Lately, REITs have been performing very well, with many trading at all-time highs. A lot of High Yield Landlord subscribers are naturally very happy about this.
Still, I know that many investors out there are wondering:
Is it time to lock in some profits? Should I sell some of my REITs?
I’ve been getting this question an awful lot lately.
And it makes sense, because REITs (VNQ) across the board have never been this high:
I definitely understand the urge to take profits given this large runup. Even aside from the increasing REIT valuations, there are some other risks looming in the market.
Despite the vaccine rollout and our supposed return to normal, the Delta variant continues to spread, causing uncertainty and even renewed restrictions in some places.
Furthermore, the Federal Reserve keeps moving their rate hike timeline, and they’ve now guided for interest rate hike(s) as early as 2022.
Then there’s the fact that last time REITs were at an all-time high, they subsequently dropped 43% on average during the pandemic selloff. What kind of investor wouldn’t want to avoid that?
So, considering all these risks, is it time to sell REITs?
The answer is: it depends on the REIT.
We can’t just make a broad statement about the REIT market as a whole. The fact is, some REITs have plenty of room left to run higher, while others are trading far above their fair value.
That’s why even in the High Yield Landlord Portfolio, we’ve sold and locked in profits on many of our positions.
However, all of these profits have been rolled into other REIT positions, which just goes to show that we are still finding plenty of value even in today’s market.
Today, we’ll provide some examples on the kinds of REITs it may be wise to sell, and then reveal some others that we still think are a good buy.
Even though REITs are one of my favorite investment vehicles, I can still admit that some REITs today simply offer a poor risk-to-reward ratio. These are the kinds of REITs I would consider selling.
Generally speaking, there are three kinds of REITs that I think offer a poor risk-reward ratio:
There are still a few bargains in the hotel REIT market, but for the most part we think this segment of the REIT market is still too risky to justify a position at these prices.
Just a few months ago you could have picked up many REITs in this sector on sale, but now many are already trading above pre-Covid share prices as if the pandemic was over. Host Hotels (HST) is a great example:
The fundamentals of these companies remain challenged, and it could take a lot longer before things return to normal.
The US is preparing to reopen its border to European travelers, but with Covid cases surging in countries like Germany, the recovery in international tourism will likely take a lot longer than what's priced into these hotel REITs:
A large degree of past international travel was also business related, and this segment may never reach its previous levels of popularity thanks to evolving communication technology like Zoom (ZM).
Meanwhile, Airbnb (ABNB) has kept gaining market share, increasing the competition for guests.
For all these reasons, I really can’t make sense of the rapid price recovery of the hotel REITs, and I can’t justify investing in them at these levels. Unfortunately, I think it will remain one of the worst performing segments of the REIT market well into the future.
REIT preferred shares have not only fully recovered since the pandemic, many now trade at a 5-10% premium above their par value. Again, we simply find the risk-reward ratio of REIT preferred shares to be unappealing.
The average yield-to-call of a REIT preferred share is often ~3%. That may sound okay for today’s low yield market, but it’s actually still a near-zero real return if you conservatively account for taxes and inflation.
That’s why we’ve sold several of our preferred shares, including:
These investments have served us well, and we have nothing against preferred shares necessarily. It’s simply that the measly 3% yield-to-call doesn’t justify the risk one takes on by holding these shares.
Many REITs have taken advantage of leverage during our previous extended period of declining interest rates.
This has allowed many REITs to achieve great returns, but unfortunately leverage cuts both ways - and in trying times it can be enough to destroy a previously flourishing REIT.
We’ve seen this play out very clearly historically: REITs with lower leverage simply outperform their peers over the long haul. So when valuations are high and other risks abound, we prefer to cut high leverage plays and stick with REITs that have less debt on their balance sheets.
This is one of the reasons why we recently let go of Iron Mountain (IRM). Despite the company’s high leverage and other challenges in the digital age, it is now priced at near all-time highs. We were all too happy to buy IRM at $25 per share, but after crossing the $45 bar, the risks outweighed any potential further reward.
As you’ve seen above, there are some REITs to consider selling given high valuations and other risks in the economy.
However, we’re still buying other certain kinds of REITs, specifically in these three categories:
REITs are commonly seen as slow-growth real estate investments, but in reality, there are many REITs that are complementing their own property investments with other side businesses to grow faster.
As an example, REITs in the asset management business are able to achieve very impressive growth because they can leverage the capital of others to achieve stellar returns.
By using an asset management model, SAFE has been able to 12x its capital under management since inception and has gone on to become one of the most rewarding REITs in the US. This has created a lot of value for STAR and SAFE shareholders, and we expect this kind of growth to continue for years.
Similarly, some REITs offer construction, property management and/or brokerage services to other investors to boost their profitability. Armada Hoffler (AHH) is doing exactly that and in today's environment, that's a big catalyst for the company.
The blue chip REITs tend to get all the attention (and investor capital) which has caused their valuations to run up as of late.
Many investors would say WELL is priced at a premium because it has stronger fundamentals, but that actually isn’t so. In fact, we like MPW's future fundamental outlook better, as the company owns hospitals which are on the rise, while WELL operates mostly in the more challenged senior living sector.
This is a specific example in the healthcare REIT subsector, but you’ll find this pattern plays out all across the REIT market. That’s why we’re investing in smaller cap, lesser known REITs like MPW.
When it comes to REITs, few investors tread outside of US exposure. This means there is less competition and often more opportunities in foreign and emerging market REITs.
We’ve found a good deal of value in Canadian REITs at High Yield Landlord lately. The Canadian real estate market is on fire, yet these companies trade at large discounts compared to their US counterparts, even though many of them are actually in a better place financially and fundamentally.
RioCan REIT (OTCPK:RIOCF), for example, has better fundamentals than most of its US shopping center REITs, but it has underperformed by 20-30% in the recovery.
There’s no easy answer to the question: “is it time to sell my REITs?”
Instead, investors should evaluate whether their REITs continue to offer an attractive risk-reward profile. Currently, many REITs at high valuations are riskier than they are rewarding.
However, there’s still plenty of value to be found in the REIT market if you know where to look.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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This article was written by
Jussi Askola is a former private equity real estate investor with experience working for a +$250 million investment firm in Dallas, Texas; and performing property acquisition in Germany. Today, he is the author of "High Yield Landlord” - the #1 ranked real estate service on Seeking Alpha. Join us for a 2-week free trial and get access to all my highest conviction investment ideas. Click here to learn more!
Jussi is also the President of Leonberg Capital - a value-oriented investment boutique specializing in mispriced real estate securities often trading at high discounts to NAV and excessive yields. In addition to having passed all CFA exams, Jussi holds a BSc in Real Estate Finance from University Nürtingen-Geislingen (Germany) and a BSc in Property Management from University of South Wales (UK). He has authored award-winning academic papers on REIT investing, been featured on numerous financial media outlets, has over 50,000 followers on SeekingAlpha, and built relationships with many top REIT executives.
DISCLAIMER: Jussi Askola is not a Registered Investment Advisor or Financial Planner. The information in his articles and his comments on SeekingAlpha.com or elsewhere is provided for information purposes only. Do your own research or seek the advice of a qualified professional. You are responsible for your own investment decisions. High Yield Landlord is managed by Leonberg Capital.
Disclosure: I/we have a beneficial long position in the shares of STAR; EPR; AHH; MPW; RIOCF 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.
Additional disclosure: Relevant disclosure to presented performance: past performance is no indication of future results. Our portfolio may not be perfectly comparable to the relevant index. It is more concentrated, includes international REITs, and may at times invest in companies that are not typically included in REIT indexes. The performance of our portfolio is underrepresented because it is affected by withholding taxes on all dividends. This is not the only account that I own, but it is the first account that I created for the sole purpose of building track record and it is now over 5 years old, which is probably just enough to assess results. The performance is money-weighted.