Last October, I wrote a letter the subject explaining why I stopped buying rental properties to buy real estate investment trusts (REITs) instead. I argued that REITs they were not cheap, giving an opportunity investors to buy wealth at a discount to its fair value.
Since then, REITs have risen 36% on average, as has private real estate mostly static or the value decreases slightly:
I would also add that this it’s just an average of the REIT sector, represented by the Vanguard Real Estate ETF (VNQ), which combines the good with the good. it’s bad.
If you were choosing and investing in on the right REITs, you would have done it a lot better. For example, ours the greatest of all REIT investment during this the time it was Essential Properties Realty Trust (EPRT), and it’s up 57% in just 11 months:
But are REITs still a compelling investment opportunity, or has the window to invest in them already closed?
I believe it the first is true.
Even after the recent rally, a lot of REITs still trade in big discounts relating to the fair value of their physical property.
Take the example of BSR REIT (HOM.U:CA), which I discussed in last year’s article. It is an apartment REIT specializing in the fast-growing Texan market. It is built at a huge discount rate of 42%. back in October 2023 and has recovered somewhat since then, however still it is trading at a 24% discount today.
In other words, you can still buy an equity interest in BSR real estate for 76 cents on the dollar, a better deal than you can get on the private market. It trades at ~6% implied cap ratebut its properties are suitable for close to ~5% cap rate in the private market.
But I think trading days REITs on big discounts now they are counted. The only reason for a REIT they have no value as they are today is because the market is overreacting to rising interest rates.
REITs are generally less leveraged, and their fundamentals are not it had a big impact. Actually, REIT cash flows and dividends continue to rise in 2022, 2023, and so far in 2024, despite rising interest rates.
However, it still causes their share prices to fall because a lot of Income investors sold their REITs, regardless of their fundamentals, to reinvest in bonds and Treasuries instead. These investors never indeed they were interested in owning REITs, but they had invested in them to get a yield on a yieldless land. But as soon as bonds and Treasuries offer good yields, they sell off, causing REITs to crash.
This is very clear when you look at the strong inverse correlation between REIT share prices and interest rates in this bear market:
But now we will see the opposite happen as interest rates return to low levels, which is why REITs have started to recover.
The credit market predicts that interest rates will drop by about 250 basis points within a year from now:
This expectation has already pushed some investors to reinvest in REITs, and as rates slowly return to lower levels, I expect many investors to rethink their fixed income allocations and return to the REIT sector.
REITs are still relatively cheap, trading at discounts to their net asset values, and it’s rare to find good REITs that still offer a 5% to 7% dividend yield.
REITs weren’t that great when you could get 5% yield on money market funds and short-term Treasuries, but as that changes to 2.5% to 3%, REITs will be a hot commodity again.
How High Do They Offer?
Historically, REITs have generally trade a small amount of their goods, and this it makes sense, given all the benefits they offer in terms of private bathrooms.
You’re essentially getting the best of both land, stocks and real estate, in one package, and that’s worth the premium:
| Private real estate | REITs are public |
|---|---|
| Illiquid | Liquid |
| It’s fixed | Various |
| Expensive, labor-intensive management | Cost effective management |
| Unlimited credit | Limited liability |
| Limited access to money | High access to finance |
| Discount rate | Premium Rating |
However there are still many of those REITs trade at a 25% to 50% discount compared to the fair value of their properties, net of debt. This is something in the end why I keep buying more REITs instead of rentals.
I I don’t know invest in equality of rental properties at a discount of 25% to 50%. This means that just going back to their fair value can unlock 50% to 100% upside in some cases, and now we have a clear catalyst for this accomplished.
For this reason, I just Don’t miss the point of buying private real estate today. You pay a lot to buy a private, concentrated, private asset that works hard and takes a lot of credit risk for lower returns at the end.
Research clearly shows that buying REITs at a discount is a strategy to achieve the highest returns:
Follow the Leaders
But don’t just take it from me. Leading private real estate investment firm, Blackstone (BX), which manages $1 trillion in assets, today prefers to buy REITs instead of private real estate.
Earlier this year, it bought Tricon Residential (TCN) and paid a 30% premium. because. Then a few months later, it acquired Apartment Income REIT (AIRC) and paid a 25% premium. because. Now, it there are rumors is trying to buy a third REIT, Retail Opportunity Investments (ROIC), and this move has already sent its share price up 25%.
Blackstone spends tens of billions of dollars acquiring REITs because they are the cheapest real estate that can buy today—of course cheap ones that Blackstone is willing to pay ~30% premiums to their recent share prices and still think about that gets a good deal.
I follow the same path but on a smaller scale. As REITs recover, I will probably get back into buying private real estate eventually, but right now, I can’t make sense of it because REITs are so attractive.
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