Galeanu Mihai
Bank of America Securities analyst Jeffrey Spector mapped out a strategy for REIT investing in 2023, even though real estate historically underperforms during downturns. And many strategists and economists are expecting a downturn next year as the Federal Reserve continues to ratchet up rates in its inflation-fighting campaign.
“We do see a bull case for quality REITs with BofA Investment Strategy recommending long bonds in 1H23 & long stocks 2H23,” Spector wrote in a recent note to clients. “In our view, high quality REITs offer a good blend given they are stocks with bond-like features.”
BofA economists are expecting a mild recession starting in Q1 and ending in Q3, with unemployment peaking at 5.5% in Q1 2024. Spector points out that REIT fundamentals typically lag the economy by four to six months, so the weaker demand may not show up in the sector until mid-2024.
“As a result, we believe ’23 guidance will be extra conservative with wide ranges, another key risk to watch,” he wrote. BofA’s earnings estimates for REITs in 2023 are below the Street consensus. Further cuts are expected.
With financial conditions tightening, transaction volumes will remain low, he said, “and we may not have price discovery until 2H23.” Still, high quality REITs will see more opportunities as private leveraged owners face a cash crunch. Spector advises that investors focus on quality and income in ’23.
Key quality REIT characteristics are; resilient pricing in the face of a recession; multi-year earnings visibility based on secular growth drivers; strong, flexible balance sheets; visible and above-average distribution growth; and highest prospect for global inflows resulting in relatively steadier asset values and steadier cap rates despite higher rates.
By sector, BofA’s Spector said industrial, manufactured housing, self-storage and senior housing screen the best on key criteria. “We believe these sectors will demonstrate the most resilient pricing power in ’23 based on multi-year secular growth drivers and offer the best earnings visibility and distribution growth,” he wrote.
Here are his stock picks by sector and what he has to say about them:
Single-family rentals: American Homes 4 Rent (NYSE:AMH), which owns the second-largest single-family rental home portfolio, stands to benefit from limited new supply of single-family homes and demographic tailwinds. “As mortgage rates rise, we expect demand for single-family rentals to accelerate as homeownership becomes less attractive on a relative basis.” Self-storage: CubeSmart (NYSE: CUBE), with a high quality portfolio and a large exposure to NYC, screened the best of its peers on 2023 earnings growth and has an attractive valuation with the lowest 2023 PEG and PEGY ratio. “We view NYC’s market as a key catalyst for continued growth given its high density, unique demographics, and strong demand tailwinds.” Office: Corporate Office Properties Trust (NYSE: OFC), with a portfolio of high security office buildings and data centers in the Washington, DC, region and Huntsville, AL, region, mainly serves federal government and defense contractor tenants. “We expect demand and tenant retention for OFC’s buildings and development projects to perform best among office peers with growing geopolitical and economic risks.” Industrial: Prologis (NYSE:PLD), with the largest global industrial portfolio and property fund business, also has the strongest balance sheet in the industrial REITs sector and should benefit from e-commerce demand and the pick-up in US manufacturing. “We expect PLD will continue to generate sector leading SS NOI growth of +8% as it maintains strong pricing power given low availability and its markets screen with stronger rent growth prospects versus peers.” Retail: Regency Centers (NASDAQ:REG), the second-biggest strip mall REIT, focuses primarily on grocery-anchored centers with strong demographics. “We believe REG will continue to benefit from the strong retail environment as retailers continue to upgrade store footprints and expand into the most dominant shopping centers.” In addition, the REIT expects project spending of $150M-$200M per year over the next five years. Manufactured housing: Sun Communities (NYSE:SUI) acquires, operates, develops, and expands manufactured housing and recreational vehicle communities and marinas. “SUI is in a unique position within REITs in 2023 given its guidance for accelerating rate growth. Management is also laser focused on managing expenses across the organization.” Healthcare: Wellcare (NYSE:WELL), which owns and develops senior housing, skilled nursing/post-acute, and medical office buildings, is well positioned for accelerating occupancy gains as senior housing recovers from the pandemic. “WELL has the highest exposure to senior housing operating assets within our coverage universe and based on our demographic analysis has the best positioned portfolio. Longer term, demographic trends are favorable as baby boomers continue to age.”
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