Malls And Hotels: Buy When There’s Blood In The Streets

In the middle of a bull market, you can invest in stocks and expect a decent return. When stocks are priced at their fair valuation, you can get returns in the 6%-12% range as their earnings grow.

That kind of return is nothing to sneeze at. But you can do much better. If you buy in the middle of a bear market, you can get returns well in excess of the market’s long-term average. For example, if you bought REITs (through the VNQ fund) right at the bottom in 2009, you’d have tripled your money in just two years.

The lesson is obvious:

Those who buy when there’s blood in the streets are rewarded later.

Particularly those who invest in REITs during times of crisis. Real estate has a long history of weathering economic downturns and coming back stronger than ever. That goes for REITs as well as direct investments in real estate.

Tripling your money in two years is a great investment result. Yet in many ways, REIT returns after the great recession were predictable. In 2009, they showed all the telltale signs of being undervalued:

  • Single-digit cash flow multiples.
  • High dividend yields with a massive spread over Treasuries.
  • Trading at deep discounts to net asset value (NAV*).

Today, this exact same situation has emerged once more. In the immediate aftermath of the COVID-19 market crash, REITs fell 43% from all-time-highs. Since then, they’ve rallied, but are still down significantly for the year. As a result, investors can get many REITs at steep discounts to fair value.

This Crisis Is Not Like the Last One

It’s one thing to say that REITs are cheaper now than last year, but quite another thing to say they’re good buys now. In the Great Financial Crisis, REITs were down for a good reason. They were massively overleveraged and struggled to refinance. As a result, they had to cut dividends and raise equity at highly dilutive prices. You’d expect prices to decline in that kind of environment.

Today it’s very different. While some REITs struggled with rent collections early in the COVID-19 lockdown era, they had already turned it around. And this year, REIT balance sheets are much healthier than they were in the great recession. With plenty of liquidity and access to credit, they’re in much better shape. Not only that, but banks are well capitalized, so financing won’t be an issue.

Where to Look Now?

In November, bargains abound in the REIT space. But you need to know where to look. Not all REITs were impacted equally by the pandemic. Some were beaten down dramatically while others have only dipped slightly.

For example, cell towers, data centers, and other “infrastructure” REITs such as Digital Realty (DLR.PK) and American Tower (AMT) haven’t been impacted much at all. We don’t see many bargains in this space.

Digital Realty Announces Pricing of €225 million of Additional Green Bonds - Global Ethical Banking

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On the other hand, many other sub sectors have been badly beaten down in the markets.

Hotel, mall, shopping center, and net lease REITs have gotten absolutely trashed. This is where the value resides today.

ChartData by YCharts

It’s precisely those REITs whose cash flow was actually impacted by the crisis that you should be looking at.

What you want is a situation where the decline in price is greater than the long-term damage to the actual business. If a REIT suffers some minor collections issues and NOI declines 10% YoY, that’s definitely a setback. But if the price goes down two-thirds on that news, then you may have a market overreaction.

Over the past months, all of these REIT sub-sectors experienced large improvements in fundamentals.

According to KlePierre (OTCPK:KLPEF), Class A mall traffic and sales are already back to 90% of pre-crisis levels.

And according to Nareit, net lease rent collection rates are up from 72% in April to 95% in September. Shopping centers were hit harder with 50% collection rates in April, but have now already recovered to 82%:

All REIT sub-sectors are beginning to recover. Yet they’re still priced as if a major financial disaster is looming. This presents opportunities for astute buyers to accumulate quality REITs at discounted prices. When we fully emerge at the other end of this crisis, people who bought REITs will be rewarded—just like what happened in 2009.

To illustrate, we can look at a few examples.

Example 1: Mall REITs

Mall REITs are a classic example of a sub-sector that got trashed in the great recession. They were overleveraged and forced to raise equity simultaneously. Yet you can look at a REIT like Macerich (MAC), which soared after the crisis.

Chart

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Today, the market is once again pricing MAC for a catastrophe. Down 72% year-to-date, it has taken a severe beating. Yet the actual underlying portfolio is sound. Not excessively leveraged, it has plenty of liquidity to ride out the 2020 crisis. And its tenants have doubled their average sales per square foot over the past decade, so these are not dying assets. The pandemic is a severe, but temporary crisis, and we expect Class A malls to bounce back. Bought at pennies on the dollar, these REITs could richly reward investors.

Example 2: Hotel REITs

Hotel REITs sold off dramatically in the 2008-2009 crisis like they did this year. People don’t tend to take many vacations when they’re out of work. That hit hotels hard in the financial crisis when unemployment was rampant and travel was down.

Yet despite that, it only took five short years for Host Hotels (HST) to 5x investors’ money.

Chart

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Today, hotels are cheap once again. Like in the Great Recession, they’ve lost revenue thanks to people canceling their travel plans. This time, there also have been lockdowns in the mix. But despite the temporary loss of revenue, their assets are still great and people will travel again in the future. Many of these hotel REITs trade at substantial discounts to NAV. Make no mistake: This is the riskiest of all the REIT sub-sectors we’ve discussed. But it’s also the one that stands to gain the most in the recovery.

The bottom line is this:

Fortunes are made in times of crisis.

The more beaten down a sector or industry is, the more bargains are available in it. Yes, some companies that get beaten down deserve it. But many more are simply underpriced. This describes the current state of many sub-sectors within the REIT world.

Today, you have the opportunity to earn an outsized return if you pick the right REITs. The recovery is already underway, but bargains still abound.

Generational Buying Opportunities 

The recent market crash has created exceptional opportunities. Many high-quality REITs are now offered at >8% sustainable dividend yields and have 100-200% upside potential in a recovery.

At High Yield Landlord, we are loading up on these discounted opportunities and share all our Top Ideas with our 2,000 members in real-time.

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Disclosure: I am/we are long KLPEF; MAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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