6 Stellar REITs At Big Discounts To NAV

Many equity REITs have seen a dramatic shift in price-to-NAV ratios over the last year or two. It’s no surprise that equity REITs are down. You can’t read anything about them without hearing that prices are lower.

However, the magnitude of the shift to high-quality REITs may be surprising:

Looking at Sun Communities (SUI), Alexandria (ARE), Mid-America Apartment (MAA), Rexford (REXR), Realty Income (O), and W. P. Carey (WPC), we can see that all of them trade at substantial discounts on price-to-NAV.

Why is that relevant? Because, in theory, the NAV calculations (consensus analyst estimates) should reflect the real estate’s market value. In practice, it won’t be perfect. But it should give a general idea. Yet we’re seeing several RETIs that typically traded around NAV or above NAV trading below NAV. In some cases, dramatically under NAV.

I think each of these REITs represents a nice value today.

It’s worth noting that price-to-NAV has historically been pretty volatile for some REITs. Realty Income has deviated significantly from NAV in prior periods. Most of the time, the deviation was the price-to-NAV being significantly above 1.00, but the fact remains that the price isn’t anchored to NAV.

Two Worlds

In theory, REITs should usually trade pretty close to the fair market value of assets. That was we would see the real estate market and the public equity market assigning similar values. Some weaker REITs will frequently trade at discounts because of issues with the REIT. For instance, a terrible management contract would merit the REIT trading at a significant discount to the value of the underlying assets.

However, when the REIT has a good management team at a fair cost, it should be much easier for a REIT to gain a premium to NAV. Today, there are very few REITs achieving a premium of any kind.

Which Came First?

Equity REITs trade above NAV have an opportunity to issue equity. That should increase NAV since the new shares are bringing in more cash than the real estate was worth.

If they trade below NAV, in theory, they should be selling off assets and repurchasing shares. Of course, REITs that perpetually trade at a discount to NAV don’t want to constantly shrink the REIT because it wouldn’t be able to support overhead costs. However, we’re not talking about any of those junkers so far.

Therefore, the REIT should generally be able to gradually arbitrage the difference in share price and NAV. That doesn’t mean they will, but it means they should be able to do it. Of course, it doesn’t work if the NAV calculations are garbage. However, let’s pretend for this article that the Wall Street guys are doing a great job.

You want to see REITs driving NAV higher over time, even though it will dip occasionally. MAA was very successful in increasing NAV per share over the last decade:

We can even see that shares often traded at a modest premium to NAV. In late 2020 through early 2022, the share price really took off. As it dipped, we also saw NAV decline. The drop in NAV has been vastly smaller than the drop in the share price though.

I’m not convinced NAV has stabilized just yet, but shares are at an unusually large discount to NAV. Even if NAV declined, share prices could improve from a better price-to-NAV ratio.

The big risk here is the amount of new apartment construction. In 2024, new supply should be a big headwind to leasing. Regardless, management has done a great job running this REIT, and they do trade at an unusually cheap price-to-NAV.

For a little comic relief, I added the average target stock price to the chart:

Those target prices were, on average, constantly getting updated to reflect the current market price. Not a perfect reflection, but pretty close. During the sharp decline, they’ve been slower to trend down. However, the general trend is still pretty clear.

When you look at Realty Income, you’ll see a different picture. The consensus NAV per share estimates are absurdly stable:

I think that the consensus NAV figure is a bit stable. The cap rate on acquisitions for O has moved over the last few years. That swing in cap rates suggests that there’s probably a swing in the value of the portfolio as well. However, Wall Street doesn’t model it that way.

Plunging Net Asset Value

Now, I want to provide one more chart.

This is the price-to-NAV for Hudson Pacific Properties (HPP). While price-to-NAV for equity REITs is a useful metric, this is a lesson in why investors shouldn’t focus on it too much:

Since the middle of 2015, HPP has never posted a premium to NAV per share. The consensus NAV estimates topped out right around the start of the recession. They declined moderately, but only moderately. Today, share prices are much lower than they were during the pandemic.

Here’s a little zoom-in on part of the chart to highlight the absurdity of the disconnect:

In June 2022, shares were listed at a greater than 50% discount. However, share prices continued to fall. After a moderate recovery in the last few months, shares are trading at $6.47 today. That’s less than half the price from our arbitrary date of June 22, 2022.

More Charts

I said one more chart, but I feel like including more.

Can you guess what the chart says for Medical Properties Trust (MPW)? If you predicted that NAV plunged well after the share price, you’d be precisely right:

That’s brutal. MPW frequently achieved a premium to consensus NAV figures, but not anymore. That’s pretty rough. I’d say I warned investors, but you probably already know that.

How about another?

Do you know when consensus NAV estimates are least useful?

When you’re dealing with a very small REIT or a sector where real estate values are plunging.

This is a very small REIT. It’s awful. I warned investors about it repeatedly. Got into some great arguments. You’ll notice the NAV lines move sharply. That’s because there were so few analyst estimates. At one point, there were 3 consensus estimates. But by the end, there was only 1. I’m kidding, obviously, there was eventually 0. But for a while, there was 1.

I present to you the “magnificent” (not really) Wheeler Real Estate Investment Trust (WHLR):

Reverse splits are fun because they enable a historical price in the hundreds of dollars for something that was likely junk from the start.

WHLR was a shopping center landlord. The issue wasn’t shopping centers. The value of shopping centers that are chosen well and properly maintained didn’t plunge. Just take a look at Brixmor Property Group (BRX):

This is a much better shopping center REIT. Did their NAV plunge? For a bit during the pandemic. Remember when tenants were upset about having to pay rent when the local laws wouldn’t let them open? Leases still required payment and people still wanted to be able to buy some stuff in person. The sector eventually recovered.

Conclusion

The first 6 REITs are REITs where I expect long-term growth in FFO and AFFO per share. They may have some rough years, but they should still generate solid growth. I also expect growth in dividends per share. However, some shares currently have much lower payout ratios. Focusing only on the dividend yield would be too simplistic, though I understand that’s very popular with many Seeking Alpha readers.

Among this group, I am most interested in SUI, ARE, REXR, and MAA.

We don’t cover HPP. We decided not to cover office REITs (except for occasionally calling out bad ones) years ago because we expected them to have weaker return prospects. There are legitimate arguments for the sector now based on valuation. However, I don’t try to catch every falling knife. I’ll just dodge office REITs.

Extra Credit

Good article, but it needs more data to demonstrate the trend.

I pulled the price-to-consensus NAV ratios for more equity REITs that often carry premiums.

• Prologis (PLD).
• Terreno (TRNO).
• National Retail Properties (NNN).
• Agree Realty (ADC).
• Equity LifeStyle (ELS).

Notice how those ratios fell:

Every one of those shares saw the ratio decline by at least .14x from the 5-year average. I don’t think the 5-year average is too wild. It includes the high prices from late 2022, but it also includes the deep discounts from the pandemic.

Does that mean everything is a bargain? No. But prices generally aren’t too bad. I’ve been arguing that net lease REIT growth rates would suffer in 2024 due to higher rates of debt. It seems the market is considering that risk factor now.

However, I really want to take a moment to reflect on one of my favorite articles. In October 2019, I wrote a boring article about 2 dividend stocks.

If you think my articles are snarky now, you should see the meme game there.

The article focused on trashing City Office REIT (CIO) and Franklin Street Properties (FSP).

Since I prepared the piece, there have been:

• 1 other bearish piece on CIO.
• 0 other bearish pieces on FSP.

Why didn’t anyone take the time to trash these REITs?

My thesis was based on high leverage and high payout ratios.

Let’s see how that’s playing out:

What’s the lesson? If you’re playing stocks around a discount to NAV, you should know the long-term histories for price-to-NAV and the trends in NAV. Even for a focus on dividends, it is critical to understand the accounting or have someone on your team who understands it.

How to Hedge

Some investors want to go market-neutral by shorting other stocks in the same sector. I’ve considered that sometimes. I don’t want to bother sharing the Vanguard Real Estate ETF (VNQ) because several of the top holdings are in my portfolio also. That’s a bit too much overlap to be efficient.

A better choice would be the Invesco KBW Premium Yield Equity REIT ETF (KBWY). However, I wasn’t the only one to think of that:

Using Iborrowdesk.com, I can see that typical costs for shorting KBWY range in the 6% to 10% range. Consequently, investors would need to hunt through the top holdings instead. I think the emphasis on picking sucker yields is a poor strategy, but that’s a huge fee for shorting.

New Conclusion

There are some great REITs at big discounts to NAV. Interest rates create a significant head to growth in FFO and AFFO per share. Investors hunting for value in the sector would still be wise to focus on higher quality REITs that can withstand the higher rates.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.