

It is always fascinating to me how everyone claims to be a value investor and everyone knows that the time to buy is when prices are low. Yet, once a crash really occurs, most people will find excuses to not buy and will miss the opportunities.

In case you weren't aware of it, the big private equity players like Blackstone ( BX ), Brookfield ( BAM ), and Starwood ( STWD ) sure think that these prices are low enough already.

They have been buying REITs hand over fist ever since their share prices began to crash in 2022.

Blackstone alone has bought $30+ billion worth of REITs and here is what their management said in a recent conference call:

"The best opportunities today are clearly in the public markets on the screen and that's where we're spending a lot of time." - Jonathan Gray, President/COO, Blackstone Q2 2022 Earnings Call

Similarly, Starwood is accumulating REITs, and here is what their CEO said just a few weeks ago:

"By the way, when credit comes back, you are gonna see REITs take off... 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..." - Barry Sternlicht, CEO/Chairman, Starwood Q3 2023 CNBC Interview

These are some of the most sophisticated real estate investors in the world. They have multi-decade track records of excellent performance, better access to information, and the best knowledge, and they are clearly very bullish on REITs.

So with in mind, are you still so confident that REITs are a poor investment?

The reality is that no one can time the market. Not me. Not you. Not Blackstone. Not Starwood.

However, what we do know is that buying good cash-flowing real estate with growing rents, low leverage, and good management at a 30-50% discount to its fair value is a no-brainer to a long-term-oriented investor.

This is why I am accumulating REITs at these levels.

Could prices drop lower? Sure, but they could just as well rapidly recover. Since I cannot time the market, I take positions, accumulate in many phases, and earn dividend income while I wait patiently for long term upside.

For further details see: