3 'Strong Buy' REITs That Will Rip Higher

Summary

• Large US REITs have fully recovered, but opportunities remain abundant in other segments of the REIT market.
• We currently find the best opportunities in small-cap, foreign, and value REITs.
• We present 3 such opportunities that we bought recently and expect to rip higher over the coming years.
• Looking for a portfolio of ideas like this one? Members of High Yield Landlord get exclusive access to our model portfolio. Learn More »

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As I write this article, the Vanguard Real Estate ETF (VNQ) is pushing new all-time highs, and increasingly many investors think that REITs are getting pricey:

Data by YCharts

While it is true that "some" REITs are now richly valued, it can be very misleading to assess an entire sector based on the performance of a single ETF. That's because:

• VNQ is market-cap weighted: This means that most of its capital will go towards the largest REITs, and as a result, VNQ is a poor representation of the REIT market, which is dominated by smaller and lesser-known companies. Many of these smaller companies are yet to recover.
• VNQ is mostly invested in growth REITs: Data center REITs, industrial REITs, cell tower REITs, etc. are all doing very well and that's where most of VNQ's money is going. The beaten-down sectors are poorly represented in VNQ and still offer bargains.
• VNQ skips all international REITs: Finally, VNQ only invests in US REITs, but today, there are REITs in over 30 countries, many of which are a lot cheaper.

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So yes, US-based mega-cap growth REITs have now fully recovered, but that's only one segment of the global REIT market, and investors need to realize this when they look at VNQ.

At High Yield Landlord, we currently find the best opportunities in three segments of the market that are underrepresented by VNQ:

• Small-cap REITs: These REITs often aren't included in ETFs and are rarely covered by analysts or the media. Since they aren't getting much attention, it is more common for them to become mispriced and trade at large discounts relative to their larger peers.
• Value REITs: The market has become increasingly polarized with growth REITs rising to new all-time highs, while value REITs continue to trade at steep discounts to pre-crisis levels. If you think that we will eventually get past the pandemic, there are some great opportunities in beaten-down REIT sectors.
• Foreign REITs: Finally, the US REIT market is by far the biggest and most popular among investors. REITs were created just around a decade ago in Europe and not surprisingly, there are plenty of opportunities because they are still misunderstood/underfollowed.

Lately, we have been buying a lot of REITs that fit into these three categories and in today's article, we will highlight 3 of them that we expect to rip higher over the coming years:

EPR Properties (EPR)

Even as the REIT market recovered to new all-time highs, EPR has languished behind and still trades at a 33% discount relative to its pre-crisis levels:

Data by YCharts

EPR is what you would describe as a Value REIT.

It failed to recover because it owns mainly experiential net lease properties such as movie theaters, water parks, golf complexes, and bowling facilities.

These properties suffered tremendously during the pandemic, but we now already see the light at the end of the tunnel, and EPR is poised for a strong recovery.

There is a lot of pent-up demand for all sorts of experiences. Movie theaters are reportedly the busiest since the beginning of the pandemic. Its biggest tenant, AMC (AMC) has managed to avoid bankruptcy. And we remain convinced that movie theaters are here to stay simply because they are absolutely essential in the monetization of new blockbusters:

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Most importantly, EPR recently gave an important update to shareholders: it reinstated a monthly dividend of $0.25 per share following a strong recovery in its rent collection and an improved future outlook.

We think that when it is all said and done, the pandemic will have set back EPR by a few years, but most of the pain will prove to be temporary. EPR only gave moderate rent cuts and it always received something in exchange: longer leases, higher rent escalations, master lease protection, etc. Once we get past the pandemic, we also expect the market to gain renewed confidence in the movie theater industry, which will have proven that it's here to stay.

We believed that EPR was cheap when it was priced at $70-80 prior to the crisis, and today, you can still buy it at $50 per share due to temporary fears that will slowly fade away over the coming quarters.

At the current price, the dividend yield is 6%, and once we get past this crisis, we expect the dividend to grow rapidly.

Put simply, EPR offers a higher yield, faster growth, and greater upside potential than most of its peers. It comes at the price of greater short-term risk, but if you are long-term oriented, the risk is well worth it. We like the risk-to-reward and bought more when the dividend was reinstated.

RioCan (OTCPK:RIOCF)

Just like EPR, RioCan has also missed out on the recent surge to new all-time highs and continues to trade at a ~20% discount to pre-crisis levels.

Data by YCharts

RioCan is what you would describe as a Foreign REIT.

It failed to recover because it is based in Canada, and Canadian REITs have not recovered as fast as US REITs.

RioCan owns mainly grocery-anchored, service-oriented shopping centers in highly urban areas. We like these assets because they generate recession and e-commerce resistant rental income. People need to eat and you cannot get a haircut or your nails done on Amazon (AMZN). You wouldn't expect rapid growth from these properties, but they deliver high and resilient cash flow, which is precisely what people need in today's low-yield world.

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The closest thing to RioCan in the US is Regency Centers (REG) and therefore, it is interesting to compare their performance.

REG has already fully recovered from the pandemic, leaving you thinking that it must own better properties and have a better outlook.

We think it is the opposite.

Unique to RioCan is that most of its properties are located in Toronto, which is one of the strongest real estate markets in the entire world. Here is how Toronto compares relative to some of REG's biggest markets:

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From a real estate standpoint, Toronto is a fantastic market because (1) it is growing rapidly, (2) vacancy is very low, (3) and new supply is highly constrained.

This has allowed RioCan to limit the damage of the pandemic and outperform its US peers from a fundamental perspective.

But since this is not yet reflected in RioCan's share price, it has become quite opportunistic relative to US peers. We think that it is only a question of time before RioCan catches up to its peers, potentially unlocking 30% upside, and while you wait, you earn a 4.5% dividend yield that's set for growth as well.

Broadmark Realty Capital (BRMK)

Finally, specialty housing lender, Broadmark Realty has failed to recover with the rest of the broader REIT market:

Data by YCharts

BRMK is what you would describe as a small-cap REIT.

We think that it failed to recover because it is small in size, underfollowed, and misunderstood by the market. It became public only shortly before the pandemic and that surely didn't help its cause.

But BRMK is particularly interesting because it presents an opportunity to gain exposure to the booming housing market at a discounted price and an 8% dividend yield that's paid on a monthly basis.

That's compared to the 2-3% yield that's offered by most large-cap housing REITs like Invitation Homes (INVH), American Homes 4 Rent (AMH), and Camden (CPT).

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How is it possible that BRMK yields so much more?

Its business is different.

Instead of buying stabilized properties and earning rental income, BRMK makes hard money loans to housing developers, who then pay interest to BRMK.

This is a riskier business model, but BRMK enjoys important risk-mitigating factors:

• It has zero debt on its balance sheet.
• It has first rank mortgages on the properties.
• Borrowers also give personal guarantees.
• The LTVs are in the 60-70% range, leaving margin of safety.
• And finally, the average home price has appreciated by 16% over the past year, and rents are rising by 5% on average, the fastest growth in over a decade.

When you take all of that into account, we think that BRMK's business model makes a lot of sense in today's environment and has the potential to deliver superior risk-adjusted returns. It capitalizes on the undersupply of housing and provides expensive capital to developers who urgently need it.

Priced at a near 20% discount to pre-crisis levels, we think that BRMK is deeply discounted relative to other housing REITs, which today trade at up to 30% higher levels than before the crisis began.

We give it a Strong Buy rating below $10 and a Buy rating below $12. It is right around $10 at the moment.

Bottom Line

The VNQ ETF is mostly comprised of US mega-cap growth REITs. Those have fully recovered and are now priced at new all-time highs.

However, that's only one segment of the REIT market, and there are many other segments that continue to present attractive opportunities.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of EPR, REG, RIOCF, CPT, BRMK either through stock ownership, options, or other derivatives. 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.