Uncovering Hidden Opportunities in REITs
When it comes to Real Estate Investment Trusts (REITs), many investors view them as a monolithic entity, reacting uniformly to economic news. However, this oversimplification masks the diverse range of property types within REITs, each with its unique strengths and weaknesses.
The Mispricing Opportunity
With many investors viewing REITs through a broad lens, substantial mispricing occurs between property types. Fundamental strengths and weaknesses are not properly priced in, leaving some sectors significantly undervalued and others overvalued. This article will focus on the premium sectors, highlighting both broad overvaluation and anomalous pricing within each sector.
Industrial REITs: A Tale of Two Stories
Industrial REITs, trading at 20X AFFO, are the cheapest of the premium sectors. While fundamentals have weakened due to high new supply and reduced demand, mark-to-market leasing spreads remain enormous. However, rapid AFFO growth now has a shorter 5-year runway, making the sector correctly priced at a slight premium. Within the sector, STAG Industrial, Inc. (STAG) and Plymouth Industrial REIT, Inc. (PLYM) offer opportunistic value due to their lower exposure to new supply.
Storage REITs: Speculative Growth
Self-storage REITs, trading at essentially the same multiple as industrial, imply significant growth. However, the assumed growth is more speculative, with existing leases at price points above street asking rates. As the sector is dramatically oversupplied, extreme discounting is needed to attract customers, reducing the REITs’ ability to lock in higher rental rates. This makes the sector overvalued, with minimal valuation or fundamental variance within.
Manufactured Housing REITs: A Long-Term Outperformer
Manufactured housing REITs consistently top the list for same-store NOI growth, driven by two underlying strengths: limited new supply and strong demand. Even at a 21.6X multiple, the growth is strong enough to outperform. Within the sector, UMH Properties, Inc. (UMH) offers cheaper access to the same growth fundamentals, while Flagship Communities Real Estate Investment Trust (OTCPK:MHCUF) is absurdly cheap at 12.7X 2025 estimated AFFO.
Single Family Rental REITs: A Niche Play
Single family rental REITs occupy a niche between apartments and homes, providing tenants with the homeowner lifestyle. While they have benefited from two factors – low interest rates and home price appreciation – the future may not extrapolate the past. Home appreciation was pulled forward by interest rate changes, and there is likely to be a catch-up period of lower appreciation. As such, we are on the sidelines, waiting for a cheaper entry point or reacceleration of fundamentals.
Data Centers: Riding the AI Hype Train
Data centers have seen egregious valuations due to astronomical demand growth. However, most data centers are unprotected from new supply, making it difficult to funnel demand growth to existing centers. Digital Realty Trust, Inc. (DLR) has had mixed success in raising rents, while Equinix, Inc. (EQIX) has an advantage in colocation centers. Overall, data centers are significantly overvalued.
Timber and Farmland REITs: Misunderstood Value
Timber and farmland REITs are often perceived as expensive due to their high AFFO multiples. However, land is a different asset class, with returns driven by appreciation and special purposes like higher-better-use. By adding appreciation to AFFO, these REITs are actually among the most discounted sectors, trading at around 80% of asset value.
Conclusion
REIT sector AFFO multiples are not well correlated with fundamental growth, presenting both traps and opportunities for high growth at a cheap price. It’s essential to dig deeper, understanding the unique strengths and weaknesses of each property type to uncover hidden value.
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