As a REIT dedicated investor, I am arguably incented to be a permanent bull, but if I’m being honest, I think REITs are slightly overvalued right now. The REIT index has risen excessively on the flight to yield trade and many of the issues are priced for perfection.
As a result of this, our portfolio does not resemble the REIT index. We are still 100% REITs but we do not participate in the sky high trades that make up the bulk of the major ETFs. I’m not going to buy a manufactured housing REIT trading at 32X 2019 FFO or a coastal industrial REIT trading at a 4% cap rate. At those prices, any cut to growth outlook or increase in interest rates will send them tumbling. These are good companies but the valuation makes them incredibly risky. They could reasonably fall 20% even if nothing goes wrong fundamentally.
Instead, what we do is find the pockets within REITs where valuations are enticing. It is a bit of a conundrum but even in this environment of high valuations, some REITs are trading at outrageously cheap multiples. There has been a sort of winner-take-all mentality in which the biggest and priciest REITs have gotten all of the investor dollars. The valuation rift has widened and the ignored REITs have actually gotten cheaper.
These overlooked REITs fall in a wide scope with little in common with one another, allowing us to build a diversified portfolio within the deep value space. Some of these don’t even match a profile of something that would be downtrodden with long term market dominant companies like MPW, SLG and IRM trading at huge discounts to peers. Others are cheap on idiosyncratic risks like UNIT, or social media risks like CXW.
Another source of cheapness is the misappropriation of sector headwinds to specific companies. Mall weakness at a national level has been applied to all mall REITs evenly despite some of them clearly overcoming the headwinds.
So while REITs at an index level are looking pricey and low yield, 2CHYP remains deep value. We will continue to collect the oversized cashflows and dividends that come with this valuation.