Summary
- I've been a real estate investor for over 35 years and I've seen many real estate cycles.
- However, I'm seeing something that I've never seen in my experience as a real estate investor.
- Now, after over a dozen years of writing (and +3,500 articles on Seeking Alpha), I’m taking it to another level.
Back in July, Cohen & Steers published a piece titled, “ Rising rents matter more to REITs than rising rates .” It began with this declaration:
“Despite the prospect of near-term volatility, REITs are well-positioned to help mitigate higher interest rates , sticky inflation, and challenging economic conditions.”
Right about now, you might be thinking something along the lines of, “Well that information would have been nice back in July. But it’s November now. So thanks for nothing.”
In which case, tell me how this next bit – prediction though it was at the time – doesn’t apply just as well today:
“With supply-chain disruptions and high commodity prices likely to [stay] elevated for a prolonged period of time, the Fed is expected to continue raising rates at least through 2022 . This rising-rate environment is posing significant questions for investors on how to be positioned.”
And how about this part:
“In the current cycle, inflation remains above trend, growth expectations are slowing, and Treasury yields are rising. At the same time, consumer savings remain solid even though off the peak levels of 2021, and unemployment is holding at historically low levels, with more job openings than unemployed people .”
As such, three whole months late though it may be, I’m going to quote Cohen & Steers’ conclusions about real estate investment trusts… which just so happen to agree with my own.
If You Know Something About REITs…
I don’t mean to detract from Cohen & Steers’ excellent research and commentary, but…
I really have been preaching about REIT resilience in times like these for a while – far further back than November 1st's “ Inflation Buster: 3 Apartment REITs With Pricing Power ,” for the record. Take “ Protect Your Nest Egg With These Inflation-Resistant REITs .”
Published on June 3, a whole month before Cohen & Steers’ piece, it featured this summary:
- “ REITs tend to outperform during periods of rising and unexpected inflation .
- This contrasts with bonds and other stocks’ modest or negative inflation sensitivity.
- We believe that now is the perfect time to own REITs .”
On January 6, I shared “ Inflation Busters: I Ain’t Afraid of These REITs .” On December 14, 2021, I published “ 2022 Outlook: The Inflation Trade and Rising REITs .” And on August 19 and 20, 2021, I featured “ 3 Monthly-Paying, Inflation-Fighting REITs for Mom ” and “ 3 Top Growth REITs to Fight Inflation ,” respectively.
Go back to June 17, 2021 – far, far before the Federal Reserve was ready to admit that inflation was a problem at all – and I shared “ 2 Inflation-Fighting REIT Buys .” In fact, just searching for titles with “Inflation” in them, I can go all the way back to 2013: “ Get Your Dry Powder Out for the REIT Way to Beat Inflation .”
Why?
Because I know my REITs. Which means I understand that they’re natural inflation hedges.
Avoiding REITs Right Now (or Ever) Is Silly, to Say the Least
As I wrote in my most recent – though hardly latest – book, The Intelligent REIT Investor Guide :
“The vast majority of REITs are public real estate companies overseen by financially sophisticated, skilled management teams with the ability to grow their companies’ cash flows (and dividends) at rates higher than inflation. It’s not uncommon to get total annual returns of 8%. All you need is a 4% dividend yield and 4% capital appreciation resulting from 4% annual increases in operating cash flow and property values.”
Now, I understand that inflation was recorded at 8.2% in September. But that will go down eventually. And even if it didn’t, wouldn’t you rather keep as much of what you’ve got as possible regardless?
This brings me back to that Cohen & Steers article, which features paragraphs like:
“… some investors think they should avoid REITs when interest rates are rising. History shows us differently.
“Although sharp increases in interest rates may unsettle markets in the near term, history shows that the direction of the economy and job growth tends to have a greater impact on REIT returns than rising rates do .
In other words, the environment that may be pushing the Fed to raise rates is one that can benefit REITs in the form of higher rents while REITs’ characteristics can make them an inflation buffer .”
To back its main point up, the authors:
“… analyzed the 12 largest one-month increases in the 10-year U.S. Treasury yield dating back to 2000. The data showed that while REITs have underperformed equities in the immediate aftermath of significant yield increases, they have historically outperformed 3, 6, and 12 months after such increases…”
I know that REITs are down for the year, but all the information above has me convinced that a REIT revival is around the corner.
REIT Revival #1 - Agree Realty ( ADC )
Agree Realty is a blue-chip REIT that operates in the net-lease retail sector. Many of the lease agreements that they enter into are sales-leaseback transactions, meaning they are actually buying the property from their tenant and then leasing it back to them.
This is very common practice, and many great REITs utilize this strategy, including the likes of Realty Income ( O ) and National Retail Properties ( NNN ), two REITs we have discussed a lot.
Agree Realty currently has a portfolio of over 1,600 properties that make up 34 million square feet of leasable space. The company focuses a lot of attention on high-quality tenants, which is why nearly 70% of their tenants are investment grade.
On the year, shares of ADC are outpacing the REIT sector as a whole ( VNQ ) as well as some of its closer competitors in Realty Income and National Retail Properties. ADC shares are down only 4% on the year, which is very encouraging considering the S&P 500 as a whole is down over 20%.
As mentioned, ADC’s management team focuses on working with high-quality tenants. Top tenants include: Walmart ( WMT ), Tractor Supply ( TSCO ), Dollar General ( DG ), CVS ( CVS ), and Lowe’s ( LOW ), just to name a few. The top 10 tenants make up over 36% of total annualized base rent for the company.
Here is a full look at the company’s top tenants:
Working with these strong tenants, who enter into long-term leases, ADC has maintained a very high occupancy ratio and generated strong cash flows.
Over the past five years, investors in ADC have enjoyed over 90% total return, and a 12.7% CAGR since going IPO in 1994, which happens to be the same year Realty Income went IPO. In that same timeframe, the company has managed to grow the dividend at a 5.5% CAGR as well.
Speaking of the dividend, ADC currently pays an annual dividend of $2.88 per share, which equates to a dividend yield of 4.25%.
In terms of valuation, shares of ADC currently trade at an AFFO multiple of 18x, which is well below their five-year average of 21x, meaning shares appear undervalued at the current moment.
At iREIT on Alpha, we currently rate shares of ADC a BUY.
REIT Revival #2 - Digital Realty Trust ( DLR )
Digital Realty Trust is a blue-chip data center REIT that has been trading like data centers have been going out of style. On the year, shares of DLR are down a staggering 45%.
The stock market as a whole is down big, but why the big underperformance for DLR you might be asking yourself.
I just mentioned overall market weakness as a reason, but so is rising interest rates, but more notably has been the short-selling being done by notable short-seller Jim Chanos.
Mr. Chanos has come out and stated that the big tech companies that rent data center space right now from the likes of Digital Realty Trust are going to start building or buying their own real estate to house their own data centers.
That is certainly a fair argument, but first off there is no indication that is happening at all or even any time soon, and number two, the need for data center space is not going away.
In the company’s most recent quarter, we saw the demand remain quite strong. After all, Digital Realty set a new all-time high for bookings, signing $176 million of annual revenue to new leases.
This has continued to be a common thing, debunking Mr. Chanos’ viewpoint, as the company has made new records in three of the past four quarters. Demand for data center space continues to be strong.
Here is a look at the growing demand over the years.
DLR is one of the largest data center REITs on the market today with a market cap of $27.7 billion. The company is the largest global provider of cloud and carrier-neutral data center and interconnection solutions.
According to Precedence Research, they estimate that the cloud computing market size will grow to roughly $1.6 trillion by 2030, growing at a CAGR of 17.4% from 2022 to 2030. That is an enormous market for cloud providers, but also the often forgotten segment of data center providers.
Digital Realty has over 4,000 global customers and over 300 data centers across the globe.
The company has also built up a reliable balance sheet with a BBB rating. The company has a net debt/EBITDA ratio of 6.4x.
Currently, shares of DLR now trade at a forward P/AFFO multiple of 14.6x. Over the past five years, DLR shares have traded at an average AFFO multiple of 21.6x.
This valuation is MUCH more intriguing, which is why we at iREIT rate shares of DLR a STRONG BUY.
REIT Revival #3 - VICI Properties ( VICI )
VICI Properties is one of the largest hospitality and gaming landlords in the country and is the largest landlord now on the Las Vegas strip. Along the Las Vegas strip, the REIT owns the likes of Caesars Palace, MGM Grand, New York New York, and Mandalay Bay, just to name a few.
All in all, the REIT owns 43 properties, with 45% of the portfolio along the LV Strip.
Through August, VICI was actually a top performing REIT, as shares were up nearly 20% at that time, but have since pulled back. On the year, shares are still in the green by 4%.
VICI uses a master lease contract to structure many of their leases. This structure comes in handy for a single tenant that may have multiple properties that are covered under the master lease, and this structure protects VICI from a tenant wanting to close one specific location.
I discuss it often, but one reason I like a lot of the net-lease retail REITs in large part is due to the long-term leases they enter into with built-in step-ups. If you thought those companies had long-term leases, wait until you see VICI. This leading gaming REIT has a weighted average remaining lease term of 43.7 years. The company also reported an occupancy rate of 100% during the quarter.
During these times of high inflation we are in, it is important to note that many of the leases VICI enters into has step-up rent escalators that are tied to CPI. Give where inflation has been, many of these leases will cap out at the highest rent escalator in the near future, which is a catalyst for the company and the stock.
In terms of valuation, shares of VICI currently trade at an AFFO multiple of 16.8x, which is roughly in-line with their five-year average of 16.5x.
The company also pays a generous annual dividend of $1.56 per share, which equates to a dividend yield of 4.9%.
In Closing…
I’m headed to San Francisco in a week where I will be attending REITworld, Nareit’s annual conference that brings together REIT management teams, investors, and analysts for educational sessions, one-on-one private meetings, networking events, and more.
I’ve arranged to meet one-on-one with over two dozen REIT CEOs and while there I’ll be touring a state-of-the-art data center owned by Digital Realty.
Note: Members at iREIT on Alpha get full access to all interviews (videos and transcripts)
I’m highly bullish with REITs and I consider now one of the best times in my entire life to invest in this highly predictable dividend paying asset class.
In fact, right now I’m plowing around $.75 out of every disposable $1.00 of my personal income into the sector. I missed the buying opportunity in 2009 as I was just getting started (at the time) as a REIT analyst.
Now, after over a dozen years of writing (and +3,500 articles) and over 35 years of experience in real estate investing, I’m taking it to another level.
For further details see:
Who's Ready For A REIT Revival?