2023-08-07 07:00:00 ET
Summary
- U.S. markets have been down recently, creating opportunities to buy quality stocks at lower prices.
- Real estate investment trusts have been trading low compared to the larger market, presenting undervaluation and potential buying opportunities.
- However, investors should be cautious and carefully evaluate stocks to ensure they are headed toward a turnaround before making any purchases.
I know the U.S. markets are down as I write this on Aug. 3. I know they were down on Aug. 2 - some significantly. And I know we don't know what the next day will bring.
It could be more of the same.
That negative reality can put some people on edge, making them shy away from buying anything at all. Which, for the record, is a shame.
Buying quality stocks at lower prices is one of the best pieces of advice I can (and do) give to those of you who want to retire in comfort. Or even style.
Assuming that's all of you, stay tuned. Because my team and I will definitely have companies to write about if prices keep falling the way they are.
Admittedly, my team and I will have companies to write about even if the market goes back to believing everything is peachy perfect. There are always stocks on sale somewhere, if you only know where to look.
That's the precise topic I'm writing about today - especially for the braver-than-most crowd that loves a sale.
Perhaps a little too much.
Again, I'm all about buying low, just with one caveat I've already mentioned. The stock in question has to hold up against careful evaluation.
Forget hunches. Forget the fear of missing out - FOMO. Forget unverified advice.
I want to know beyond a reasonable doubt that the cheap company in question is headed toward a turnaround.
"Lackluster" REIT Price is Putting it Nicely
Real estate investment trusts (REITs) - my typical topic - have been trading low compared to the larger market. I believe I've shared this comparison before, but here it is again a few weeks later:
That darker, thicker blue line?
That's the Vanguard Real Estate Index Fund (VNQ) Stock Price Today, Quote & News) - early on Aug. 3 - commonly used as a benchmark of average REIT prices.
The lighter, thinner blue line, in comparison, is the S&P 500.
The difference between the two is pronounced.
Now, it's true that much of the S&P 500's upward trend has been due to tech stocks. Back on June 2, JPMorgan noted how :
"… while the stock rally is broader than meets the eye, there's still no denying that big tech has been a powerhouse. Nvidia (NVDA) made it into the exclusive $1 trillion market cap club this week, joining the ranks of Apple (AAPL), Alphabet (GOOG) (GOOGL), Microsoft (MSFT), and Amazon (AMZN). The stock is now up an eye-popping 175% just this year - making it the best-performing company in the S&P 500. Those five also account for 8.7% out of the S&P 500's 10.7% year-to-date return."
Now two months later, Barron's reminds us that nothing much has changed. While it does point out that "stocks in the Dow outperformed" big tech in July.
"Gains by a few big tech companies are" still "the biggest factor behind the stock market's strong showing so far this year."
One way or the other, I think it's pretty safe to say that REITs are not in favor. There's a lot of undervaluation going on and, frankly, a whole lot of altogether ignoring.
And the office sector?
In case you missed it, I covered office REITs here and here .
It's hard to generate enthusiasm about anything other than AI these days. And REITs are pretty darn far from that topic, both in definition and perception.
Unless of course we're talking about data center REITs, Digital Realty (DLR) and Equinix (EQIX).
Discerning Between a Sale and a Bargain
So now that I've established how most REITs are trading down these days, let's go back to that whole loving-a-sale-a-little-too-much concept that I opened with.
To understand what I mean, let's first start out by stating a very important fact: How a sale and a bargain aren't always synonymous.
The former simply means something is cheaper than before. The latter implies a value that's higher than the price being proffered.
As I detailed in " Alexandria Real Estate: Debunking the 'Litt Piece' ," Alexandria Real Estate (ARE) is a quality company with an out-of-favor stock. Considering its past performance, present position, and future prospects…
It's a bargain I'm happy to point out.
I doubled down on the "Litt Piece" recently. Just in case you missed it, here's the link .
Unfortunately, the REITs I'm reviewing today don't fall into that category. As I presented recently:
"The key to (my recommendations') success is rooted in the concept of identifying companies with competitive advantages… with an emphasis on:
- Quality
- Pricing power
- Cost of capital
- Economies of scale
- Management."
All these factors should come together to show sustainable growth.
"The common thread (here's) that these companies deliver the highest returns because they generate sustainable ROIC… In other words, we're not looking for the so-called 'one-hit wonders.'"
We're also not looking for yield traps and sucker yields - REITs with unmanageable dividend payment proportions or flat-line growth prospects.
It's a topic I preach against often enough. But today's exact market conditions have highlighted a few of these tempting "opportunities."
That's why I promised at the very end of "My Biggest Winners" that I'd be writing another piece titled " Don't Get to Cute ." Because building a strong portfolio doesn't just mean "identifying stocks" we can "own for generations" that will "deliver real economic value."
It also means knowing which investments to avoid at all costs.
A Textbook Value Trap
One Liberty Properties (OLP) is a net lease REIT that owns 121 properties (10.9 million square feet) consisting of Industrial (56.4%), Retail (29%), Restaurants (5%), Health/Fitness (4.6%), Theaters (3.1%), and other (2.4%).
Top tenants include Haverty (HVT), FedEx (FDX), LA Fitness, Northern Tool, and NARDA Holdings. Since January 2007 OLD has returned 3.5% per year to shareholders, compared with these peers:
- OLP: 3.5%
- Realty Income (O): 8.1%
- Agree Realty (ADC): 7.0%
- NNN REIT (NNN): 6.9%
- Prologis (PLD): 7.1%
As illustrated below, OLP has not grown its dividend since 2018, and currently, the payout ratio is 90% (based on AFFO). Furthermore, OLP's cost of capital these days is going to make it difficult for the company to become a dividend grower.
OLP's equity yield is 10% and the company relies on higher leverage (secured debt) to grow. We estimate the WACC to be around 9% which means that it must acquire properties at cap rates of 9% or higher to generate positive investment spreads.
Although the shares look attractive at $19.92 with a P/AFFO multiple of 10x, and dividend yield of 9.0%, we believe there are much better opportunities in the net lease REIT sector right now.
Consider names like Realty Income, VICI Properties (VICI), Agree Realty, and NNN REIT - all much safer than OLP - and should generate steady dividend growth in the years ahead.
Avoid OLP!
Consider these blue-chip REITs instead:
- Realty Income: 5.2% yield and we forecast 20% annual returns
- VICI Properties: 5.0% yield and we forecast 15% annual returns
- Agree Realty: 4.5% yield and we forecast 20% annual returns
- NNN REIT: 5.6% yield and we forecast 25% annual returns
A Textbook Sucker Yield
Annaly Capital (NLY) is a residential mortgage REIT that invests in Agency MBS mortgages (guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae), MSRs (mortgage servicing rights), and non-agency residential loans.
Over the past decade, NLY has done a terrible job of delivering positive returns to shareholders. In terms of its market valuation, the stock has lost 53.0% over the last 5 years. In July 2018, NLY stock traded for approximately $42.00 per share but is now currently trading at $19.83 per share.
NLY's share price has been just as volatile as its earnings history. As you can see below, this high-yielding sucker yield has been a chronic dividend cutter, with an earnings history that would keep any investor up at night.
I consider NLY a dangerous REIT that should be avoided at all costs.
I cannot fathom why anyone would want to own a stock that has such an unpredictable and highly volatile dividend history.
Even after a dividend cut ( 26% in March 2023 ) shares are now in "sucker yield" territory, with a dividend yield of 13.1%. Analysts are forecasting negative growth of 31% (in EPS) in 2023 and negative growth (of 4%) in 2024.
If you're going to chase yield, here are a few of our favorites:
- Blackstone Mortgage (BXMT): Yielding 10.9%
- Starwood Property (STWD): Yielding 9.2%
- Ladder Capital (LADR): Yielding 8.5%
Building a SWAN Life
I'm in the process of launching a REIT masterclass, which I will include in the title "Building a SWAN Life."
The key to SWAN (sleep well at night) living is to avoid lower quality, higher risk stocks and focus on investing in companies that are thriving to create real economic value.
Whether it's a REIT, BDC, MLP, or ordinary C-Corp., you must remember that businesses create value by investing capital at rates of return that exceed their cost of capital.
Sustained levels of high cash flows lead to stability in valuation, as a substantial portion of asset value stems from relatively predictable cash flows.
By adopting asset-allocation targets that unite with your own personal risk tolerances, you can vastly increase the odds of investment success and sleep well at night.
Don't be too cute!
Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
For further details see:
Don't Get Too Cute