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The REIT Paradox: Cheap REITs Stay Cheap


  • The Real Estate Investment Trust industry has evolved considerably since the dawn of the 'Modern REIT' era in the early 1990s. REITs have evolved into dynamic growth-oriented operating companies.
  • Even as REITs have permeated into the mainstream, many of the traditional "style factors" and stock-picking techniques that work in other equity sectors haven't worked in the REIT space.
  • Counterintuitively, the evidence suggests that "high dividend yield" and "low valuations" as factors led to persistent underperformance in the REIT space while "growth" has been persistently undervalued.
  • In a business where "cost of capital" is the true competitive advantage and the driver of more than half of the sector's FFO growth, cheap REITs tend to stay cheap due to limited external growth potential.
  • Other factors that have exhibited persistent outperformance include balance sheet quality and property sector selection. We also identified a "sweet spot" of market capitalization that is associated with outperformance.
  • This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

The REIT Paradox: A Factor Analysis

In this report, we take a deep dive to analyze the underlying factors that drove performance within the REIT sector over the past decade and extract the major lessons that can be learned. Even as REITs have permeated into the investing mainstream, many of the traditional "style factors" and stock-picking techniques that work in other equity sectors haven't worked in the REIT space, a conundrum that has puzzled analysts and investors.

real estate special report(Hoya Capital, Co-Produced with Brad Thomas through iREIT on Alpha)

Last week, we analyzed the overall performance of the real estate sector during the 2010s in Recover And Rebuild: A Decade In Review. If the 1990s were the "Genesis" and the 2000s were the "Terrible Teens," the 2010s was the "coming of age" decade. REITs moved out of their parent's basement and into their own place in 2018 as GICS carved out an 11th equity sector for the equity REIT sector. As of last August, real estate represented roughly 3% of the S&P 500 and roughly 10% of the mid-cap S&P 400 index.

sector weightgs

Despite entering the 2010s scarred and wounded from the devastation of the financial crisis, REITs and Homebuilders delivered generally strong and steady performance throughout the last decade following an intensely volatile 2000s. Despite being viewed as a more defensive and yield-oriented sector during a decade that saw the longest US economic expansion in history, REITs (VNQ) produced an impressive compound annual total return of roughly 12.6%, slightly shy of the 13.5% annual total return on the S&P 500 (SPY).

Despite the mild underperformance over the last decade, REITs have actually outperformed the S&P 500 by more than 100 basis points per year over the last 25 years according to NAREIT, with average annual returns of 11.18% compared to 10.15% on the S&P

Announcement: Hoya Capital Teams Up With iREIT

Hoya Capital is excited to announce that we’ve teamed up with iREIT to cultivate the premier institutional-quality real estate research service on Seeking Alpha! Sign up for the 2-week free trial today!

This article was written by

Hoya Capital profile picture

Alex Pettee is President and Director of Research and ETFs at Hoya Capital. Hoya manages institutional and individual portfolios of publicly traded real estate securities.

Alex leads the investing group Hoya Capital Income Builder. The service features a team of analysts focusing on real income-producing asset classes that offer the opportunity for reliable income, diversification, and inflation hedging. Learn More.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Hoya Capital Real Estate advises an ETF. In addition to the long positions listed below, Hoya Capital is long all components in the Hoya Capital Housing 100 Index. Real Estate and Housing Index definitions and holdings are available at HoyaCapital.com. It is not possible to invest directly in an index. Index performance cited in this commentary does not reflect the performance of any fund or other account managed or serviced by Hoya Capital Real Estate. All commentary published by Hoya Capital Real Estate is available free of charge and is for informational purposes only and is not intended as investment advice. Data quoted represents past performance, which is no guarantee of future results. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (80)

Nice article. While I don't disagree With the premise, don’t you think it is sort of picking and choosing your numbers to utilize some charts that show the results of a single year? To say that one category out performs and then bring a single year as proof is far too small of a sample size to prove any “rule”. I’ve also been running into the problem recently that your article seems to share; with the market expansion going on for over ten years it is becoming difficult to figure out how recessions effect stock performance. Your assertions of return don’t take a single recession or serious market contraction into account. Even with your ten year charts you are arguing using data from a single market expansion in which growth stocks and generally riskier stocks have not been brought to account by a retraction.

I believe that many of your points are good and valid, but feel that to assert “facts” of market trends based on your chosen time frames creates data that could be self serving and is steeped in a recency bias.
Hoya Capital profile picture
Thanks, @Buy_and_hold_hobbyist. You certainly raise some good points regarding time period issues that we considered.

We try to make clear the parameters and limitations of the analysis. We also cited other sources that undertook a similar analysis with similar conclusions using data going back to the mid 1990s.
Wow, amazing article. This is a must read. So much wisdom, back with data. But I think the great lessons of this article is to make you think about some preconceived ideas. For example, higher yield doesn’t mean better total return. Also, margin of safety: not because you buy cheap that you have protection in the next pullbak/correction/bear. From the sense I got from the article, the better the underlying business is doing, the better you’ll do for total performance.
Awsome article, great commentary, and a must read for investors interested in eREITS. I tend to look at total return rather than just focus on yields. Once the yield gets to 6 or 7% I get gun shy to initiate a position. That’s just me. I’ve been happy with DLR, AMT, PLD, O, STOR, NNN, WPC, VTR, and HASI for several years in IRA’s. Yes, I’ve enjoyed the dividends but love the capital gains also, particularly AMT! I’ve had to trim a few times in several of my holdings, but often layered back in to full positions. I love investing in eREITS. Easier to understand in many respects. They make up about 12% of my total portfolios. I think this year is unlikely to be as good as last year. But I’ve always been a long term holder of most of my investments. Lastly, I do pay attention to debt levels, payout ratios( lower for faster growers like AMT), and great management. Again, a very informative article and commentary. Thank you!
Hoya Capital profile picture
I appreciate the comments, @Mr.Sceptic. I like that portfolio quite a bit.
Helpful article, thanks. Agree that high yield and low valued REITs often don't perform or recover compared to higher valued REITs, but how does it happen? Your comment here, that individual REITs require qualitative assessment, seems key, because some of your empirical findings appear to conflate cause with effect. I.e. Higher valuations and lower yields seem more the result of success (e.g. from good management and portfolio selection, consistent operating income, quality investor/analyst relations, etc.), than causes of success. The resulting improvements to cost of capital, lower debt/equity, are then helpful, but not always predictive of future success. Much still depends on just why a REIT appears undervalued or overvalued, and if its management and business model are still sound, and poised to perform well going forward.
Hoya Capital profile picture
Yes, all very good points. We tried to adjust for those effects by taking the data at the start of each year and comparing it to returns at the end of the year. Certainly, many of the factors overlap as well... especially FFO multiples, dividend yields, and debt ratios.
Excellent analysis! Since this data covers a decade, maybe 10% to 15% of the REITS that existed at the start were bought out or merged by the end. How did you handle the data for these? Or does your analysis only include REITS that traded over the whole time period, leaving out those that fell by the wayside? Thanks, YO
Hoya Capital profile picture
@Yodaorange There were 10 separate data series, 1 for each year beginning in 2010. At the start of the decade, there were closer to 100 REITs in the series. By the end, there were around 150.
Let me be more specific. For example, these eight equity REITS were trading on 1/1/18, but were all bought out/merged by 12/31/18.

Quality Care Properties
DCT Industrial Trust
Gramercy Property
Forest City Realty Trust
LaSalle Hotel Properties
Select Income REIT

How did you account for these in your calculations?
EliasMouawad profile picture
@Yodaorange In deed. GGP had an impressive return. I even recall once reading that it was the best stock ever...
This was a very informative article. Thank you for publishing it.
surfgeezer profile picture
Excellent article. Yield + DGR matters is how I look at things also, "Total Return" not so much.

I completely get why other people do, I just find it far to fickle to base my investment decisions on. Maybe it is my distrust of crowd thinking. Probably also because I am both a retiree and leveraged myself.

We do agree yield spread is the basic biz of REIT's- and mine. What I don't do in either stocks or my RE is EVER depend on a sale for actual payments- why I distrust "TR". Simply way to volatile IMO, but yep in good times it will always outperform the slow yield spread biz- until it does not.

If your leveraged and depending on TR its a recipe for disaster IMO. So I stick with yield spread and depend on the compounding Amortization inside the leverage for TR- eventually. The compounding of the Interest down and the excessive spread buying shares is my retirement yield spread biz. TR, again, not so much unless I releverage and I can pick those times, which is when TR matters.

We agree CoCapital is a big deal, why I have held O since it was yielding far higher for that agreed nice DGR- when it had a nice yield spread :).
Hoya Capital profile picture
Thanks and good insights, @surfgeezer.
The author is spot on with the major claims here though. Financial integrity coupled with grow in a lucrative sector is the best insurer of rising dividend payout. I've bitten on my share of rotten high yielding apples and have gotten stuck for years with painful dividend cuts adding insult to injury. A great example here is MAA which I came to own through CLP, it sells at rich valuations but has a strong multi year trend line. The yield is below 4% but it recently raised the dividend and gas returned appx 36% in the past year. If you're in retirement assets you should be able to harvest gains easily. TR is really all that matters if you can manage the tax end of it. And taking dividends involves taxation as well. Look at ARCP, PSEC, WPG, CBL and even NLY. Part of the benefit of many REITs as an investment will always be growth potential. If an investor wants the highest yields I think cefs, bdcs and select ETFs provide a better vehicle.
Robert Hutten profile picture
Thanks so much for the article. The data you provide is always appreciated. I have been looking at your "Real Estate Total Return Performance" chart every time you include it. The discernible patterns I see in it are
--Manufactured homes have beat the index almost every year since 2008, reflecting a limited supply, their affordability, stickiness of the customer, and an aging population with limited resources.
--Net Lease provides a fairly stable return generally above the index--probably a result of low risk and low interest rates coupled with a generous supply of risk averse investors needing income
--Hotel returns are extremely volatile depending on where one is in the economic cycle. Homebuilders also have high volatility--generally reflecting up and down sentiment about the economy and interest rates
--Cell towers and data centers are relatively new categories--cell towers in 2012 and data centers in 2015--and yes they have done very well based on the promise of 5G and cloud computing-- but it is hard to judge what will happen to them in a down cycle.
--Malls and shopping centers have tanked starting in 2016--fear of retail apocalypse. The big question is have they hit bottom--I am betting they have--but that is a speculative bet in the extreme
There are probability a lot of other things that can be said--but point is if one can figure out where the macro issues stand, there is a much better chance of an above average return. I do not believe I would rely on a couple financial statistics, though they are helpful.
M Plaut profile picture
A wonderful article that IMO should be published and republished once a year.
Hoya Capital profile picture
Thanks, @M Plaut. Good idea, we'll plan on updating this next year.
anyone have any thoughts on APTS - at 52 week low... 8% div....

is this a loser reit lol
Great article. Thanks for the great analysis.
Great analysis! Thanks
Wondering if all your total returns included reinvestment of dividends?
Given the range of yields between high and low payers, this could have made a significant difference in the results.
As Einstein is reputed to have said "The most powerful force in the universe is compound interest."
Hoya Capital profile picture
Yes, good point. These total return figures would indeed assume reinvestment of dividends.
team Gabe profile picture
That means the high dividend/low growers would be great candidates for calls selling. ( less risk of assignment)
Brad Kenagy profile picture
Great article!

From this article, one can infer that mall stocks and a stock like Tanger (SKT) will continue to underperform.
Hoya Capital profile picture
Ha! I didn't think you'd miss that opportunity to tackle Tanger. ;)

But in all seriousness, as I noted, there are indeed exceptions to the rule. There are a handful of low-yield REITs that chronically underperform (office REITs are a great example) and a handful of high-yield REITs that continue to crush it. (net lease REITs are good examples)
Allen Greathouse profile picture
this should be mandatory reading
DonPaul Olshove profile picture
nice analysis - so to summarize:
for the last couple decades, the most profitable REITs to own were the "growth" REITs - those that were best at buying RE on the cheap and flipping to the retail market by selling stock.

While the "growth" REITs do include the business of ownership and management of RE, it's clear that the extra profits are coming from the flipping, a somewhat different business than owning and operating RE investments.

Of course this has been a period of decreasing interest rates and excess capital availability. I wonder how the "growth" REITs will do in a capital constrained environment.
Not trying to pick at your comments, but adding some perspective. I don’t believe that flipping is an accurate description of the driving component of growth at any of these companies. REITS have been net buyers throughout the last two decades - really since inception in 1960. For example, the equity market cap of reits in 2000 was roughly 150billion and its 1 trillion+ today. They are constantly managing the portfolios (buying, selling) to optimize earnings growth. Selling assets is usually dilutive to earnings unless you replace that stream simultaneously and these companies don’t get much lasting credit for special dividends.

The fact that these companies pay out a good portion of the cash flow forces constant attention to capital allocation that earnings retaining corporations can sometimes ignore or be more lax with. To grow a reit you really need access to equity capital - often. To raise equity frequently you have to demonstrate the ability to grow per share cash flow. If you can grow cash flow, you can grow the dividend. Investors pay for growth. If you can’t do these things, another reit or a private investor will consume the portfolio and you will go away. It’s pretty Darwinian in an investor positive way. That said, as pointed out in the excellent article here, segment matters. So a “b” mall portfolio doesn’t have a lot of huge interest....though even cbl does have an activist in the mix currently.

It is also not a factual statement that retail investors are getting stuffed or “flipped to” by reits. Most of the reits north of 1bln in equity cap are 90%+ owned by institutions. Most closer to 100%. And Mgmt is aligned because this is their sole activity or at least that is the most common situation.

Nice work Hoya.
DonPaul Olshove profile picture
REITs are supposedly investment in real estate. "Real" RE investment is done on a long term capitalization rate. The "growth" REITs are selling at prices that suggest capitalization rates of about 4% when the open market is around 7%. Buy at 7, sell at 4 wash, rinse, repeat, and grow bigger. Yes, it works. Nevertheless, it looks to me like the growth REITs are currently overpriced by about 40%, and that's assuming that the current interest rates hold.
Eric Peterson profile picture
This article is a convincing and well-done proof that lower yields and higher FFO multiples outperformed substantially in 2019. I think what has been shown is that during a very good year for REITs, it was best to be invested in the most aggressive REITs.

But what about longer periods? For example, what about buying the lowest-yielding and "most expensive" REITs at the beginning of each year from 2010 through 2019? What would have been the results? And maybe go back to the beginning of 2007, so we include a couple horrible years for REITs.
Hoya Capital profile picture
I should have been more clear- the "Winning Factors" chart is the data from 2010-2019.

We focused-in on 2019 because these trends were consistent with the longer-term trends and the data was a little "cleaner." (ie: the yield and FFO thresholds could be defined and actionable)
Eric Peterson profile picture
Thanks. Yes, I somehow missed the 2010-2019 chart and focused on the 2019 charts. It would still be interesting to see this from the stock market peak in mid-2007 to the low in early 2009, to see if the low-yield and high price/FFO REITs got crushed more than others, or held up better than others.
hawkeyec profile picture
So my question is are there any REIT funds that invest in a pool of REITs that are based on some or all of these factors?
Hoya Capital profile picture
The only multi-factor REIT ETF that I'm aware of is Hartford's RORE. However, the factors that they use are not entirely consistent with these findings.

There are a handful of higher-growth (lower-yielding) real estate ETFs as well that would probably be the most appropriate to play these factor tilts.
Yes, SRET is a REIT ETF that I happily own.
Not to mention that SRET gives you a global coverage which may somewhat mitigate the bubble that is potentially brewing in the U.S. real estate.
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