I have approximately 50% of my portfolio invested in REITs (VNQ).
Needless to say, I am very bullish on REITs, often described as a “cheerleader for REITs.”
However, I also write articles on REITs that I would sell.
In what follows, I will highlight two REITs that I would consider selling if I owned them today:
Evaluating Easterly Government Properties (DEA)
DEA is a REIT that owns mostly single-tenant office buildings, considered as the single worst property sector.
During my private equity days, we always avoided these assets. Although they offer a nice cap rate and long lease term, the risk of value destruction is significant once the lease is over.
Especially in the post-pandemic world, tenants’ needs have dramatically changed, leading to a significant risk of vacancy for single-tenant office buildings. Add to that the recent surge in interest rates and a tighter lending environment for offices, and you have a perfect recipe for disaster.
As a result, valuations for these assets are crashing down, pushing Office Properties Income Trust (OPI) to almost fully eliminate its dividend, and other similar REITs have all crashed in value and trade at just 3-5x their FFO.
DEA is the exception, still trading at a relatively high 12x FFO.
The reason for this resilience is that it focuses mainly on single-tenant office buildings leased to government agencies. However, this does not shield DEA from the risks. A recent study showed that the physical occupancy rate of office buildings leased to government agencies is even lower than that of corporate tenants, at around 25% in many cases.
Government tenants hold even greater bargaining power than corporate tenants. When they vacate the property, the result would be devastating to the landlord. Often, properties leased to government agencies may have been built specifically for them with unique characteristics. Remodeling and leasing costs in case of a vacancy are significant.
Moreover, properties leased to government agencies tend to trade at lower cap rates, implying greater risks.
REIT Investment Analysis: A Prudent Guide for Savvy Investors
When analyzing REITs as a potential investment, one must be cautious of the risks concealed beneath their glossy facade. Though the allure of real estate investment trusts may be potent, not all that glitters is gold. An evaluation of two REITs — DEA Realty and UMH Properties — provides critical insights into their divergent operational strategies and future prospects.
DEA Realty (DEA)
DEA Realty finds itself in choppy waters as the commercial real estate landscape undergoes unwelcome metamorphosis. The expiration of leases presents a precarious predicament, placing government agencies in control of negotiations. Evidently, the pervasive vacancy of office buildings has tilted the balance of power in favor of tenants, compelling landlords to contemplate substantial capital injections for property redevelopment in a desperate bid to secure tenancy.
Regrettably, DEA’s future is marred by the prospect of significant vacancies and unduly high payout ratios, imperiling its coveted dividends. With OPI’s recent dividend cut and ensuing share price plummet, the specter of a similar fate looms menacingly over DEA. Consequently, prudent investors are rightfully skeptical of hailing DEA as a lucrative investment prospect at its current valuation.
UMH Properties (UMH)
Conversely, UMH Properties fortifies its position on starkly different ground. Endowed with a commendable portfolio predominantly comprising manufactured housing communities, UMH appears to boast a sound operational framework. However, the luster tarnishes upon examining its capital allocation strategy, a glaring chink in its otherwise formidable armor.
UMH falters in comparison to its counterparts, Sun Communities (SUI) and Equity LifeStyle (ELS), as their adventurous investment approach, coupled with excessive leverage, has failed to yield commensurate returns. The root cause of this underperformance is unequivocally attributable to the management’s oversight of the cost of capital in their investment decisions, leading to deleterious dilution of per-share performance.
Especially egregious is UMH’s inclination to issue discounted common and preferred equity for investments, a strategy that has failed to yield the anticipated returns, as reflected in the stunted per-share dividend growth, in stark contrast to SUI’s commendable track record.
Even more concerning are UMH’s forays into REIT share investments, a departure from its core competence that has failed to inspire market confidence, thereby impeding its cost of capital and, consequently, its valuation.
Compounding these missteps is UMH’s confounding decision to issue shares despite its purported undervaluation, a move that defies rationality and deflates confidence in the management’s capital allocation acumen.
The sum of these parts coalesce into a troubling image of UMH’s investment trajectory, prompting discerning investors to reassess their confidence in its stewardship and long-term potential.
Closing Note
In the realm of REIT investments, the forest is rife with wolves in sheep’s clothing. The allure of low valuations may blind discerning investors to the lurking perils of mismanagement, overleveraging, and faltering operations. Exercise prudence, for not all REITs are created equal, and the discerning eye stands to glean immense rewards amidst the mire of potentially treacherous investments.
