So I have some good news and some bad news for you. Important Warning To All Real Estate Investment Trust – REIT Investors
The bad news is that the REIT market has collapsed over the past few weeks. Typically, REITs provide better downside protection than regular stocks, but this time around, REITs (VNQ) did even worse than the S&P 500 (SPY):
The good news is that every crisis brings an opportunity to people who know what they are doing. So before you panic sells, take a moment to listen to what we are doing at High Yield Landlord. We believe that this will help you sleep better at night, whether this crisis and come out stronger than ever before in the recovery.
REIT Investors HODL to Current Positions
Hodl is slang in the cryptocurrency community for holding rather than selling even in times of extreme volatility.
“I am Hodling to Bitcoin (BTC-USD)!”
The idea is to never capitulate even as prices plunge. This term applies particularly well to REITs today. They are experiencing extreme volatility based on temporary issues that are unlikely to have any impact on their long-term value.
The coronavirus is a real crisis and it should not be underestimated. Most REITs will suffer from it in 2020 and declare disappointing results. We don’t doubt that.
However, the need for real estate does not go away. It’s only temporarily disrupted. In the future, we will still need office buildings to work, apartments for shelter, malls for entertainments, grocery stores for food, and so on.
In a perfectly rational market, the value of a REIT should be determined based on its future cash flow generation potential. Future means decades, not quarters. Therefore, the poor results of 2020 really should have minimal impact on valuation, unless you think that this crisis will last for many decades to come.
Yet, almost every REIT has dropped by 30%-60% by now. Does this make sense?
No it doesn’t. We are not in a rational market. Just like in 2008-2009, we are in a market full of panicked people, scary headlines, and people trying to get out to time a “bottom.” Eventually, things will get better and we will experience an epic recovery. Stock prices can rise just as quickly as they drop.
Recognizing that panicked people never make good decisions, we aim to do the opposite. When others are selling, we keep holding and buying more. We won’t risk missing the recovery by attempting to time the market, which is not possible. In summary: HODL your current REIT positions.
Buy the Correction in Phases
Prices are exceptionally cheap today. In many cases, REITs are even cheaper than in the mid of the 2008-2009 crisis.
If you have some cash, now is the time to be a buyer. Don’t listen to panicked people who tell you that the market has further to drop because the reality is that nobody knows. Timing the market is not possible.
However, we know that prices are very attractive today, and therefore, we should start buying. At High Yield Landlord, we are implementing our buying in many phases to gradually add more capital to our portfolio.
We already have made four phases of buying, each in small increments as REITs kept crashing down:
- Trade Alert: Phase 1 of buying
- Trade Alert: Phase 2 of buying
- Trade Alert: Phase 3 of buying
- Trade Alert: Phase 4 of buying
We are prepared to keep making steady additions to our portfolio for as long as this bear market lasts. We may go through 50 phases of buying if need be, and we would gladly do so. Buying real state at cents on the dollar is very rewarding in the long run.
REIT Investors – Don’t Buy Just Any REIT
Every REIT is very cheap today, but not every REIT is worth buying.
Most importantly, the coronavirus crisis has pushed many REITs into speculative territory. Hotel REITs and mall REITs are trading at extremely cheap valuations. However, their risks have increased to a point where many may not survive unless they (or their tenants) get government bailouts.
Properties have to be closed down. Yet, debt payments must continue and covenants do not go away. Banks will probably have more leniency during this exceptional period, and governments will work with landlords, but “hope is not a strategy.” The low price is irrelevant if they don’t survive until the recovery.
For this reason, many hotel and mall REITs have become “too risky to add, too opportunistic to sell.” The best opportunities for new capital additions are the companies with the strongest balance sheets, namely Simon Property Group (SPG) for malls and Host Hotels (HST) for hotels.
Hotels and malls are a tiny allocation in our Core Portfolio. In today’s crisis, most of our capital is going toward defensive properties that continue to generate steady cash flow in this crisis:
- Residential REITs: Everybody needs shelter.
- Net Lease REITs: Long leases protect landlords.
- Healthcare REITs: People need hospitals more than ever.
- Speciality REITs: Demand is unaffected by the crisis.
The interesting thing is that despite being mostly unaffected, these REITs also have dropped to historic lows. The market was very indiscriminate in its selling, mostly because ETFs and Index Funds do not think. Many of these REITs now offer exceptional, possibly once-in-a-decade opportunities for active investors.
I will give you one example from our Core Portfolio: Spirit Realty Capital (SRC) owns a diverse portfolio of net lease properties with 10 years remaining on its leases on average. These are profitable properties with ~2x rent coverage on average, which means that tenants are highly motivated to not lose these properties.
Some tenants may default on lease payments in the near term, but most tenants will keep making payments and those that miss payments will pay as soon as possible. In case of a few tenant bankruptcies, SRC will release space when the panic is over.
In other words, we are not denying that there are some short-term headwinds. But this is nothing that would put the entire viability of the company in question. SRC has a fortress balance sheet with BBB investment grade rating and near 5x fixed charge coverage.
SRC can easily withstand the near-term disruption which probably won’t last beyond 2020. Then, it’s back to normal, earning steady rent checks from its long-term leases. Yet, its share price has dropped 62% and now pays a 12.2% dividend yield with a conservative 80% payout ratio. We estimate the NAV at $46 per share. The shares are today offered at less than half of that. We are loading up.
To summarize, there exist some truly exceptional opportunities right now that won’t last in the long run. Some property sectors have become too risky in this environment, while others have been dragged down to deeply discounted territory for no good reason. Be selective!
Go Up the Capital Ladder
The market crash also led to a crash in REIT preferred shares.
Many high-quality REIT preferred shares that used to yield 5%-6% now yield closer to 10%. And this is despite now living in a 0% interest rate environment.
Rarely in history have we ever seen such massive spreads between interest rates and preferred share dividend yields.
To give you an example from our Safe Haven Portfolio: MNR Real Estate Serie C Preferred Shares (MNR) (MNR.PC) yields 10% today. MNR is an industrial REIT with class A properties, leased primarily to investment grade rated clients, including FedEx (FDX) and Amazon (AMZN). The leases are long and enjoy a high retention rate. The balance sheet is very strong and enjoys >10-year average maturities.
Note that MNR has never cut its dividend, not even its common dividend during 2008-2009. The preferred is even safer. Yet, it now pays 10%. A clear sign that the market has lost its rationality. Lock in the yield now and earn an additional ~40% upside as shares return to fair value in the coming years.
REIT Investors – Adopt the Landlord Mentality
Our final piece of advice is to think more like a landlord when investing in REITs. Landlords focus on income and long-term property appreciation. They could care less about the daily fluctuation in valuation because they are not sellers.
REITs represent income-producing real estate investments. Therefore, you should think about them in the same way. REITs always have recovered from every crash and produced solid investment results in the long run.
This too shall pass. REITs have a 100% chance of recovery based on history. Think like a landlord, not a trader when investing in real estate.
REIT Investors Bottom Line
Most importantly, you must do six things today to limit risks and boost rewards in a recovery:
- Hold on to our positions.
- Buy the correction in many phases.
- Do not try to time the bottom.
- Buy the right REITs that are the least affected.
- Go up the capital ladder.
- Adopt the landlord mindset.
Drunk people and panicked people never make good decisions. Set emotions aside and follow a steady game-plan in these turbulent times.
I was studying REITs during 2008-2009 and this looks very similar. Prices collapsed, the market was irrational, and prices recovered very quickly.
Investors who take the right actions today are set to become richer than ever before when the recovery finally takes place.
REIT Investors – Buy high-quality REITs with resilient cash flow and solid balance sheets. They yield up to 20% today (Yes, I know it is crazy!) and have the potential to double or triple in value in the coming recovery.
We are loading up. We won’t pick a bottom. But this does not matter and I’m quite confident that we will look smart in a few years from now.