2 REITs That Will Soar

Jul. 26, 2022 8:05 AM ETAVB, BEI.UN:CA, BOWFF, BSRTF, BX, HOM.DB.U:CA, HOM.U:CA, VGSIX, VGSLX, VGSNX, VNQ35 Comments

Summary

  • Inflation is at a 40-year high and it is scaring the markets.
  • Some investments actually benefit from inflation.
  • Apartment REITs are enjoying rapid rent growth and they are discounted.
  • We highlight two top picks with significant upside potential.
  • Looking for a helping hand in the market? Members of High Yield Landlord get exclusive ideas and guidance to navigate any climate. Learn More »

Inflation and the economic crisis. Financial market crash. The Red arrow on the chart is pointing Up. Golden Stack Coins With Red Arrow Showing Upward Direction for the higher inflation concept.

pcess609/iStock via Getty Images

The market has remained very volatile over the past few days, mainly due to fears of surging inflation.

The consumer price index has continued to rise and it is now approaching 9%, a level last experienced in the 80s!

Chart
Data by YCharts

But as you probably already know, REITs (VNQ) are by nature great inflation hedges because they own real assets that are essential and limited in supply, but growing in demand. Sure, some REITs are better inflation hedges than others, but overall, they are much better hedges than your regular stock (SPY) or bonds.

REITs outperform inflation is high

NAREIT

Here's the proof: rents are today growing the fastest in decades, resulting in rapid property appreciation, all while mortgages are inflated away. Here's the rent growth of various apartment REITs over the past months:

Apartment REIT rent growth

RealPage

Despite that, REITs have dropped with the rest of the stock market, and as a result, they are now priced at steep discounts as we explain in our recent market update. You can read it by clicking here.

Chart
Data by YCharts

That's a great opportunity.

Of course, we cannot know how the market will perform in the short run, but buying good REITs at large discounts has always paid off over the long run.

Again, here's the proof: REITs have always rapidly recovered from previous market sell-offs, without any exceptions. Some of the past crises were far worse than the current one, and yet... REITs always recover:

REITs Always Recover

NAREIT

Therefore, we think that now is a good time to accumulate more shares of REITs. Below I highlight a few of my most recent purchases:

Boardwalk REIT (OTCPK:BOWFF / BEI.UN)

Boardwalk REIT is one of the leading apartment REITs in Canada. It owns affordable apartment communities across Canada, but mainly in the energy-producing regions of Edmonton and Calgary:

King's Alley | 939 Bracewood Drive SW, Calgary | RentCanada

Boardwalk REIT

The company has all the characteristics of a high-quality REIT.

  • It has a strong balance sheet.
  • Great assets that enjoy recession and inflation resilience.
  • Steady organic growth prospects.
  • Accretive Capital recycling opportunities.
  • And a shareholder-friendly management team that owns 26% of the equity and only takes relatively small salaries.

Yet, the company didn't escape the recent sell-off as its share price dropped by nearly 30% over the past 3 months:

Chart
Data by YCharts

This sell-off is especially surprising because Boardwalk' assets have continued to appreciate and its organic rent growth even accelerated over the past months. In the chart below, you can clearly see that Boardwalk's rent increases have been rising month-after-month, and this strong growth is expected to continue because Boardwalk's rents are estimated to be 10-20% below market rates:

Boardwalk REIT rent growth is accelerating

Boardwalk REIT

So there is a clear disconnect between fundamental performance and share price performance.

The net asset value of the company is currently $68.61 per share, and that's based on a conservative 4.4% cap rate. Yet, today, you can buy shares at just $45 per share, representing a 35% discount. In other words, you get to buy its real estate at 65 cents on the dollar, with the added benefits of liquidity, diversification, and professional management for free on top of it.

Based on cash flow, you are paying 14x FFO, which essentially means that you earn a ~7% cash flow yield. Out of this 7% yield, the REIT pays you 2.5% in dividends and reinvests the remaining 4.5% in the growth of the company.

So in short, you are getting a great company with solid fundamentals at a deeply discounted valuation:

Boardwalk REIT investment thesis

Boardwalk REIT

We believe that the risk-to-reward is particularly compelling because we are talking about affordable housing in growing markets.

Everybody needs a roof over their heads and affordable apartment communities are some of the best inflation and recession hedges.

As long as the assets are not overleveraged or mismanaged, it is hard to lose money in the long run.

This downside protection, coupled with 50%+ upside to fair value ((NAV estimate)), makes Boardwalk a Strong Buy in today's environment.

BSR REIT (OTCPK:BSRTF/HOM.U)

For years now, people and businesses have been moving from California to Texas, and it is easy to understand why.

By simply moving, you may materially increase your after-tax income given the lack of state income tax, and you may also increase your disposable income given that everything is a lot cheaper in Texas.

This pushed a lot of large companies like Tesla (TSLA), Texas Instrument (TXN), and Toyota (TM, OTCPK:TOYOF) to move to Texas, bringing a lot of jobs and people with them.

This trend then accelerated during the pandemic, causing home prices and rents to soar in major Texan cities.

That's exactly where BSR REIT is investing. It owns mainly apartment communities in Dallas, Houston, San Antonio, and Austin, and as you can imagine, business has been very good lately:

BSR REIT portfolio composition

BSR REIT

BSR REIT apartment community in Texas

BSR REIT

Over the past year, its cash flow rose by 75%, and its NAV per share rose by 66%, reaching ~$22 per share.

In the first quarter, the REIT hiked rents by 17.4% on its new leases!

That's nearly twice the rate of inflation, and since it is leveraged, the impact on its NAV is substantial.

Assuming cap rates don't move too much, we would expect its NAV per share to reach around $25 per share by the end of the year as it keeps hiking rents.

And yet, you can buy shares today at ~$16 per share, representing a near 30% discount to its current NAV, and a 35% discount to its pro-forma forward NAV.

That's an enormous discount for such desirable assets with defensive fundamentals and high growth potential. If the valuation remains so heavily discounted, it wouldn't surprise us if BSR became a buyout target.

Major private equity players like Blackstone (BX) have acquired several residential REITs this year. American Campus Communities (ACC) was the latest one. Moreover, larger apartment REITs like AvalonBay (AVB) could also be interested as it would allow them to rapidly expand to strong Texan markets, diversify their portfolio, and likely improve their market sentiment.

Just to return to its NAV, the share price would need to rise by almost 40%. While you wait, you earn a monthly 3% dividend yield and the company keeps growing at a rapid pace.

Again, I think that it is hard to find better risk-to-reward in today's world when you consider that we are talking about defensive apartment communities that are essential no matter what.

Closing Note

I know that seeing red color is hard for some of you.

But remember that our dividend income hasn't changed. In fact, it has kept on rising. Moreover, the fair value of our REITs (based on private market transactions) remains at near all-time highs and it is much higher than what's implied by current share prices.

Eventually, the gap will close and patient investors will reap the reward. I have been through times of high volatility and each time, my REIT portfolio emerged more valuable than ever before as the market eventually recovered.

Will this time be different? I doubt so.

If you want full access to our Portfolio and all our current Top Picks, feel free to join us for a 2-week free trial at High Yield Investor.

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This article was written by

Jussi Askola profile picture
55.26K Followers
Become a “Passive Landlord” with our 8% Yielding Real Estate Portfolio.

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 BEI.UN; HOM.U; AVB 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.

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