Real estate investment trusts (“REITs”) are down 30% year-to-date, significantly worse than the S&P 500 (spy):
And in reality it’s even worse than it looks.
In reality, most REITs are small- and mid-caps, and one can imagine that smaller, lesser-known REITs must have performed even worse.
Today, it’s not uncommon to find smaller REITs that are down 40% or even 50%. Most REITs are discounted today, but smaller REITs are trading at higher discounts than their larger peers.
|FFO multiple*||Discount on NAV*|
|Small Cap REITs||11x FFOs||35%|
|Mid-sized REITs||13x FFOs||twenty five%|
|Large REITs||18x FFO||15%|
(*Estimated by our company)
I think this is an opportunity for active investors.
Smaller REITs are heavily discounted today because they are perceived to be significantly riskier during a recession, but this is not always true.
Sure, they may be smaller, but they’re still relatively large, with properties worth hundreds of millions of dollars in most cases. An individual real estate investor usually feels well-diversified in a $10 million worth portfolio, but for some reason, his REIT with a $500 million portfolio has too much concentration risk, significantly I think it will be cheaper.
Moreover, REIT investors can handle diversification themselves. If you’re concerned that his smaller REITs aren’t decentralizing enough, you can solve this problem by investing in several REITs.
Finally, lower valuations may themselves reduce risk as they provide a margin of safety. A small REIT, down 40% and trading at 8x FFO, is only down more. On the other hand, a large REIT that is down 20% and trading at 15x FFO could take on more downside risk as interest rates continue to rise. Smaller REITs pay bigger dividends while you wait because they have lower valuations. Higher yields are less dependent on market rallying and a steady flow of liquidity to buy dips. It can be obtained.
In that sense, the small-cap segment of REITs today may offer better returns with less risk than many of their larger peers. Of course, this is not always true. To avoid the value trap, you have to choose. However, with the right selection process, there are plenty of opportunities to buy among small-cap REITs after recent sales.
Below are some of the things I purchased in High Yield Landlord.
Armada Hoffler Properties, Inc.oh oh)
AHH is probably the cheapest apartment REIT based on a P/FFO of just 9.8x. Large apartment REITs typically trade close to 20x FFOs and are still undervalued today.
Why is AHH heavily discounted?
There are two main reasons.
First, AHH is a small REIT with a market capitalization of $960 million. Few investors know that, and float is too small for major institutional investors.
Second, AHH is not considered an Apartment REIT as it also owns other assets. Instead, it falls into the “diversified REIT” peer group, which typically trades at lower valuations. However, what the market seems to be missing is AHH’s exposure to apartment communities has been steadily increasing, currently reaching about 50% based on NAV (lower based on NOI). but these are lower cap rate assets).
Moreover, this exposure to apartment communities will only increase further in the coming quarters as new development project leases expire and existing communities continue to raise rents at a rapid pace. Same property NOI increased by 12.5% in apartment communities.
So, in a way, AHH will soon become a “semi-apartment REIT”, but it still trades as if it were a less attractive smaller decentralized REIT. As the market recognizes this, we expect its valuation to expand significantly, providing shareholders with up to 50% upside. Even at $15 per share, it’s still a relatively good value and can be bought today for $10.
While waiting to rise, you also get a dividend yield of 7.2%. This is well covered and growing. It recently went up by 12%.
BSR Real Estate Investment Trust (OTCPK:BSRTF)
If AHH is the cheapest “semi-apartment REIT”, then BSR is probably the cheapest “pure apartment REIT.” If not the cheapest across the multifamily REIT sector, it’s definitely the cheapest among those focused on the fast-growing Sunbelt market.
Book value per share reached $22.35 per share last quarter and this NAV estimate is based on private market transactions. Unlike his REIT in the United States, BSR is built in Canada and must provide analysts with regular NAV estimates in accordance with IFRS accounting rules.
Despite this, the company’s stock is currently only $15.
This means you can buy BSR’s portfolio of apartment communities at 30% off fair value, or 70 cents on the dollar.
Is there something wrong with that portfolio?
On the contrary, it is one of the most desirable apartment community portfolios in the entire REIT space. BSR owns primarily affordable Class B communities in rapidly growing Texas cities such as Dallas, Houston, and Austin. These cities are enjoying rapid rent growth as the influx of new residents has not kept up with enough new construction, especially in desirable locations.
As a result, BSR rents are rising rapidly. The property’s NOI increased by 16% in the previous quarter! As expected, even if growth slows a bit, growth is still substantial for REITs that are very cheaply priced.
So why is it so cheap?
Again, it’s probably too small to attract major institutional investors, and being structured in Canada, it’s also popping off most retail investors’ radars.
East Group Properties Inc. (EGP)
EGP has a slightly larger market cap of $6 billion, but is still one of the smaller industrial REITs. For reference, the largest industrial REIT, Prologis (PLD), with a market capitalization of about $80 billion.
Industrial REITs will sell off heavily in 2022, with EGPs particularly hard hit.
Despite enjoying very strong fundamentals, EGP is down 36% and trading at an estimated 30% discount to net asset value, which is very interesting.
In the most recent quarter, FFO per share increased by 13.3% and the dividend was increased by 13.6%. It also raised guidance for the full year, and management looked very bullish on its latest conference call.
However, Amazon’s (AMZN) announced that it will cut its lease for new industrial space. The market saw this as a big red flag, but it really shouldn’t have been. Amazon is a unique case because it leased an unusually large amount of space during the pandemic to ensure it got the best location ahead of its competitors.
Outside of Amazon, demand growth for industrial space remains strong. This is primarily driven by the resurgence of onshoring and the growth of e-commerce, which requires a lot of industrial space. The pandemic caused significant supply chain problems, especially in China, and then Russia’s invasion of Ukraine created even more supply chain problems. It has taught U.S. companies that there are considerable hidden costs to doing business under a dictatorship.These days it is often more efficient to have most of the supply chain in the US
This should be particularly beneficial as EGP properties are primarily located in reclaimed urban areas in the rapidly growing Sunbelt market.
The EGP offers shareholders a 60% upside potential as the stock recovers to its previous highs.
The best opportunities are often found where others haven’t looked.
Small-cap REITs are a good example.
They are ignored by major institutions due to their low trading volume, and also by retail investors due to the lack of easy access to research on these opportunities.
As a result, they are often misvalued in the market and offer a unique opportunity for more sophisticated investors.