The Market Crashes: Here’s What I’m Buying – Part 2

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In a recent article, I explain why I invest primarily in REITs (VNQ) following the recent market sell-off.

In short, I think REITs offer the best risk-reward ratio in today’s environment for 8 reasons:

  • (1) They are at least somewhat recession-proof: REITs have benefited on average from almost twice the downside protection during past recessions;
  • (2) They provide superior inflation protection: Rents are rising rapidly, and so is the value of their assets – while inflating their debt;
  • (3) They provide a hedge against rising interest rates: REITs today have the lowest debt in their history and very long debt maturities. Therefore, the negative impact of rate hikes will be much smaller than the positive impact of inflation. This is why REITs tend to outperform in times of rising rates;
  • (4) They are isolated from geopolitical risk: Today, there are growing tensions between East and West. Russia’s invasion of Ukraine and China’s zero-tolerance approach to covid-19 is causing many companies to exit certain markets and rethink their supply chains. This leads to costs and lost profits. REITs are not directly impacted by these geopolitical risks;
  • (5) They have attractive growth prospects: Most real estate sectors have been underbuilt over the past decade, and even more so in the recent past due to all the supply chain issues caused by the pandemic. And as a result, rents are rising rapidly and REITs have the opportunity to build new properties at high rates of return;
  • (6) We earn dividends while waiting: There are many high quality REITs that yield up to 6-7% in today’s market. By earning a high income, we are less dependent on market appreciation in case we face a lost decade, as some predict. We only need 3-4% annual growth to achieve double-digit annual returns;
  • (7) Valuations are heavily discounted: Today, REIT stock prices are barely back to where they were before the pandemic two years ago, but we all know real estate has seen significant appreciation since then. As a result, REITs are now trading at significant discounts to the underlying value of their properties;
  • (8) The end of the pandemic is a clear catalyst: The main reason why REITs are discounted is the pandemic. This has hurt their market sentiment due to the false perception that REITs own a lot of office properties when in reality only around 5% of REITs specialize in offices. As we slowly move away from the pandemic, more and more investors will return to REITs to diversify their portfolios and seek inflation and recession protection.

Here’s how REITs have historically performed in times of high inflation:

REITs outperform in times of high inflation

REITs outperform in times of high inflation (NAREIT)

And yet, most of them are heavily discounted today…

But before you rush out to buy any REIT, remember that not all are created equal. There are over 200, and while we’re bullish on the sector as a whole, we really only invest in 1 in 10 on average at High Yield Landlord.

Some real estate sectors are called into question. Some management teams are in conflict. And some balance sheets are better prepared than others for rising rates. Selectivity is essential in this sector:

High Yield Owner Selection Process

High Yield Owner Selection Process (High Yield Owner)

We shared a few opportunities in Part 1 of this article (OUT; STOR; HT.PE), but by reader request, we’re sharing a few more today.

The market is collapsing, here’s what I’m buying:

Today, apartment REITs are very popular. They provide inflation protection, recession resistance, and rents are rising rapidly because we haven’t built enough apartments over the past decade and more and more people don’t have the ways to buy a home, especially in the wake of the recent spike in interest rates. Most of the big apartment REITs like Mid-America Apartment Communities, Inc. (MAA) and Independence Realty Trust (IRT) are attractive, but our top pick is BSR REIT, a small cap that primarily owns communities in Texas cities. rapidly growing like Austin and Dallas.

Over the past year, the value of her portfolio has increased by 66%, as she has been able to push for significant rent increases. This year we expect the same as the company still hasn’t renewed all of its leases and is in a position to push for further rent increases. In the first quarter, new leases were signed at rents up 17.4%, ie double the rate of inflation!

Despite this, the company is now priced at a 25% discount to the underlying value of its assets. By the end of the year, the discount will probably reach 30-40% if the company’s share price does not appreciate.

It is rare to be able to buy such sought-after assets at a steep discount. Typically, the REIT market prices these companies at a significant premium.

Looking forward to the upside, we are getting a monthly dividend yield of 3% which is well hedged with a payout ratio of 63% and which should continue to grow over the next few quarters.

Apartment community owned by BSR REIT

Apartment community owned by BSR REIT (BSR REIT)

Our biggest German real estate investment is at the lowest price since late 2020, despite strong growth in 2021 and strong forecasts for 2022.

We believe the stock was undervalued at €16, and it recently fell back to €12.50. At the same time, the euro has also lost value against the US dollar, making it even cheaper for US investors.

This drop is of course caused by Russia’s invasion of Ukraine, which is causing great uncertainty in Europe. A recession could be imminent, energy prices are rising and inflation is only accelerating. It is undeniable that Russia’s invasion of Ukraine creates new risks that we have not taken into account.

However, the best opportunities emerge in times of crisis, and this is a good example. This could lead to disappointing results over the next 12 months, but it will not impact the long term trajectory of the business and therefore we believe the market is overreacting.

Something the market seems to ignore is that German real estate is seen as Europe’s “safe haven” asset class. Therefore, this crisis could potentially benefit DIC in the years to come, as more and more investors turn to German real estate investments and use DIC’s asset management services.

We believe its fair value is almost double the current share price and you also earn a 6% dividend yield as you look forward to post-war growth and recovery.

Real estate investment held by DIC Asset

Real estate investment held by DIC Asset (DIC active)

NewLake Capital Partners, Inc. (OTCQX: NLCP):

The entire cannabis industry is now in disgrace. Large operators like Trulieve (OTCQX:TCNNF) have seen their share price drop by up to 75%. Interestingly, cannabis REITs fell with them, despite record results.

It is important to understand that, unlike cannabis cultivators and distributors, REITs earn regular rent checks under long-term leases with annual rent increases that are agreed on day 1. They essentially provide the infrastructure to the industry cannabis and gain a “toll road”. as fixed costs in advance.

It’s a much more resilient company and therefore one would expect it to have escaped the sell-off, especially as its results are stronger than ever.

But that would assume that the market is perfectly rational, which of course it is not. The largest cannabis REIT, Innovative Industrial Properties (IIPR), has fallen 60% in less than a year. Some of its close peers are even further down.

Our favorite cannabis REIT is NewLake Capital Partners.

It is similar to IIPR, but it has many advantages that should lead to even better returns over time:

  1. It focuses on limited license states, reducing risk;
  2. It is much smaller, which results in faster growth as it acquires new properties;
  3. It still hasn’t invested all the proceeds from its IPO, providing a predictable path to growth;
  4. It is just starting to use debt and has a clean balance sheet;
  5. It is even cheaper than the IIPR, with a price of just 11.5x FFO and a dividend yield of 6.5%.

REITs with such strong fundamentals and growth prospects typically trade at significantly higher valuations and lower yields. The main reason the NLCP is so cheap is that cannabis is currently out of favor, but the market narrative will change again, and now is a good time to buy stocks at a cheap valuation. We expect a 50% uplift and while you wait, you receive a generous income.

Cannabis facilities owned by NewLake Capital Partners

Cannabis facilities owned by NewLake Capital Partners (NewLake Capital Partners)

These are just 3 of the many REITs we are accumulating right now.