If I Could Only Buy 3 REITs, It Would Be These

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Written by Sam Kovacs.

I cover about 120 stocks. It is the upper limit which I believe I can follow with the help of an assistant.

Of these 120 stocks, 17 are real estate investment trusts, or REITs, which means that the sector is slightly over-represented in my universe.

This isn't surprising. As an income investor, REITs are vehicles which are structured to deliver dividends, and as such every REIT is a potential investment for me.

While REITs have had a bad month, declining 6.72% in the past 30 days, they are still flat-ish year to date at -1%.

The future performance of REITs over the next few months will depend on whether or not we get one more rate cut.

The performance in the past month can be attributed to the fact that the market has gone from expecting no more rate cuts, to at least one more rate cut this year.

Payrolls, CPI, and ultimately fed decisions will continue to be the key numbers which influence the overall direction for REITs.

One thing is sure, is that higher rates have made it tough for some REITs to operate.

Medical Property Trust (MPW) just cut its dividend by 50%. Earlier this year, Piedmont Office Realty Trust (PDM) cut its dividend by 41%.

As spreads between rent and rates has narrowed, some REITs have found themselves unable to cover their dividends.

This is a scenario which we want to avoid at all costs.

But it's not as bad as it seems across the board.

Over half of the equity REITs surpassed their Q2 FFO expectations.

From the 115 REITs examined by S&P Global Market Intelligence, 71 outperformed their FFO projections, while 19 matched the consensus estimates.

After having looked in detail at as many REITs as one possibly can, if I could only buy 3 REITs at current prices, it would be these.

Realty Income Corporation (O) has been an income investor favorite for decades; and with good reason.

The triple net lease REIT has developed a reputation for conservative growth, by operating a business model which relies on only the highest quality assets.

Investor Presentation

O operates a diversified portfolio of mission critical properties, with high quality tenants across the board.

This hasn't made O immune to the decline in REITs in the past year.

The price is on the way down, and at $56 is now at the lowest it has been since Q2 of 2020.

Looking at the chart, there seems to be strong resistance around the current level, as the $56 price has served both as resistance and support multiple times during the past 10 years.

O DFT Chart (Dividend Freedom Tribe)

If the stock continues to sink lower, however, further support likely wouldn't happen before $51.

But O's income is steady. The dividend is 75% of the funds from operations, or FFO, which is a very manageable level and one investors should be satisfied with.

The REIT has one of the best balance sheets amongst all REITs, 92% of its debt is fixed, with no significant maturities before 2026, which mitigates the impact of rates being higher for longer.

Investor Presentation

O's superior financial position and conservative management has historically provided it with consistent investment spreads even as rates increase. Furthermore, recessionary environments have typically led to attractive acquisition opportunities for O as it leverages its position to buy out struggling operators.

Investor Presentation

If there was just one REIT you'd own, it would be O.

Especially at the current price.

Topping up the position at the current $56 mark makes total sense. Topping up again at $51 if the stock continues to decline would be the next target.

Long O.

Rexford Industrial Realty, Inc. (REXR) is a smaller industrial REIT which we identified as an investment opportunity earlier this year.

The slide from the Q2 investor presentation gives a good overview of what makes it special.

After Prologis (PLD), it is the largest pure-play industrial REIT.

It is also the only SoCal pure-play industrial REIT.

Investor Presentation

Why does this matter?

It matters because while industrial REITs have seen strong demand and will likely continue to see strong demand in upcoming years, not all geographies will see this translate into higher rents.

In states like Texas and Arizona, and to a certain extent Florida, where supply isn't constrained, significant new projects will come online, which will lead to pricing pressure amongst operators in these geographies.

This isn't the case in SoCal. One exception would be Inland Empire, but REXR is mostly immune to this as well, as it focuses on units with an average of 29,000SF, and most of the new units are above 100,000SF. This is why we see slight negative net absorption for SoCal, but positive absorption for REXR.

Investor Presentation

This strategic moat that REXR has dug out for itself in the strongest port market of the country (and no exodus from California will change this significantly in the future) has led to 75% cash leasing spreads. That means that when they sign new leases, they've increased rent by 75%.

REXR will reap the benefits of its strong position in upcoming years.

In the latest earnings presentation, the company highlighted that NOI would grow 31% in the next two years without any further increases in market rent, or any new acquisitions. This is a 15% yearly growth rate.

Investor Presentation

Growth will likely be higher, as REXR will likely make new acquisitions. They recently announced the acquisition of a new $210mn facility.

Currently, REXR trades at $52 and yields 2.9%.

REXR DFT Chart (Dividend Freedom Tribe)

Given the growth profile and unique approach to industrial real estate, I believe that REXR should yield somewhere in the vicinity of its 10-year median yield, around 2%.

This implies a $75 price target, nearly 50% above the current price and below the ATH, which suggests strongly that as REITs recover, REXR could soar back to these levels.

I'm long REXR and love the stock.

The shares of Alexandria Real Estate Equities, Inc. (ARE) now trade at $117, giving the stock a 4.2% yield.

ARE DFT Chart (Dividend Freedom Tribe)

ARE is the only pure play life sciences REIT. They own and manage life science and technology campuses in regions they deem to have the right mix of location, funding, expertise, and infrastructure to foster a thriving life science sector.

ARE Website

These, unsurprisingly are located in coastal university towns.

What is so special about life science properties?

Unlike traditional office space, they are actually NEEDED to perform the research.

Shorts have said that lower footwork suggests less need for their locations, but this is shortsighted, and the data does not suggest this.

ARE maintains very high occupancy ratios in its portfolios, and its new developments are already highly leased. Of its existing pipeline that will be delivered through Q4 2024 and Q2 2026, 94% and 70% are already leased respectively.

Alexandria Investor Presentation

As the American population continues to age, and as health continues to deteriorate (as suggested by obesity trends), the need for more and more medications will continue to grow.

Demand for these properties is driven by R&D spend at pharma companies.

The total R&D pipeline in the U.S. has increased nearly every year since 2001.

It is clear that the trend is up.

Pharmaprojects

ARE has ridden this wave brilliantly, and this has resulted in total returns which have not only beaten the S&P 500 (SP500) but also the NASDAQ (COMP.IND) since its IPO in 1997.

Alexandria Investor Presentation

This increased demand for their spaces, as attested by their 16% cash renewal rates last quarter, has driven increases in FFO of 7.4% per year on average for the past 10 years.

Alexandria Investor Presentation

Now even if ARE were to slow its growth to 5%, and that this growth would lead to 1-1 increases in dividends (not a bold assumption for a REIT), then it would still be a phenomenal income investment.

If you were to invest $10K in ARE today, reinvest the dividends at a constant yield, while the dividend increased at 5% per annum, then 10 years from now you'd expect $1,097 in annual income, or an 11% yield on your original investment.

Dividend Freedom Tribe

ARE's tenants are stable through all economic conditions.

During the Great Financial Crisis, they only saw a 70 basis points decline in occupancy.

Alexandria investor presentation

New life sciences properties coming onto the market might challenge this slightly, but I'm really not too concerned. The increase in available life sciences properties will unlikely exceed growing demand for research from pharma research.

ARE is priced as if it were a speculative office REIT. It is not. Below $125, it's a total bargain.

REITs are one of the best-priced asset classes currently. It's hard to pick the bottom, but what is sure is that they are much closer to the bottom than ever. Buying close enough to the bottom is what matters, as does selling close enough to the top.

Nobody gets the exact bottom or top every time.

But if you're going to build up your portfolio's REIT positions, might as well do it with some of the best assets out there.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of ARE, REXR, O either through stock ownership, options, or other derivatives. 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.