The Best REITs to Buy


Real estate investment trusts have had a rough year, sliding amid worries about the impact of higher interest rates and tight credit. The Morningstar US Real Estate Index is up 11% this year through mid-December versus a 25% return for the broad-based Morningstar US Market Index.

Dividend stock investors like the high yields that REITs offer. And given their recent struggles, REITs look attractive from a valuation perspective today: The real estate stocks that Morningstar covers, as a group, are about 8% undervalued relative to our fair value estimates.

Real Estate: High Interest Rates Lead to Negative Performance Despite Solid Growth7 Best REITs to Buy Now

The REITs below all earn 5-star Morningstar Ratings, which means they are significantly undervalued according to our fair value estimates as of Dec. 14, 2023.

Realty Income OEquity Residential EQRVentas VTRApartment Income AIRCHealthpeak Properties PEAKPebblebrook Hotel PEBUniti Group UNIT

Here’s a little more about each of the best REITs to buy, including commentary from the Morningstar analysts who cover them. All data is as of Dec. 14, 2023.

Realty IncomeMorningstar Price/Fair Value: 0.76Morningstar Uncertainty Rating: LowMorningstar Economic Moat Rating: NoneForward Dividend Yield: 5.32%Industry: REIT—Retail

Realty Income, trading at 24% below its Morningstar fair value estimate of $76, is the only name on our list of the best REITs to buy that earns a Morningstar Uncertainty Rating of low, which means the REIT requires a lower margin of safety to be considered a buy than other names on this list with medium or high uncertainty ratings.

Realty Income is the largest triple-net REIT in the United States, with more than 13,100 properties that mainly house retail tenants. The company describes itself as “The Monthly Dividend Company,” and its line of business and operating metrics make its dividend one of the most stable sources of income for investors. Even though over 80% of Realty Income’s tenants are in retail, most are focused on defensive segments, with characteristics such as being service-oriented, naturally protected against e-commerce pressures, or resistant to economic downturns. Additionally, the triple-net lease structure places the burden of all operational risk and cost on the tenant and requires the tenant to make capital expenditures to maintain the property rather than the landlord. These leases are often long term, frequently 15 years with additional extension options, which provides Realty Income a steady stream of rental income. Coverage ratios are also very high, so tenants are healthy and unlikely to request rent concessions, even during downturns. The steady, stable stream of revenue has allowed Realty Income to be one of only two REITs to be members of the S&P High-Yield Dividend Aristocrats Index and have a credit rating of A- or better. This makes Realty Income one of the most dependable investments for income-oriented investors.

Stability comes at the cost of economic profit, however. The lease terms include very low annual rent increases around 1%, which helps keep the coverage ratio high but severely limits internal growth for the company. Therefore, to grow, Realty Income must rely on acquisitions. The company has executed nearly $35 billion in acquisitions over the past decade at average cap rates around 6%. Given the access to cheap debt during this time, it has created a lot of value. However, increased competition has lowered cap rates, and the recent rise in interest rates has started to squeeze the company’s spread and its ability to create value. We remain concerned that at some point, the valve for creating value will shut off and Realty Income will be left with just a low internal growth story.

Kevin Brown, Morningstar senior equity analystLearn more: What is the Morningstar Uncertainty Rating?Equity ResidentialMorningstar Price/Fair Value: 0.72Morningstar Uncertainty Rating: MediumMorningstar Economic Moat Rating: NoneForward Dividend Yield: 4.25%Industry: REIT—Residential

Equity Residential is currently trading at a 28% discount from its fair value estimate. It’s the first of two residential REITs on our list of the best REITs to buy.

Equity Residential has repositioned its portfolio over the past decade to focus on owning and operating high-quality multifamily buildings in urban, coastal markets with demographics that allow the company to maintain high occupancies and drive strong rent growth. The company has sold out of inland and southern markets and increased its operations in high-growth core markets: Los Angeles; San Diego; San Francisco; Washington, D.C.; New York; Boston; and Seattle. These markets exhibit traits that create demand for apartments, like job growth, income growth, decreasing homeownership rates, high relative cost of single-family housing, and attractive urban centers that draw younger people. The company regularly recycles capital by selling noncore assets or exiting markets and using the proceeds for its development pipeline or acquisitions, a strategy that has produced strong returns.

However, high inflation has driven revenue significantly higher as apartment leases are generally only a year long, allowing Equity Residential to push rate growth that has matched inflation. Revenue growth has decelerated in 2023 from the 2022 highs as inflation growth has come down, but it is still well above historical average while expense growth also remains elevated. As a result, the company’s funds from operations per share are already above prepandemic levels, and we expect continued same-store growth to push FFO even higher.

Kevin Brown, Morningstar senior equity analystVentasMorningstar Price/Fair Value: 0.70Morningstar Uncertainty Rating: MediumMorningstar Economic Moat Rating: NoneForward Dividend Yield: 3.56%Industry: REIT—Healthcare Facilities

The first of two REITs focusing on healthcare facilities on our list of the best cheap REITs to buy, Ventas is 30% undervalued relative to our $72 fair value estimate.

The top healthcare real estate stands to disproportionately benefit from the Affordable Care Act. There is an increased focus on higher-quality care in lower-cost settings. The best owners and operators in the industry, which can provide better outcomes while driving greater efficiencies, should see demand funneled to them from the best healthcare systems. Additionally, the baby boomer generation is starting to enter its senior years, and the 80-and-older population, which spends more than 4 times on healthcare per capita than the national average, should almost double over the next 10 years. Long term, the best healthcare companies are well-positioned to take advantage of these industry tailwinds.

The coronavirus was a major challenge for the senior housing industry as the senior population was one of the worst hit from the virus. Even a few cases led to quarantines of entire facilities, which caused dramatic declines in occupancy early in the pandemic. However, we remain optimistic about the sector’s longer-term prospects, given that the industry has steadily recovered over the past two years, supply will likely remain below the historical average in the coming years, and the demographic boon will create a massive spike in demand for senior housing. We also like Ventas’ acquisition of New Senior Investment Group to expand its exposure to the sector ahead of what we believe will be a decade of strong growth.

Kevin Brown, Morningstar senior equity analystApartment IncomeMorningstar Price/Fair Value: 0.70Morningstar Uncertainty Rating: MediumMorningstar Economic Moat Rating: NoneForward Dividend Yield: 5.16%Industry: REIT—Residential

Apartment Income has large, high-quality properties in the suburban and urban submarkets of Boston; Philadelphia; Washington D.C.; Miami; Denver; San Francisco; San Diego; and Los Angeles. This REIT, which owns a portfolio of 73 apartment communities with more than 25,000 units, is trading at 30% below its fair value estimate of $50.

Apartment Income has significantly slimmed down the portfolio of multifamily buildings it owns over the past decade to just its best assets. The company invests in metropolitan markets with solid demographic trends that allow the company to maintain high occupancies and pass along consistent rent increases. Demand for apartments depends on economic conditions in their markets like job growth, income growth, decreasing homeownership rates, high relative cost of single-family housing, and attractive urban centers. Apartment Income’s portfolio is typically more suburban than its multifamily REIT peers, which has put it at a slight disadvantage over the past economic cycle, but it should favor growth in the company as millennials move from the urban centers out into the suburbs over the next few years. The company regularly recycles capital by selling noncore assets or markets and uses the proceeds to fuel targeted acquisitions with strong growth prospects, a strategy that has improved the company’s performance over the past few years.

Apartment Income has significantly streamlined its portfolio and strategy over the past decade. While the company has decreased its portfolio from over 300 properties at the end of 2008 to 73 properties, the company owns approximately the same number of assets over that time frame in the eight markets it currently considers to be core. The company’s exit from markets with lower growth prospects has increased the portfolio’s expected average growth. The company completed the sale of the last of its affordable living and asset management businesses in 2018, segments with limited growth prospects that the company has been trying to exit for years. In 2020, Apartment Income spun off its development pipeline and lease-up portfolio into its own company so that the remaining company could focus on the highest-quality assets. These efforts have brought Apartment Income’s portfolio closer to its peers in terms of both asset quality and market exposure. While the company still has a differentiated portfolio from its peers, we expect it to have similar internal and external growth opportunities.

Kevin Brown, Morningstar senior equity analystHealthpeak PropertiesMorningstar Price/Fair Value: 0.62Morningstar Uncertainty Rating: MediumMorningstar Economic Moat Rating: NoneForward Dividend Yield: 5.96%Industry: REIT—Healthcare Facilities

The second REIT focusing on healthcare facilities on our list is Healthpeak Properties. This REIT is trading 38% below our fair value estimate of $32.50.

The top healthcare real estate stands to benefit disproportionately from the Affordable Care Act. With an increased focus on higher-quality care being performed in lower-cost settings, the best owners and operators in the industry, which can provide better outcomes while driving greater efficiencies, should see demand funneled to them from the best healthcare systems. Additionally, the baby boomer generation is starting to enter its senior years, and the 80-plus population, an age range that spends more than 4 times on healthcare per capita than the national average, should almost double in size over the next 10 years. Long term, the best healthcare companies are well-positioned to take advantage of these industry tailwinds.

Given the significant challenges that the coronavirus presented to the senior housing industry, Healthpeak made the strategic decision in 2020 to dispose of most of the company’s senior housing assets in multiple transactions for around $4 billion in total proceeds. As a result, Healthpeak’s life science and medical office portfolios are now prominently featured in the company’s portfolio as the proceeds from the senior housing sales were reinvested into these two sectors. Healthpeak has high-quality assets in top markets that attract credit-grade tenants in both segments, so we believe it makes sense to strategically focus the company on the segments where it has an advantage. Despite the possibility of further changes to the ACA, we think any changes will still result in a coordinated value- and outcome-based system that will provide Healthpeak’s current portfolio with strong tailwinds.

Kevin Brown, Morningstar senior equity analystPebblebrook HotelMorningstar Price/Fair Value: 0.54Morningstar Uncertainty Rating: HighMorningstar Economic Moat Rating: NoneForward Dividend Yield: 0.27%Industry: REIT—Hotel & Motel

Pebblebrook Hotel is the only REIT in the hospitality services sector on our list of the best REITs to buy. It is trading 46% below its fair value estimate of $27.50.

Pebblebrook Hotel Trust is the largest U.S. lodging REIT focused on owning independent and boutique hotels. After merging with LaSalle Hotel Properties in December 2018, the company owns 47 upper-upscale hotels, with more than 12,100 rooms located in urban gateway markets. Pebblebrook’s combined portfolio has a higher revenue per available room price point and EBITDA margin than its hotel REIT peers.

The coronavirus outbreak significantly affected operating results for Pebblebrook’s hotels, with high-double-digit revPAR declines and negative hotel EBITDA in 2020. However, the rapid rollout of vaccinations allowed leisure travel to quickly return, driving high growth in both 2021 and 2022. We think the company should continue to recover as business and group travel eventually returns to 2019 levels by the end of 2024 in our base-case scenario. However, several factors will remain headwinds for hotels over the long term. Supply has been elevated in many of the biggest markets, and that is likely to continue for a few more years. Online travel agencies and online hotel reviews create immediate price discovery for consumers, preventing hotels from pushing rate increases even though it is nearing full occupancy on many nights. Finally, while the shadow supply created by Airbnb doesn’t directly compete most nights, it does limit Pebblebrook’s ability to push rates on nights when it would have typically generated its highest profits.

Kevin Brown, Morningstar senior equity analystUniti GroupMorningstar Price/Fair Value: 0.48Morningstar Uncertainty Rating: Very HighMorningstar Economic Moat Rating: NoneForward Dividend Yield: 10.47%Industry: REIT—Specialty

The highest-yielding REIT on our list of the best REITs to buy, Uniti Group is also the cheapest, trading 52% below our fair value estimate.

Uniti’s business is dominated by its triple-net leases, which results in little variability in operating results. The firm’s lease with Windstream makes up about 70% of total revenue and nearly 90% of EBITDA. Following Windstream’s bankruptcy in 2019, Uniti and Windstream renegotiated the lease, which has an initial term that runs through 2030. The renegotiation leaves Uniti with very stable and predictable financial results, but the firm has sought to grow and diversify.

With the dearth of sale-leaseback deals,…



This article was originally published by a www.morningstar.com . Read the Original article here. .