VNNVF - Why I Stopped Buying Rental Properties To Buy REITs Instead

2023-04-22 09:00:00 ET

Summary

• I bought a rental property in 2021.
• But today, it makes no sense to buy rental properties.
• REITs are heavily discounted and allow you to benefit from yesterday's low interest rates.

One of my favorite topics to discuss here on Seeking Alpha is that of REITs vs. Rental properties.

I like to write about this topic because I used to be a private equity real estate investor and I later became a real estate investment trust, or REIT ( VNQ ) analyst as I learned more about their advantages.

So I understand both sides.

Each has unique pros and cons, and I have covered those quite extensively here on Seeking Alpha. You can read my latest comparison by clicking here.

Instead of repeating the same facts, I will today focus on a different angle of this comparison. I want to discuss two reasons why, especially today, REITs are much better investment opportunities than rental properties.

REITs vs. Rental Properties: Valuations & Interest Rates Play an Important Role

Overall, I think that REITs are better investments than rental properties at most times. This is because they are able to earn higher returns with lower risk and require little work from investors.

But there are exceptions.

At times, REITs can get pricey and private markets may offer better opportunities. This led me to buy a private property in late 2021 as an example.

Back then, the REIT market was near all-time highs, it was getting harder to find new opportunities, and I happened to come across a great deal for a private property.

I was able to buy the property at a discount to my estimate of its fair value, I was also able to add value to it by making a few small changes, and finally, I could finance the purchase with a very low interest rate.

So it made sense back then.

But times have changed again and now, it is the complete opposite.

REITs have crashed, and they are priced at some of their lowest valuations in years. They dropped by 30% in 2022 even as their cash flows kept on rising, and as a result, they are now offered at large discounts relative to the value of the real estate they own.

Lots of REITs trade at 30, 40, or even up to 70% discounts to their net asset. I am looking at you, Vonovia SE ( VONOY / VNA)!

These valuations are reminiscent of the great financial crisis, according to the investment firm Janus Henderson:

So here you need to ask yourself:

Would you rather buy a private property and pay full price?

Or would prefer to buy an interest in a well-diversified and professionally-managed portfolio at a steep discount to its fair value?

I think that the answer is quite simple.

This is one of the main reasons why Blackstone Inc. ( BX ), Brookfield ( BAM ), Starwood, and other private equity players have been buying lots of REITs lately, despite typically favoring private equity investments.

Blackstone bought $30 billion worth of REITs just last year, and last week, they again announced another near $1 billion REIT buyout in the UK. Last year, the company's COO, John Gray, also said the following on the BX Q2 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." John Gray, COO of Blackstone.

Similarly, Brookfield has been buying a lot of REITs. Last year, they bought several European REITs. In 2021, they also bought out their own publicly listed REIT, essentially taking it for themselves. And the year prior, the company's CEO, billionaire Bruce Flatt, said the following :

"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."

See a pattern?

Let's look at one more. Starwood's CEO, billionaire Barry Sternlicht, just recently went on CNBC and he said the following :

"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."

The point that I am trying to make here is that you, of course, want to get the best deal possible when buying real estate.

Well, today, the best deals are in the publicly listed REIT market and these major private equity players understand this.

They are buying REITs because they essentially allow them to buy real estate at a steep discount to its fair value.

But it is not just that.

Buying REITs also allows you to invest in real estate with the benefits of yesterday's interest rates because REITs have often locked them for many years to come.

This is an important, yet overlooked advantage of REITs in today's environment. If you were going to walk to a bank to ask for a mortgage, you would pay a very high interest rate. The national average for a 30-year fixed rate mortgage is today 6.81%.

But if you invested in REITs, you could benefit from all the debt that they have secured in recent years at very low interest rates. It is the equivalent of buying a property with a low-rate mortgage that's tied to it. It significantly increases its value, but the market is not today giving any credit to REITs for this valuable advantage.

Just to give you a few examples: National Retail Properties ( NNN ), Alexandria Real Estate ( ARE ), and Simon Property Group ( SPG ) secured a lot of very cheap debt in 2020 and 2021 with long terms and fixed rates.

As such, you can benefit from this cheap debt by investing in these REITs today. If you bought private properties today, your debt would be a lot more expensive.

Bottom Line

I think that REITs are better investments than rental properties at most times anyway.

But when you then add the benefits of lower valuations and lower interest rates, it is not even a fair comparison anymore.

REITs are a lot more compelling investments when you take all of this into account and this is why even the most sophisticated private equity investors are now pouring money into REITs.

Unlike individual investors who worry about short-term volatility, they focus on long-term prospects and they understand that buying good real estate at 50 cents on the dollar is likely to be a great investment in the long run.

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