Real estate investment trusts, known as REITs (VNQ), have experienced significant gains recently, prompting investors to seek advice on the best course of action. However, it would be erroneous to assume that the recent surge in REITs signifies an inopportune time for investment, as their overall trajectory still leaves them down by over 25% since the start of 2022. What’s more, various REITs are down up to 50% despite the rally, shedding light on the historically low valuations that persist across the sector.
Distinguishing Investment Potential Amidst Sector Averages
It’s crucial to discern that despite the recent surge, REITs remain attractively priced. In fact, the prevailing consensus around anticipated interest rate cuts indicates that the recent rally may simply be a prelude to further upward movement. Major financial institutions like Morgan Stanley (MS), Goldman Sachs (GS), and Bank of America (BAC) are predicting significant rate cuts by mid-2024, suggesting that REITs are still heavily discounted and could offer substantial upside potential.
Indeed, the prospect of acquiring REITs at their nadir is a rare feat. Considering the persistent undervaluation, current prices are likely to be perceived as significantly cheap in the hindsight of five years. However, the emphasis should not be on indiscriminate acquisition; rather, it is imperative to identify the most promising opportunities emerging from the recent rally.
Discovering Untapped Potential: RioCan Real Estate Investment Trust
Among the standout REITs that have evaded the recent surge is RioCan Real Estate Investment Trust. Notably, RioCan has notably underperformed its industry counterparts, such as Brixmor Property Group, even throughout the duration of the pandemic. This underperformance is glaring considering that RioCan’s properties have experienced substantial appreciation in value while its share price has plummeted by 25% over the past five years.
Furthermore, RioCan is currently trading at a significantly lower valuation compared to its peers, with price-to-adjusted funds from operations (P/AFFO) and price-to-net asset value (P/NAV) ratios signaling a substantial discount relative to similar entities such as Brixmor.
This substantial discount is partly attributed to the market’s lukewarm treatment of Canadian strip center REITs compared to their American counterparts, despite the defensive cash flow and predictable growth prospects that such properties offer. This discrepancy is evident not only in RioCan’s performance but also in the performance of other Canadian peer entities such as SmartCentres REIT (SRU.UN:CA; OTCPK:CWYUF).
It’s essential to acknowledge that while RioCan may exhibit a slightly higher leverage compared to its American peers, its ownership of properties in highly urban centers with robust long-term growth potential compensates for this weakness. These properties, primarily situated in cities like Toronto, benefit from formidable barriers to entry, limited land availability, stringent zoning regulations, and higher replacement costs compared to market values. Consequently, embarking on new development projects in such areas is an unlikely proposition.
Pursuing Prudent Investment: Selective Purchases in the REIT Sector
Considering the aforementioned factors, it is evident that the recent rally has differentiated opportunities within the REIT sector, with certain entities remaining undervalued despite the overall uptrend. This underscores the importance of discerning between better and lesser opportunities. Accordingly, we are strategically accumulating shares in two specific REITs that have not participated in the recent rally, rendering them even more attractively priced relative to their peers.
It’s worth noting our recent divestment of our position in Brixmor Property Group, which yielded a total return of 155.9%. Despite the strong performance of service-oriented strip centers similar to those owned by Brixmor, we concluded that their escalation had reached its peak. These properties, benefiting from defensive cash flow and predictable growth prospects amidst declining rents due to high inflation, are poised for steady cash flow growth. However, our decision was driven by the observation that better prospects lay elsewhere.
Therefore, in the aftermath of the recent rally, guidance and discernment are paramount, as certain REITs continue to present compelling opportunities. It’s imperative to navigate this landscape with prudent and selective investment, leveraging the shortcomings of the recent rally to identify undervalued assets with untapped potential.
