How to invest in real estate: REITs to consider and avoid

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Real estate mutual funds have had a rough few years, but opportunities abound – if you know where to look.

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

There are many storm clouds. The

MSCI US REIT index
has lost 23% after dividends since the Federal Reserve began raising interest rates in March 2022, versus a 7% decline for the

S&P 500 index.

According to Evercore ISI’s Steve Sakwa, REITs generally trade at about 85% of their net asset value, versus a long-term average of 99%. Relative to expected earnings, REITs appear less cheap: The group is going for a multiple of 18.4 times estimated adjusted funds out of operations for the year ahead – a key metric for the group – compared to their long-term average of 17.4 times. The sector has a dividend yield of 4.5%, while the 10-year US Treasury yields 3.8%. That’s not as good as it sounds: the current premium of 0.66 percentage points is half of the historic premium of 1.33 points.

REITs are not a monolithic asset class. Beneath the surface, there are real industry differences – a microcosm of broader market and economic shifts. For office REITs, the post-pandemic work environment means that many companies need less space, reducing demand, although long-term leases dating from before 2020 are delaying the full impact. Mall REITs have long been under pressure from e-commerce, while warehouse REITs have benefited. Enthusiasm about artificial intelligence has boosted data center REITs in recent weeks. That has created opportunities – and risks – for investors.

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

Large wireless companies such as

Verizon communications

(VZ) and

AT&T

(T) couldn’t function without the communications towers owned and operated by cell tower REITs like American Tower, which essentially act as antenna rental companies. Profit margins are ample, recurring income is high and the future is clear, given long-term contracts with often annual rent increases. The industry is in the midst of an upgrade to 5G networks, which offer faster service but whose signals don’t travel that far. More antennas are needed, and that will ensure that lease growth for American remains stable despite the potential economic weakness. Meanwhile, the stock is trading near its lowest P/AFFO in a decade.

Alexandria Real Estate Equities owns and operates laboratories and other life sciences research and development facilities throughout the country. Unfortunately, now is not a good time to own those things. Biotech companies have been under pressure since the bankruptcy of Silicon Valley Bank, and if venture capital funding slows, it could squeeze demand for lab space. Shares of Alexandria are down 33% since February and risk appears to be discounted in the shares, which have not been this cheap since the financial crisis. For investors looking for a less risky way to bet on biotech, Alexandria could be the right choice.

Americans’ collective habit of shopping online requires billions of square feet of warehouse space to store, process and transfer all that stuff. Not even concerns about a slowing economy have slowed down shopping, and that meant 17% year-on-year rental growth and an almost historic low vacancy rate of 3.6%. Rexford Industrial Realty, focused on Southern California, is smaller than Warehouse Titan

Prologis

(PLD), but growing faster. The stock has been hit this year by concerns about the development of new backyard warehouses. But demand should more than keep pace, supporting rents.

Vici Properties owns a portfolio of casino and race track properties in Las Vegas and beyond, including Caesars Palace and 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 per share growth of 10% this year and 5% next year, attractive rates compared to the broader REIT space’s 3% to 4% annual earnings growth. “Vici owns some of the most productive assets in the country, with higher visible growth and a multiple of more than 15 times its cash flow,” writes

J.P. Morgan
‘s

Anthony Paulo.

The frenzy of artificial intelligence has entered the REIT world. Digital Realty Trust, a data center REIT, is a good example of this. The stock had lost half its value since early 2022, but then

Nvidia

(NVDA) reported results that made AI a must-have for any investor. Shares of Digital Realty rose 20% in the week following that May 24 announcement. AI will mean more business to the REIT, but it’s hard to know when this 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 experiencing headwinds in other areas. Approach with caution.

Fewer employees are coming to the office, and that’s a problem for Boston Properties, the largest publicly traded US office REIT. It’s not an immediate problem. At the end of March, about 89% of the square meters had been let, a large part of which was tied up in long-term leases. But the next few years will still be challenging, with 18% of leased space due to expire in 2025. Inventory is down 55% over the past year, so much of the bad news is already priced in: Boston Properties is trading for 9, 5 times forward AFFO, versus the five-year average of nearly 22 times. However, there is no clear positive catalyst to boost equities, nor is a heavy debt burden helping.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com