Protecting your money in real estate stocks means understanding the property types
Real estate stocks are crashing with the rest of the market with the index down 30% since January. Why aren’t these assets protecting investors from the panic and how do you find the REITs that will grow your portfolio?
In this video, I’ll show you the outlook for each of 10 property types and then reveal the three best REITs to buy right now.
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Why are Real Estate Stocks Falling?
Nation, you know I’m a big believer in real estate investing not only for those double-digit returns and cash flow but also as a way to smooth out the ups-and-downs of the stock market. No other asset class has made as many millionaires as property and it can be a huge stress reliever when stocks crash.
That’s how it’s SUPPOSED to work. Real estate is supposed to save your ASSets when other investments crumble…so what the hell is happening lately?
The Vanguard Real Estate ETF, ticker VNQ, a fund of almost 300 real estate companies, has plunged 30% so far this year, far worse than even the 23% loss on the S&P 500.
But that broader real estate number is misleading because of the GIANT difference in the returns on different property types. In fact, I’ve found a few REITs that are actually positive on the year.
In this video, I’ll walk you through the data to find the best real estate stocks and which ones you need to avoid like…[I almost said plague there…too soon?]
Real Estate Stocks by Property Type
I put together returns data on real estate investment trusts with a market cap over $50 million. That’s 209 REITs tracked by Morningstar and you really start to see the winners and losers when you look at it this way.
There are just eight REITs with returns in positive territory through March and the first thing I want you to notice here is the trend in property types. So in this first group, you’re seeing data centers with Digital Realty and Equinix. You see government properties in that Easterly and Postal Realty in the next group and you’ve got a few cell tower REITs.
Back to the data though and another nine real estate stocks are showing losses of less than 10% year-to-date…which sucks but it’s still better than the 20% plus loss on the market.
Our next group here, 16 REITs are posting losses of between 10% to 20% this year and here we’re seeing some farmland REITs and storage stocks.
Now bear with me because it’s about to get ugly. I want to take one more look at that chart and then I’ll go through an outlook for each of these property types as well as revealing those three REITs to buy and the ones to avoid.
Another 27 REITs suffered losses from 20% to 30% in that January through March period and the trend in these seemed to be healthcare, residential and industrial stocks. While you would think healthcare would be doing well, the senior care facilities have been hit hard and hospitals are trying to figure out how to deal with surge capacity.
Last here, and this shouldn’t surprise anyone, those real estate stocks in hotel, office and retail have been slammed with losses from 30% to 50% and worse!
REITs Outlook 2020 by Property Type
Before I reveal my three favorite REITs to buy, I want to walk through an outlook on the 10 real estate property types. Please, PLEASE watch through these because I get a lot of questions about these in the Facebook group, especially on those mortgage REITs that are posting dividend yields of 10% and higher…but could be the about to crash.
First we have three property types that I think could do fairly well over the next year; digital-focused, storage and industrial.
Those REITs holding data center property, fiber optic and connectivity assets and the cell towers…these companies could actually benefit from the stay-at-home environment. Even after we get back to business as usual, we’re looking at an explosion in data from 5G and the Internet of Things appliances so any property that helps that flow of data whether its from your phone or computers or other devices, all going to be big winners.
Now understand, I’ll be showing you examples of REITs in each of these property types but that doesn’t mean rush out to throw all your money at these. I’ll share my three top picks in a moment but make sure you check these out for things like growth in funds from operations, that FFO measure, price to FFO and the coverage ratio.
Industrial REITs, especially those that own warehouse space and logistics assets could do really well. Another trend of the stay-home economy is that online shopping and all those deliveries have to be stored somewhere before they get shipped out. That means demand for warehouse space could boom.
Storage REITs should also do relatively well. We’re a consumer nation and people buy way too much shit that they then need to store away. Now this one is probably a little shakier than those other two types, especially if unemployment gets so bad that people stop paying for their storage units. So far though, we’re seeing pretty good performance from the storage REITs.
Next we have three property types that are more of a question mark, so probably require a lot more research to make sure the companies are positioned. These include healthcare, residential and farmland REITs.
Healthcare REITs are the biggest question mark here and could either do really well or crash into bankruptcy. Obviously the senior care facilities are hurting and could see a demand crisis depending on how bad the epidemic gets.
You would think that hospital and other healthcare facilities would do well considering the case load but understand that a lot of those treatments might not get reimbursed or fully-paid. We don’t know what kind of lawsuits will come of this, hospitals not being able to meet the surge demand or other problems.
Now there’s probably a distinction to be made here between the real estate stocks that I recommend during this crisis and the ones that could be your best returns after. We could see a wave of healthcare spending to upgrade infrastructure and capacity so once we come down from the peak of this emergency, the hospital and other healthcare REITs could be some of your best bets.
There’s also an opportunity in these hardest hit real estate stocks we’ll look at including those senior care facilities. I’m not saying jump in now because I don’t think the worst is over. There will be a lot of hotel, retail and office REITs that will not make it.
Just like the banks though after the 2009 financial crisis, picking up the pieces after the disaster could be some great returns but I think you can wait it out as much as a year to make sure the REITs in these property types will survive.
Residential REITs are another question mark here because it should be relatively counter-cyclical. That means the demand for these properties doesn’t follow the economy down as much as say office or retail space.
The problem here is those mortgage and rent deferral programs passed locally and federally. This might be a great program to help people in need, the bucks gotta stop somewhere and it’s going to be investors that eat it.
Larger apartment REITs will probably be better able to manage it. I’m not as sure about the REITs owning single-family property and the losses are going to be astronomical in the student housing REITs.
As an Iowa boy, Farmland REITs are something I’ve been interested in for a while but you might want to hold off. Obviously we still need food so the demand is still there for the land but farmers were already hit on the trade war with crop prices hitting multi-year lows…now with the virus, it’s not going to help farmland defaults. A lot of the larger farms are reporting difficulty getting people to help with the crops, so the migrant labor they used to count on just isn’t there anymore.
Now the real estate stocks that will be hardest hit during the crisis. Again, there might be an opportunity to pick up the pieces but we will see massive losses on these and many may in the hotel, office and retail space may never rebound.
Understand that it’s not just the virus that’s hitting office and retail property. We’ve seen that trend to tele-commute and work-from-home as well as the growth of ecommerce developing for years.
The problem for many of these REITs is that, not only does shelter-in-place threaten that rents go to zero for a period but that it also accelerates those trends going forward.
We’ll see more companies keep a portion of their workers on a contract, work-from-home basis once they see how much cheaper it is. We’ll see more people shopping online after their forced to do it and realize how easy it is.
And that’s going to be a problem for even the quality office and retail REITs. Even marginally lower demand for this space is going to bring down rents across the board so even that Class A office property.
So maybe the best of the bad here is hotel REITs because they should see demand rebound to normal after people start traveling again. For now though, conferences are being canceled and people are calling off the summer vacations so it’s going to stay ugly for a while.
There’s a caveat with office space and that’s REITs operating government property which is generally more stable anyway. That $2 trillion stimulus is going to mean more government workers to manage it so these REITs could be relatively safe.
Now we have to talk about one of the most popular REITs out there, Realty Income, ticker O. More than 85% of the property in its portfolio is retail-focused so right in that danger zone. Now most of Realty Incomes property is in that non-cyclical type like pharmacy, convenience stores and dollar stores so it might not get hit as bad as the REITs owning the shopping malls. Again though, just a generally weak consumer spending environment will hit this company so be careful here.
Our last property type before those three best REITs, and this one isn’t an equity REIT. I’m talking mortgage REITs here and these could be the next big crash in the market.
Investors in these are going to be the ones eating all those rent deferral programs and the prohibition on evictions. Not only that but new issue of mortgages, so the investment supply for these companies could be a huge problem. I’ve talked to mortgage broker friends that are pointing to problems with the non-qualified portion of the mortgage market, those loans that don’t qualify for federal guarantee programs and that defaults in these could surge.
So that’s the outlook on the property types and I think a few of these could really come through, not only in that ability to protect your portfolio from more stock market pain but returns here could be very strong.
Best Real Estate Stocks to Buy and REITs to Avoid
Now I want to reveal those three best real estate stocks, three REITs I’m buying and ones that deserve another look.
First here is Digital Realty, ticker DLR, and you could probably look at Equinix, ticker EQIX, in the same theme.
Digital Realty owns 260 data centers in 40 major cities all around the world so you’ve got that data theme plus some international diversification. Shares are up 12% so far this year and not exactly a steal at a price of 20-times funds from operations. The stock does pay a 3.3% dividend yield though and should be a consistent grower for your portfolio.
The standout in an otherwise tough office market is Easterly Government Properties, ticker DEA, with a 4% dividend yield.
The company owns 68 properties across the U.S. and leases to government agencies, so you’ve got more stable demand here compared to traditional office space. Shares are up 5.7% in 2020 and also trading for 20-times FFO.
Next is a play on the 5G theme with American Tower, ticker AMT, owner of 180,000 cell towers on nearly every continent.
Next is a play on the 5G theme with SBA Communications, ticker SBAC, owner of over 30,000 cell towers across North and South America.
Even though AMT is down 4.8% this year, I think I like it a little better than rival SBA Communications which is up 10% year-to-date. The dividend yield of 1.8% is higher on AMT and it trades for 25-times FFO versus a much higher 35-times valuation on shares of SBAC.
AMT has a much broader base of towers across the North and South America, Asia, Europe and the middle east versus just 30,000 towers at SBAC and mostly in the U.S. and Brazil. Still though, both might do well on that 5G rollout and the trend to Internet of Things.
Now for the three REITs to avoid, I’m going to go back to those broader property types and not recommend against a specific stock so I keep my ass out of court. And we’re talking here about hotel, retail and mortgage REITs.
For the hotel group, how long is it before people are really comfortable with traveling and what happens if there’s another outbreak in the fall? The flu comes back each year and there’s no evidence that coronavirus isn’t just as seasonal.
For retail-focused REITs, especially the ones owning shopping malls and large department store space; we’ve already seen a multi-year disaster in these. Companies like Sears and Toys R Us fell into bankruptcy and even the ‘strong’ names like Macy’s were on the edge…and that’s when consumer spending was strong. What happens when retail sales fall off a cliff?
Retailers are completely shut down and some like Cheesecake Factory have already publicly said they’re not going to be paying rent. The trend to online shopping is only going to accelerate in all this and there will be a wave of retail vacancy over the next year.
As for those mortgage REITs, Nation PLEASE do not chase those yields. I know double-digit dividend yields look like they’re going to make you rich but these companies are going to be the ones left holding the bag when people stop paying rent.
Now again, you’ve got a choice to make looking at these real estate stocks. You can go with these three REITs that will be relatively safer and still provide solid returns or you can try to catch a falling knife in the hardest hit property types. Those hotel and retail REITs are trading at big discounts and some will survive to rebound from this crisis. Don’t feel like you need to rush into these though and can instead wait for the dust to settle on bankruptcies.