Real estate investment trusts are very appealing income vehicles. They provide investors with a steady monthly or quarterly dividend paycheck, independent of the market environment, or state of the economy (at least for the most part). Since investors had more than enough reasons in 2016 to flee to safety and buy REITs (oil price crash, fear of energy-related debt defaults in the financial and BDC sectors, Brexit referendum), REIT prices have increased gradually from the early year lows.
Commercial real estate investment trusts like Realty Income (NYSE:O), or National Retail Properties (NYSE:NNN) have increased in price just as specialized REITs including Digital Realty Trust (NYSE:DLR) have. Frankly, the high valuation multiples based on funds from operations, or adjusted funds from operations, make REITs rather unattractive income vehicles for the time being.
Both Realty Income and National Retail Properties are selling for FFO multiples north of 20x, tilting the reward-to-risk ratio, and not exactly for the benefit of long term income investors. In the case of Digital Realty Trust, I have actually recommended to take some chips off the table.
An attractive niche in the REIT market has been the healthcare sector, which affords investors with very compelling long term growth characteristics due to a steady increase in life expectancy on the back of improvements in the medical field.
For instance, I took a risk in February and recommended investors to buy HCP, Inc. (NYSE:HCP), a healthcare REIT that at the time quickly went from in-favor to out-of-favor on reduced revenue projections. The shares were selling for ~$26 at the time, and there were reasons to jump into the breach: 'HCP, Inc. - 3 Reasons To Buy The Meltdown'. Fast forward a couple of months, and HCP has rebounded strongly, recovering all losses in the meantime. HCP now sells for $39. Very nice.
However, valuations of healthcare REITs have expanded fast lately, and a little too fast if you ask me. Quick surges in market prices leave income vehicles vulnerable to profit taking, which can make it prudent to wait a bit until a market correction has made REITs a little more affordable. And a correction will come at one point or another.
Correction May Offer New Entry Opportunity
One healthcare REIT I'd definitely consider buying on a drop is Care Capital Properties, Inc. (NYSE:CCP).
I first covered Care Capital Properties in June, 'Buy This 8% Yielding Healthcare REIT For Income And Growth', and I obviously liked the growth and income combination of the healthcare REIT. However, like most REITs, Care Capital Properties has become a lot more expensive in the last month (CCP is up ~19 percent over a one-month period), and its shares are at the risk of overheating.
Care Capital Properties said that it expects its normalized FFO to clock in between $2.85-$2.95/share this year, which implies that the REIT's shares are selling for ~10.3x 2016e normalized FFO. What's more, CCP is now WAY overbought, further putting the REIT's investors at risk of a pullback.
At the very least, the significant increase in REIT prices this year is reason enough to tread a little more cautious now. Like most REITs, Care Capital Properties has seen a surge in valuation lately, which puts the company at risk of a correction. Care Capital Properties is selling for ~10x normalized 2016e funds from operations, which is a much more reasonable multiple compared to other REITs right now, but investors WILL pull away from the overheated REIT sector at some point. Wait for a drop towards $26 before buying.
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Disclosure: I am/we are long O.
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