The 10 Most Undervalued Real Estate Investment Trusts

Real estate stocks have had their ups and downs over the past year, but there may be opportunities in this space for undervalued, high-dividend companies.

Real estate investment trusts, better known as REITs, had their best year ever in 2021. A bullish combination of a booming economy and bottoming out interest rates was rocket fuel for the group. Not only has the U.S. economic recovery benefited real estate, but yield-hungry investors have also flocked to the hefty dividends his REIT stocks offer.

The Morningstar US REIT Index surged 41.1% last year, and the Morningstar US Real Estate Sector Index similarly surged 38.3%. (SPG)Scored 95.7%, Prologis (PLD), which rose by 72.3%. Those returns made real estate the second-best performing sector in the U.S. stock market in 2021, after energy, and even outpaced technology stocks’ 33.9% rise. Vanguard, which manages the fund strategy, manages the Vanguard Real Estate ETF. (VNQ) It was the best year in its 18-year history with a return of 40.5%.

But with interest rates skyrocketing and recession fears spreading, returns have turned from feast to famine in 2022. The Morningstar US REIT Index has fallen 23.4% to its worst level this year.Simon Property Group fell 35% from its November all-time high, while mall REIT Maserich (Mac) is down 52% from its high. VNQ, on the other hand, is down nearly 14% in 2022, its biggest loss to date since the ETF’s inception.

The good news for investors looking to put their cash to work is that thanks to a sharp drop in stock prices, many of these high-yield stocks are now trading at steep discounts compared to what Morningstar’s equity analysts would peg their fair value to. It is being traded. Simon Properties, which offers a yield of 6.6%, is undervalued by 33% and Ventas (VTR)A REIT focused on senior housing and healthcare properties yields 3.9%, undervalued by 29%, according to Morningstar analysts.

Top 10 most undervalued REIT stocks

Maseric
Simon Property Group
Ventus
Healthpeak property
kimko realty
well tower
Equity Residential
Essex Property Trust
Avalon Bay Community
invitation home

Jeffrey Korich, who manages the $1.5 billion Baron Real Estate Fund (BREFX) For nearly 13 years, the rising interest rate environment could be a “mixed bag” for real estate stocks, but “looking forward to the next few years, the REIT case is compelling,” he said.

“Many REITs are rated attractively,” says Kolitch.

What are REIT stocks?

A real estate investment trust is a company that owns a portfolio of office buildings, shopping centers, hotels and apartments. Real estate generates income from rents and capital appreciation. REITs must pay out at least 90% of their earnings to investors in the form of dividends, making them attractive investments for income-oriented investors. The Morningstar US REIT Index has a trailing 12-month dividend yield of 3.0%, which is double his yield on the broader stock market.

Index-level dividend yield for the most recent 12-month period ending 31 July.

REITs offer high dividend yields, but typically cannot carve an “economic moat” that provides a sustained competitive advantage over other REITs in this space. As a result, 82% of all his REIT stocks covered by Morningstar analysts have a “no moat” rating.

“Most of the time, you buy a building or land across the street and build a replica of an existing building to compete directly with a successful business,” says Kevin Brown, senior equity analyst at Morningstar. “But these companies can add value through good management, drive operational efficiencies that far exceed industry standards, and through external growth, know when to acquire new assets and sell old assets. And we know what to develop when the time is right.”

Brown said he credits many REITs with exemplary stewardship. This is a designation for companies with good corporate stewardship practices related to balance sheets, investments, and shareholder distributions.

How are REITs performing compared to the broader market?

Over the past 12 months, the Morningstar US REIT Index has fallen 4.4%, better than the overall market’s 7.6% decline over the same period.

Morningstar US REIT vs. Morningstar US Market Index from January 2021 onwards.

But this year’s returns hide the extent of the ups and downs of REIT fortunes over the past two years. In 2020, REIT stocks were hit hard by pandemic lockdowns. In particular, his REIT stocks, which hold real estate focused on retail, residential or medical facilities, were hit. He ended the year with US market indices up 20.9% in 2020 and REITs down 4.7%, even as the broader US stock market recovered from the pandemic-triggered bear market. I was. That dynamic changed in his 2021, with REITs far outperforming the broader market until underperforming again in early 2022 when interest rates began to rise.

How will rising interest rates and inflation affect REITs?

Now, high inflation and rising interest rates are complicating the REIT landscape, says Baron’s Kolitch. “Some REITs offer inflation-protective qualities because they can reset rents frequently,” he says. For example, hotels can set room rates daily, thus instantly offsetting rising inflation costs. Storage Center REIT leases typically renew monthly.

“But when it comes to interest rates, the answer is not straightforward,” says Korich.

Rising interest rates will affect REITs in two main ways, according to Morningstar’s Brown. One is higher funding costs, and the other, he said, is that dividend yields become less attractive than bond options.

“When interest rates rise, U.S. Treasury yields will rise, making risk-free options more attractive than REITs,” he says. “Investors will shift from REITs to government bonds.” Additionally, REITs add value by acquiring new real estate assets or building properties, he said. “REITs need to issue new bonds to fund expansion and acquisitions. Financing growth becomes more expensive as interest rates rise.”

Brown points out that some types of REITs can have a greater macroeconomic impact than others. “The negative impact is magnified because malls are more sensitive to the overall economy.”

But despite the current situation and investor concerns about the economy, “a short-term recession doesn’t change my 10-year outlook for the company at all,” says Brown.

Morningstar media and telecoms equity analyst Matthew Dolgin says REITs that own data centers and cell towers are less susceptible to economic shifts.

“Cell Towers have rent escalators in their contracts to account for inflation,” he says. “In many cases, it not only offsets rising costs, but benefits the business.” And in some data centers, costs pass directly to tenants.

Which REIT stocks are currently undervalued?

“Like most markets, REITs are now substantially away from their latest highs, with some bigger than others,” says Dolgin.

A screenshot of the Morningstar US REIT Index shows real estate investment trust stocks currently trading at the biggest discounts compared to analyst-appraised fair value estimates. All of these undervalued stocks are his REITs focused on retail, residential, or medical facilities.

Maseric

Mac
Industry: Retail REIT
2022 annual performance: -35.8%

“The repositioning of many of Maserich’s malls following the Sears closures in 2019 has produced positive results, supporting our estimate that Maserich could achieve a yield of 7.75% on future redevelopment projects. increase.”