As investors, we often hear about the benefits of contrarianism – going against the crowd and embracing a different viewpoint. However, it can be challenging to stay true to this strategy when the market is driven by fear or greed. Instead of taking advantage of buying opportunities during market downturns, many of us fall victim to the fear of missing out on something.
But what if we told you that one of the most consensus views in the market right now is “higher for longer” interest rates? And what if we also mentioned that this could present a unique contrarian opportunity for investors?
The current market sentiment has caused bonds, dividend-paying stocks, and Real Estate Investment Trusts (REITs) to sell off heavily in recent months. The rise in bond yields has led income-seeking investors to turn to lower-risk bonds, putting pressure on dividend stocks like REITs to increase their dividend yields in order to remain competitive.
However, we believe there is potential for a different outcome. Contrary to the market’s expectations, we see a high likelihood of an impending recession, which historically has resulted in a decrease in both inflation and interest rates. With this in mind, we have identified two REITs that could benefit from a potential drop in interest rates: Alexandria Real Estate Equities (ARE) and Crown Castle (CCI).
Alexandria Real Estate Equities (ARE)
ARE owns state-of-the-art, Class A life science R&D properties located in the most productive and highly sought-after innovation clusters in the United States. Unlike traditional office buildings, these facilities are not as susceptible to remote work. The critical nature of the research and the intellectual property housed within these buildings make them indispensable to their tenants.
Furthermore, ARE’s high-quality, energy-efficient building designs and unbeatable locations act as a “moat” against increasing competition. While the market is concerned about the influx of new supply in the life science real estate sector, we believe the majority of it will not match the same level of quality in construction or location as ARE’s properties.
Additionally, ARE is well-positioned for falling interest rates due to three key factors: a significant valuation discount, a fortress balance sheet, and potential increased venture capital funding for biotech startups. ARE currently trades at a price to Adjusted Funds From Operations (AFFO) multiple of under 11x, compared to a 5-year average multiple of 25.5x. With a strong credit rating, low debt, and fixed interest rates, ARE will likely be minimally impacted by rising rates. As interest rates decline, we anticipate a resurgence of venture capital funding in the biotech space, benefiting ARE’s tenant base.
Crown Castle (CCI)
Crown Castle boasts one of the largest portfolios of telecommunications infrastructure in the US, including cell towers, small cell nodes, and fiber optic cable networks. The ability to colocate multiple tenants onto the same infrastructure is a significant advantage for CCI’s business model.
Although CCI has faced challenges recently, such as lease cancellations with Sprint as a result of the T-Mobile merger and concerns about rising interest rates, we believe the company is well-positioned for potential interest rate drops. By reducing its exposure to floating rate debt, CCI has mitigated the risks associated with rising rates. Furthermore, the company’s debt maturity schedule is manageable, with no significant maturities until the second half of 2023.
In terms of valuation, CCI currently trades at around a 12x AFFO multiple, compared to a 5-year average of 23x. If interest rates were to decline, even reaching a conservative 18x multiple would imply a 50% upside from the current price. With a dividend yield of 7% and expectations for a return to mid-to-high single-digit growth, CCI offers an attractive opportunity for investors.
Both ARE and CCI are high-quality REITs with strong balance sheets, investment-grade credit ratings, and attractive real estate assets. While some investors may be hesitant to invest in these sectors due to the current market sentiment, we see the opportunity for significant returns.
Investors can take advantage of the current market by buying shares of ARE, which offers over a 5% dividend yield and the potential for long-term growth. Similarly, CCI provides a 7% dividend yield and the prospect of substantial upside if interest rates decrease.
While we acknowledge the potential risks associated with these investments, we believe that staying true to a contrarian mindset and embracing the concept of being a “landlord” in the long run will pay off. By proactively seeking out opportunities in sectors that have been negatively impacted by rising interest rates, investors can position themselves for potential soaring returns.