Sell ​​alert: 3 REITs are becoming risky

REITs (VNQ) are trading today at their lowest valuation levels since the Great Financial Crisis:

And historically, it has always been a good idea to buy REITs when their prices have been so strong.

I do not think that This time will be different. If you can buy quality real estate for a fraction of the price, you can hardly go wrong in the long run.

But just because REITs are opportunistic doesn’t mean they’re all worth buying. This is a huge and diverse sector with over 1,000 companies worldwide, and just because two companies share the acronym “REIT” doesn’t mean they have anything in common.

I’m very bullish on REITs, but I’m still objective enough to recognize that many of them are likely to disappoint over time.

Here are three REITs that I would avoid today:

Boardwalk is a Canadian REIT that primarily owns residential properties.

It was once our largest Canadian REIT investment and we even predicted in October 2020 that it would increase in value by over 100%.

The REIT used to be so cheap!

But four years later, this potential has now been exhausted and the REIT has become expensive compared to comparable investments.

Historically, Boardwalk has traded at a discount compared to most other apartment REITs because it primarily owns older Class B properties in riskier, energy-sensitive markets.

But right now, the market is doing particularly well for this company and it is far outperforming its competitors, closing the valuation gap.

For once, it’s the opposite. Boardwalk is priced at a premium. It currently trades at an implied cap rate of ~5%, while top-tier apartment REITs like Camden Property Trust (CPT) in the U.S. trade at an implied cap rate of 6.5%. And that’s despite Camden enjoying:

• Much larger scale
• With an investment grade rating of A-
• A better long-term track record
• Superior development capabilities
• More secure market presence

My capital is limited and for this reason I sold my position in Boardwalk and reinvested the proceeds in some cheaper competing products.

I wouldn’t mind owning it again at some point in the future. I’ve gotten to know the management and really like their approach. The valuation just isn’t as attractive compared to other apartment REITs in today’s market.

Universal Health Realty Income Trust (UHT)

Many investors are buying Universal Health Realty for one important reason:

The dividend yield today is 7.7%, even though the company has been able to increase its dividend for around 35 years in a row.

This is one of the longest dividend growth streaks of any REIT and the stock has rarely traded at such a high yield, so why not buy now?

Here are two main reasons:

1) I expect the dividend to be cut. Right now, the payout ratio is ~90%, which leaves little room for error as the company faces declining cash flows due to tenant issues, rising vacancy, growing capital expenditure needs, and rising interest expenses. I know the REIT raised its dividend in December 2023, and some people like to think that the “safest dividend is the one that just got raised,” but note that the dividend increase was only 0.7%. Its purpose was just to continue the winning streak. WP Carey (WPC) did the same thing shortly before cutting its dividend, alienating its shareholders who then perceived the cut as a betrayal of management. I fear the same thing could happen here in the near future.

2) An even bigger problem is that the company’s valuation makes little sense to me. It is actually more expensively valued relative to its close competitor Healthcare Realty (HR), despite the fact that it (1) owns weaker assets, (2) has a worse balance sheet, (3) is externally managed, creating conflicts of interest, (4) and has worse growth prospects.

We used to own UHT but exited at the end of 2022 at $47.76.

I’m glad we did that as the stock price is $10 lower today.

Getty Realty (GTY)

Getty Realty is one of the most popular net lease REITs and I think this is primarily for two reasons:

1) The company primarily owns gas station/convenience store net rental properties that are considered recession-resistant. Investors also seem to like these particular properties because they are familiar with them, as they regularly visit such properties themselves.

2) It offers a dividend yield about 100 basis points higher than its net rental peers, Realty Income (O), Agree Realty (ADC) and NNN REIT (NNN), despite growing at roughly the same rate over the long term:

	Dividend yield
GTY	6.5%
Ö	5.9%
ADC	5%
NNN	5.4%

click to enlarge

So why don’t I buy it?

There are three main reasons for this.

First, I fear that many of these properties will suffer a permanent loss in value over the long term due to the rapid transition to electric vehicles. Before you comment, “Yeah, but electric vehicles need charging too, and those are convenience stores…”, let me tell you that I understand that. But there are better places to charge electric vehicles than these convenience stores. Most people will charge them at home in most cases, and when they’re on the road, they’ll charge their electric vehicle at a grocery store, restaurant, or entertainment venue rather than waiting at a small convenience store. So I believe we won’t need nearly as many of these charging stations anymore.

I also realize that the transition to electric vehicles will take a long time. But real estate investors are long-term investors, and if there is a risk that your property will be empty in 20 years, that should be reflected in today’s value.

Finally, I am also concerned that converting these properties to other uses will be very expensive. I used to work for a private equity firm and we avoided gas stations for exactly this reason. If there are leaks or there have been in the past, it can be very costly to repair any ecological damage.

The second reason is that the company has a large debt load to deal with next year, which will likely lead to a significant increase in its interest expenses:

Some of its close competitors have done a much better job with their balance sheets. NNN REIT, for example, has a >2x longer average debt maturity than Getty Realty.

And the final reason is that you don’t get a lower valuation for the higher risk. Getty trades today at a similar valuation multiple to its peers, despite having a weaker balance sheet, more exposure to rising interest rates, and a portfolio that is far less diversified and more exposed to the risk of falling property values ​​and rents over the long term:

	FFO multiple
GTY	12.6x
Ö	12.5x
NNN	12.5x

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Therefore, even if you disagree with my opinion on electric vehicles, there is little point in buying Getty. You should be rewarded with a lower valuation for taking that risk, but that is not the case.

Concluding remarks

You can greatly improve the risk-reward ratio of your portfolio by being selective, and these three REITs are great examples of that. In all three cases, you could potentially get better returns with less risk if you simply invested in some of their closely related companies instead.

Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. exchange. Please be aware of the risks associated with these securities.