How to Invest in Real Estate: REITs to Consider—and Avoid

text size

Real estate investment trusts have had some tough years, but opportunities abound – if you know where to look.

Higher interest rates mean higher costs for the borrowing-dependent industry, while making REIT dividend yields less attractive compared to bond yields. And this year’s banking sector turmoil has exposed how some classes of real estate are dependent on financing from regional lenders – which may not be as readily available in coming months.

There are many storm clouds. O

MSCI US REIT Index
has lost 23% after dividends since the Federal Reserve started raising interest rates in March 2022, versus a 7% drop in the

S&P 500 Index.

REITs, in general, are trading for about 85% of their net asset values, versus a long-term average of 99%, according to Steve Sakwa of Evercore ISI. Relative to projected earnings, REITs look less cheap: The group is looking for a multiple of 18.4 times the estimated adjusted funds from operations over the next year – an important metric for the group – compared to the long-term average of 17. 4 times. The sector carries a dividend yield of 4.5%, while the 10-year US Treasury note yields 3.8%. That’s not as good as it sounds – the current premium of 0.66 percentage points is half the historical premium of 1.33 points.

REITs are not a monolithic asset class. Beneath the surface, there are real differences across the industry – a microcosm of broader markets and economic changes. For office REITs, the post-pandemic work environment means many companies need less space, lowering demand – although the long-term leases still in place before 2020 are delaying the full impact. Shopping center REITs have long been pressured by e-commerce, while warehouse REITs have benefited. Enthusiasm for artificial intelligence has driven data center REITs in recent weeks. This created opportunities – and risks – for investors.

With the annual Nareit conference set for next week in New York, here are six REITs to consider or avoid.

Large wireless companies like

Verizon Communications

(VZ) and

ATT

(T) could not function without the communication towers that cell tower REITs such as American Tower own and operate, essentially acting as antenna owners. Profit margins are wide, recurring revenue is high, and future visibility is clear, given long-term leases that often have annual rent increases. The industry is in the midst of an upgrade to 5G networks, which provide faster service but whose signals don’t reach as far. More antennas are needed and this will keep rental growth steady for American despite potential economic weakness. Meanwhile, the stock trades near its lowest P/AFFO in a decade.

Alexandria Real Estate Equities owns and operates laboratories and other life science research and development facilities throughout the country. Unfortunately, this is not a good time to own these things. Biotech companies have been under pressure since the bankruptcy of Silicon Valley Bank, and if venture capital funding dwindles, that could weigh on demand for lab space. Alexandria shares are down 33% since February, and the risk appears to be off on the stock, which has not been this cheap since the financial crisis. For investors looking for a less risky way to gamble on biotech, Alexandria may be the way to go.

Americans’ collective online shopping habit requires billions of square feet of storage space to store, process, and transfer all of these things. Even concerns about the slowing economy couldn’t dampen the buying spree, and that meant 17% year-on-year rent growth and an almost historically low vacancy rate of 3.6%. Southern California-focused Rexford Industrial Realty is smaller than the warehouse titan

prologis

(PLD), but growing faster. Its inventory has been hit this year by concerns about new warehouse development in its backyard. But demand should more than keep up, sustaining rents.

Vici Properties owns a portfolio of casino and racetrack real estate in Las Vegas and beyond, including Caesars Palace and the MGM Grand. Post-pandemic Las Vegas is booming and casino operators continue to expand, increasing property values ​​and increasing their ability to pay rent. Analysts expect AFFO growth per share of 10% this year and 5% next year, attractive rates relative to the broader REIT space’s 3% to 4% annual earnings growth. “Vici has some of the most productive assets in the country, with the highest visible growth and a multiple that is more than 15 times cash flow,” he writes.

JP Morgan
in

Antonio Paolo.

The artificial intelligence frenzy has seeped into the REIT world. The Digital Realty Trust, a data center REIT, is an example. The stock had lost half of its value since early 2022, but after

nvidia

(NVDA) reported results that made AI a must-have for all investors. Shares of Digital Realty rose 20% in the week following the May 24 announcement. AI will mean more business for the REIT, but it’s hard to know when that will translate into real dollars. Digital Realty also remains heavily indebted – 7.1 times net debt to adjusted earnings before interest, taxes, depreciation and amortization, or Ebitda, at the end of March – and is facing headwinds in other areas. Approach carefully.

Fewer workers are coming to the office, and that’s a problem for Boston Properties, America’s largest publicly traded office REIT. It’s not an immediate issue. About 89% of its square footage was leased at the end of March, much of it tied to long-term leases. But the next few years will still be challenging, with 18% of leased space expiring through 2025. Shares are down 55% from last year, so much of the bad news is priced in: Boston Properties trades for 9.5 times AFFO futures, against its five-year average of nearly 22 times. However, there is no clear positive catalyst for rising stocks, and a large debt load doesn’t help either.

write to Nicholas Jasinski at Nicholas.jasinski@barrons.com