BRX - Sell Alert: 2 REITs Getting Pricey

2023-08-21 08:05:00 ET

Summary

• Most REITs have significant upside potential.
• But not all of them!
• We highlight a few REITs that we sold recently.

We expect a continued slowdown in inflation and an eventual decline in interest rates.

In short, the yield curve is today deeply inverted and this has historically been a near-perfect telltale sign of a recession, and if you look back at the past 40 years, you will see that periods of rising interest rates have always been followed by sharp interest rate cuts:

We don't think that this time will be any different.

Already now, inflation has returned to the Fed's target 2% level if you adjust for shelter, so there is really no need for today's high rates. The Fed is playing tough to avoid a second spike in inflation, but as these high rates begin to impact the economy, we think that it is only a question of time before interest rates return to lower levels.

This is important because we think that the rate cuts will lead to an epic recovery across the REIT sector ( VNQ ); therefore, we have recently begun to reposition our portfolio to profit from this scenario.

We have sold quite a few REITs that have limited upside left and used these proceeds to double down on other names that have a lot more to gain as interest rates return lower.

Today, we highlight two examples of REITs that we sold recently at High Yield Landlord:

Boardwalk REIT ( BEI.UN / OTCPK:BOWFF )

Boardwalk REIT has long been our biggest Canadian real estate investment in recent years, representing nearly 11% of our International Portfolio. It is an apartment REIT that specializes in affordable Class B communities with value-add potential:

The REIT has performed incredibly well over the past year and our investment thesis has now fully played out.

When we first discussed this REIT back in October of 2022, we expected about 100% upside to our fair value target...

... and since then, it has surpassed our expectations, delivering a 157% total return, which is roughly 10x more than the average of the REIT sector ( VNQ ) over this time period:

This helped stabilize the value of our Portfolio even as some of our other international picks like Vonovia (VNA / OTCPK:VONOY ) underperformed the market.

But at this point, the thesis has played and the future upside is now limited.

Boardwalk REIT is now priced at a roughly 4.6% implied cap rate, which is where it should be according to recent market transactions. At the same time, some other residential REITs remain massively discounted relative to the fair value of their real estate and therefore, we don't think that holding on to our shares of Boardwalk REIT is the most optimal use of our capital, so we sold it.

Brixmor Property Group ( BRX )

Brixmor Property Group is a good REIT that has a simple thesis. It owns defensive grocery-anchored strip centers that have historically been undermanaged and have a lot of value-add opportunities.

Their rents are deeply below market, their occupancy is not what it could be, and BRX is heavily reinvesting in its centers to increase their value. So far, it has been able to earn a near 10% NOI yield on these value-add investments and it can fund its growth internally with its retained cash flow, resulting in steady and predictable growth:

So there's nothing exceptional about it, but it earns steady cash flow and its growth story is predictable because it is not reliant on public capital markets to fund it. That makes it the exact type of investment that we like to buy if the price is right.

Back in late 2018 when we launched our real-money Core Portfolio, the price was right and we initially made it one of our largest holdings. Back then, it traded at $15.69 and offered a generous 7.1% dividend yield.

Since then, we have suffered two major black swan events, the pandemic and the historic surge in interest rates, and despite that, BRX has still gained a lot of value all while paying us significant dividend income:

So BRX has served us well over the past 5 years and we are happy about its performance, but is it still today the best use of our capital?

I don't think so.

It now trades at about 15x AFFO, which is near its fair value, and it is one of the few REITs that's near its all-time highs even as most other REITs have collapsed in value, making it relatively less compelling.

For this reason, we recently sold our position and reinvested elsewhere.

Bottom Line

Not all REITs have equally as much to gain as interest rates return to lower levels. I believe that these two REITs are good examples of that as their upside would likely be limited from here.

But some other REITs offer up to 100% upside potential in such a scenario and we are today positioning our portfolio to maximize profits when interest rates finally return to lower levels.

For further details see: