Right now, REIT valuations are still near decade-long lows, but I think the window of opportunity is closing.
Indeed, interest rates are expected to return to lower levels in 2024 and should be a powerful catalyst for the entire REIT sector (VNQ).
After all, the only reason REIT stock prices collapsed in 2022 and 2023 was because interest rates were rising, so if interest rates start falling now, it should have the opposite effect.
It has already started…
But this is still just the beginning for many REITs.
Many of them are still down 30%, 40%, even 50% and continue to trade at exceptionally low valuations. Here are three good examples that we are accumulating at the moment:
Healthcare real estate (HOUR)
On paper, Health Real estate seems like a great opportunity.
It’s the leader in the medical office segment of the market, it’s guided for 5% FFO per share growth in the coming years, it has a BBB-rated balance sheet, and yet it’s still priced at a 45% discount. % compared to its recent peak.
However, medical office buildings are much more durable than traditional office buildings.
Certainly, telemedicine has made many advances, but in most cases, doctors remain in their medical offices, even for remote consultations. Plus, it’s simply not possible to do everything digitally. A regular company employee may be entirely remote and never come into the office, but that’s simply not possible for a doctor who must evaluate patients in person to perform various tests.
This is especially true for HR properties, as they are located in medical hubs of rapidly growing sunbelt markets:
Medical clusters benefit from high barriers to entry, limiting competition from new supply, and the strong demographic growth of these markets, combined with the aging population, should serve as powerful catalysts to stimulate demand in the long term .
For these reasons, HR is moving towards strong growth in the years to come by increasing its occupancy rate and its rents.
But the market isn’t listening to their conference calls, it seems, and the focus remains on the headwinds affecting the office sector.
I believe that as HR proves the market wrong and interest rates return to lower levels, the market will eventually revalue HR at a significantly higher level, because a company of this quality will not should not be valued at just 10.5 times FFO and a dividend yield of 7.3%. .
The upside potential could reach 50%.
We wrote extensively about Vonovia when it was trading between €15 and €20 per share and made numerous purchases of stocks in this range.
Today, the stock price has already recovered to 28 euros per share, almost doubling its lows, and yet it remains heavily discounted.
In case you don’t know Vonovia, it is the largest landlord in Europe, owning over 500,000 apartments, mainly in Germany, but also in Austria and Sweden.
Today its net asset value is €50 per share and historically the shares trade most of the time at a premium of around 10% to their net asset value. This means that under normal circumstances VNA should be trading at around €55, but you can still buy it today at just half that price.
But for how much longer?
The only reason Vonovia became so cheap is because the market became concerned about Vonovia’s ability to manage its debt maturities following rising interest rates.
But these fears are gradually disappearing because:
- (1) Vonovia has made great progress in selling assets close to their net asset value and repaying short-term maturities. As a result, Vonovia is now in a good position to meet its limited debt maturities.
- (2) Interest rates are expected to fall in 2024 and further in 2025.
- (3) The transaction market is recovering in Germany and the value of real estate is even expected to increase in 2024 as interest rates return to lower levels.
We have always argued that the market is overreacting because Vonovia has a strong BBB+ rated balance sheet, well-staged debt maturities, and growing rents.
The market is now slowly coming to this same conclusion and the discount to NAV has started to narrow, but its historical valuation still has nearly 100% upside potential.
Will he get there in a year?
Probably not, but as interest rates return to lower levels and Vonovia’s net asset value begins to appreciate again, I expect many investors to flock to Vonovia again.
Today, it still offers a cash flow yield of 9%, of which it pays 3% in dividends, and reinvests the rest into deleveraging the balance sheet.
Whitestone REIT (W.S.R.)
WSR specializes in service-oriented belt centers and most of them are located in rapidly growing sunbelt markets like Phoenix, Austin, Dallas and Houston.
What’s interesting about these commercial properties is that they benefit from the rapid population growth occurring in these markets, but unlike other real estate sectors, there have been relatively few new listings. commercial spaces on the market in recent years.
This puts WSR’s properties in a strong position to increase rents, especially since its current rents are significantly below market levels. Its vacancy gap has consistently been over 15% in recent quarters, and that’s on top of the 3% annual rent increases it provides in its leases.
Overall, WSR’s rental growth has been one of the strongest in its sector and this trend is expected to continue:
For these reasons, I have previously argued that WSR has some of the best assets in its peer group, but despite this, its price today is one of the lowest.
|Whitestone REIT (W.S.R.)
|Regency centers (REG)
|Federal Real Estate Investment Trust (FRT)
But maybe not for very long.
The two main reasons why WSR has been discounted relative to its peers are only temporary.
First, WSR defended a lawsuit brought by its former CEO, who had sued WSR after he was fired for cause. This cost WSR a lot of money in legal fees, but just recently it announced that it had won the case in court.
Second, WSR’s leverage has been a bit higher than industry averages, and while the company has been rapidly deleveraging its balance sheet, this has been obscured by all the recent legal fees.
If you remove the legal fees and WSR continues to grow the same way, its balance sheet will be comparable to its peers in a few years, and the market will no longer have a good reason to price it so low.
Simply returning to the current NAV could unlock around 30-40% upside potential, and while you wait you get a 9% cash flow yield, around half of which is paid out in dividends, the remainder being retained for deleveraging and growth.
The REIT market has now begun its recovery, but it still has a long way to go.
Many REITs remain heavily discounted and offer significant upside potential in 2024.
Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. exchange. Please be aware of the risks associated with these actions.