Recently, someone told me that "your REITs will go bankrupt".
He explains to me that REITs are facing a perfect storm because:
- They are overleveraged.
- They own offices, malls, and hotels.
- Zoom (ZM), Amazon (AMZN), and Airbnb (ABNB) are stealing their lunch.
- We are approaching a recession.
- Interest rates have surged like rarely before.
- The banking crisis is leading to tighter lending requirements, even as a lot of debt is expected to mature in the coming years.
- Even the likes of Blackstone (BX) and Brookfield (BAM) have already defaulted on some individual properties, so how could REITs, which are a lot smaller, survive the crisis?
Scary, right?
And he is not alone to think this way. REITs are down 30%+ since late 2021. Moreover, REIT cash flows have actually grown by ~10% over this time period, which means that valuations have been nearly cut in half:
According to a recent study by Janus Henderson, REIT valuations are today reminiscent of the great financial crisis, trading at large discounts relative to the value of their assets.
So clearly, the sentiment is very negative.
But are REITs really going bankrupt?
No, they are not, and here's my rebuttal.
With this article, I want to correct some important misconceptions once and for all. Here is a short recap of my answer to the claim that REITs will go bankrupt:
REITs are overleveraged. Wrong.
REIT balance sheets are the strongest they have been. Leverage is low at 35% on average, maturities are long at 8 years, and most of this debt has a fixed interest rate.
As such, the impact of rising interest rates is limited and this explains why most REITs have kept growing their cash flow even as their share prices collapsed.
If you have a 35% LTV and just 10% of that debt matures each year, this impacts only 3.5% of your capital stack. Yes, the cost is going up, but it is not significant in most cases.
Meanwhile, rents are surging because of the high inflation and this impacts 100% of your capital stack.
So which has the largest impact? The inflation on rents or the higher interest rates on cost? In most cases, the net impact is positive and this explains why cash flows have kept on rising.
REITs own offices, malls, and hotels, and Zoom, Amazon, and Airbnb are stealing their lunch. Wrong.
There is this common misconception that REITs own mostly offices, malls, and hotels, but that isn't correct.
In reality, only about 10% of the REIT market is invested in these properties.
The other 90% is mostly invested in defensive property sectors that include things like:
- Warehouses: Prologis (PLD)
- Distribution centers: EastGroup Properties (EGP)
- Manufacturing facilities: STAG Industrial (STAG)
- Apartment communities: Essex Property Trust (ESS)
- Single-family homes: Invitation Homes (INVH)
- Manufactured Housing: Sun Communities (SUI)
- Service-oriented strip centers: Regency Centers (REG)
- Net Lease: Realty Income (O)
- Senior housing: Welltower (WELL)
- Skilled Nursing: Omega Healthcare (OHI)
- Hospitals: Medical Properties Trust (MPW)
- Medical Office: Physicians Realty Trust (DOC)
- Self Storage: Public Storage (PSA)
- Timberland: Weyerhaeuser (WY)
- Farmland: Farmland Partners (FPI)
- Billboard: Lamar Advertising (LAMR)
- Data Centers: Digital Realty Trust (DLR)
- Cell towers: American Tower (AMT)
- Infrastructure: Uniti Group (UNIT)
- Ground Lease: Safehold (SAFE)
- Etc.
The majority of these property sectors continue to perform well. I added an example for each property sector so that you can look at their latest results. Yes, share prices are down, but their rents are actually rising.
So yes, office landlords are today struggling, but they are a minority that represents just 5% of the REIT sector and you can easily avoid them.
Finally, I would add that malls and hotels, while a minority, are actually doing very well today. That's because they own Class A properties in very desirable locations that remain in high demand. Simon Property Group (SPG) is the biggest mall REIT in the world, and its sales per square foot have never been greater. Host Hotels (HST) is the biggest hotel REIT in the world, and it has guided to grow its cash flow by about 40% in 2023.
But again, if you fear these sectors, you can easily avoid them.
Offices, malls, and hotels are only a small segment of the REIT market. Most properties are doing just fine.
REITs are facing a refinancing crisis because banks are tightening their lending requirements. Wrong.
The higher lending requirements are supposedly the final nail in the coffin that should push REITs into bankruptcy as they fail to refinance their maturing debt.
But as we just explained to you, REIT balance sheets are today very conservative with little debt and limited maturities, and most REITs own class A properties that enjoy growing cash flow. Moreover, REITs are public companies that enjoy large-scale, diversification, and professional management, and they are highly scrutinized by countless analysts, the SEC, and other regulatory bodies.
What this means is that REITs are ideal borrowers for banks. They are exactly who they want to do business with because they know that the risk of a REIT bankruptcy is extremely low.
Just look at the past.
There have been very few REIT bankruptcies over the past 50+ years. You can literally count them on one hand, and the majority of these bankruptcies were overleveraged mall REITs.
Today, most REITs have strong balance sheets and own desirable properties, and therefore, they don't have any problem refinancing their debt. Again, just look at the latest results of the REITs that we listed above.
They even have enough liquidity to keep buying more properties, pay off some of their debt, and grow their dividend.
Blackstone and Brookfield and some other private equity players recently made headlines because they defaulted on some loans, but this is only because they use far more leverage and own some office buildings, and a lot of this debt is non-recourse. They take more risk to earn higher returns, but when risk factors play out, they then hand back the keys to the lenders.
They are not representative of the REIT sector.
Bottom Line: REITs are not going bankrupt.
Balance sheets are the strongest they have ever been.
Most REITs own desirable properties that enjoy growing rents.
And so the banking crisis is not having any major impact on them.
But because of all these irrational fears, REITs are now heavily discounted as if they were going bankrupt. I think that this is a generational opportunity, and I have structured my portfolio to earn great profits as REITs recover in the coming years:
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.
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