It is interesting to watch our chat room at High Yield Landlord across the market cycles. Many of our investors are experienced and have no problem riding the cycles and exploiting the opportunities they present. We try to help.
But there are always some who respond with remarkable intensity to whatever has been happening over the past 6 to 12 months. During down periods, like the past year or the first half of 2020, disappointment and even despair abounds.
Some investors focus on the losses in their REIT portfolio during such periods. Once in a while one will announce that they are getting out of REITs. Bad timing that, selling low.
Then there are the upcycles, as in the first halves of 2019 and of 2021. Then we have investors telling us that we are geniuses and otherwise expressing ecstatic happiness. Those are good moments to reread Kipling’s “If”.
During such periods there are times to sell certain positions. It seems likely to me that there is too much buying and not enough selling from those very happy investors. Bad timing that, too.
And our momentary success attracts new members who proceed to buy at high prices or to buy high risk. Some of them get really annoyed when their investments fail to increase monotonically to infinity and beyond. Thankfully, most of our members realize that bad markets make for successful investments, although sometimes at the cost of riding out lower lows.
After a year when most of the blue-chip REITs followed the S&P 500 like buttons on a string, some have recently begun to fall like stones, diverging strongly from the broad markets and even other REITs. Opportunity follows. Let’s look for it.
A First Example
Here is a comparison of price action that I find telling. The plot starts in January 2022.
Many REITs fell to varying degrees as the broad markets (here represented by the S&P 500) did in the first half of 2022. After that, they pretty much followed the waves of the broad markets for the rest of the year. It was rather boring.
Some, like Essential Properties Realty Trust (EPRT), even have made up any losses so that they are neither up nor down, relatively speaking. I bought EPRT last summer, when STORE Capital was purchased, for reasons discussed here.
But that position was more about the growth story than either upside or income, although the dividend is not bad. The more recent evolution of my portfolio left EPRT a bit out of sync.
Then look what happened. Alexandria Real Estate (ARE) went and dropped another 20%, putting its total drop from its early 2022 high above 40%.
Alexandria is in many ways superior to Essential Properties. Their credit rating is BBB+. Essential Properties is not rated investment grade at all and has real work to do to get there.
Certainly one can worry about interest rates, discount rates, and challenges for biotech in the context of ARE. But 40% is way overdoing it.
So I sold my EPRT and put the funds into ARE. Not that I expect a return to all-time highs unless interest rates go all the way back to zero, but a double digit CAGR over a year or three seems very likely to me.
This experience stimulated my curiosity. So I entertained myself on a rainy Sunday by organizing the data about the investment-grade REITs in various ways. Let me share those perspectives with you.
The Territory
The approach was to rely primarily on the March 2023 edition of REITwatch, from NAREIT. Included in their tables is a “Long-Term Issuer Credit Rating.” My understanding is that this is from S&P Global only.
In any event, some REITs that are investment grade by some measures are not so designated in the NAREIT tables. Not being up to fixing all this manually, I just left them out.
Just in case you want to pursue their stories, here follows a (likely partial and possibly with errors) list.
With those caveats, we will start with the full list from NAREIT and then focus on some selected sublists. Here is the full list:
This table is colored by credit rating. Brief comments follow.
The rows shaded green show the REITs having A or A- ratings. Note that they span 7 economic sectors. If one was happy with quite secure dividends that would grow over time, and not too concerned about just how high the yield was, just buying this list would be a good way to go.
The rows shaded blue show the BBB+ REITs. These vary a fair bit in terms of yield, historical growth, and likely forward growth. But none of them are likely to end up in bankruptcy.
The rows shaded gold show the BBB rated group. Here is the first appearance of Office REITs other than Boston Properties (BXP) [and note that Alexandria is listed here as a Life Science REIT].
These are good companies overall, but the further you go down the table or beyond it, the more due diligence is needed. Among this group are Spirit Realty Capital (SRC), which I hold, and also the ever-popular W.P. Carey (WPC). I like W.P. Carey but suspect that they may be the REIT with the largest ratio of enthusiasm to dividend growth rate.
One can view the BBB- REITs, shown on rows shaded orange, as either being blue-chip, investment-grade REITs or being on the edge of junk ratings. There certainly are expectations much broader than REITs that the BBB- tier is where many businesses will prove to have been swimming naked when the next recession hits.
Among the group, I own only EPR Properties (EPR). And I would not do that without the level of deep examination discussed in this article.
The Bear Market Drop
A useful initial sorting is to look at the decline in price of these REITs across the current bear market. I evaluated the decline using my own data on the 2022 highs and the current price as of 4/14/23.
There are an impressive number of investment-grade REITs that have an upside of 50% or more to their 2022 highs. Here they are:
It is no surprise that the Office REIT sector dominates this list. The market seems convinced at the moment that things will be very bad for those. Perhaps it will, but there will be another side.
That said, Boston Properties is the only one of those I would own. But they do have a lot of debt due in near-term years and I am not sanguine about avoiding dividend cuts. At the moment I have a limit order on BXP at $45 (at a 9% yield).
The three rows shaded gold show REIT stocks that seem highly opportunistic to me, including BXP. I own ARE and Simon Property Trust (SPG), about which I recently wrote this article.
Save for Healthpeak Properties (PEAK), which I won’t discuss, the other REITs rated BBB+ or higher are apartment REITs, mostly in rows shaded orange. My general issue with them is that they may have been overvalued in 2021 compared to where they will end up. I discussed some of the reasons in my recent article on AvalonBay (AVB).
Here, though, I want to compare Camden Property Group (CPT), highlighted in yellow, and Essex Property Trust (ESS), highlighted in green. Here are their valuations, as Price to Funds From Operations, or P/FFO, for the past 5 years.
The valuation of CPT, a stellar REIT, was impacted by the massive enthusiasm for the sunbelt in 2021. That’s why I sold it then, as discussed here.
As a result, the 40% drop in price by CPT is not so impressive. To my eyes, and despite the challenges of being on the West Coast, the 43% drop of ESS is a good bit more significant. I don’t own ESS but might end up doing so soon.
This next table shows the investment-grade REITs with 33% to 50% upside to their 2022 highs.
Here the REITs rated in the A’s or as BBB+ are in rows shaded green. To save some length, I won’t say much. There were 10 such REITs in the previous table, there are 7 here.
And this is the table of investment-grade REITs with less than 33% upside to those highs:
Here the three high-rated REITs are in rows shaded green. One might choose to own some of the REITs in this table for income or stability. But a lot of pricing upside would seem unlikely.
We can note the very large dispersion amongst the price drops. Here in this third table the median value is about 20%. In the first table above it is about 50%. That is a huge difference in upside potential.
Recent Price Drops
It may be helpful to layer the information above with specific data about recent performance. To that end, I used the prices from 2/28/23 and 4/14/23 to see the size of the drop in the past 6 weeks. Here are the Investment Grade REITs that dropped by 10% or more:
It is clearly open season on Office REITs, with 9 of these 22 REITs being in that Sector. And there is little doubt that Diversified REIT American Assets Trust (AAT) and also Alexandria are being punished for the same reasons.
This seems the likely origin of how incredibly opportunistic ARE and BXP, in rows shaded gold, have become. The other highly rated REITs that have dropped 10% or more are in rows shaded green.
You would get no objection from me if the recent drops put you over the edge on investing in any of these. This assumes you have an investment case on grounds other than the drop itself, or the dividend yield, discussed next.
Current Dividend Yields
Naturally, investors buying during bear markets are often focused on maximizing Yield On Cost. Retirees like me may be focused on maximizing secure income. This leads us to want to see dividend yield.
The NAREIT tabulation has yields, but only as of 3/28/23. Our Market Intelligence Sheet at High Yield Landlord has real-time dividend yields. So I grabbed those from 4/14/23. Let’s start with a table of the highest current yields:
Leading the charge are four Office REITs with BBB- ratings, followed by two with BBB ratings. I shaded these yields red on purpose. They are above 10%, which is the empirical threshold where Boards often decide to cut.
The debt picture is also not pretty on some of those REITs. I wouldn’t touch them but have friends willing to take the risk.
My sweet spot seems to be the yields from 7% to 9%, shaded gold. As mentioned above, I own three of these, EPR, SRC, and SPG. And BXP shows up here again too.
The yields shaded green run from 5% to 6%. Here is where we find four of the highly rated REITs, including a couple we have not mentioned previously. The rows shaded green are the highly rated ones.
My hope is that the return to Earth of the yields for REITs shaded gold will let me diversify into some of these without loss of income. We will see if that happens.
Some of my favorite REIT stocks, including ARE and ESS show up with current yields between 4% and 5%. Likely some of you do too. Here is the table:
Takeaways
I found it fun to see where various REITs came out when looked at in these ways. Since I spend a lot of time focused on REITs, surprises were few for me.
For you, I hope these data and perspectives help you focus your own due diligence and investments. Just please don’t run off and buy Office Properties (OPI) for the sake of the yield.
One aspect really surprises and puzzles me. Amongst the investment-grade REITs, the more highly rated ones fell further on average.
There were 10 REITs rated BBB+ and above that fell more than 33% since their 2022 highs, and only 10 others that fell less than that. In contrast, 23 out of 35 lower-rated REITs (about 2/3) fell less than 33%. I’d love to hear your theories about this in the comments.
I would also be interested in what surprised you.
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