Real estate investment trusts (REITs) have stumbled over the past year, thanks to the Federal Reserve’s 4.5 percentage points of interest rate increases.
Rising rates hurt REITs because they borrow heavily to finance their property purchases. Also, higher rates lift bond yields, making bonds a more attractive income asset versus REITs.
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The Nareit REIT index generated a total return of negative 14% over the past year. This has left real estate stocks as a whole undervalued by about 15%, according to Morningstar. It measures valuation according to its fair value estimates for stocks.
The Fed has indicated that more rate hikes are ahead, so you may not want to go all in on REITs yet. But it may be a good time to start nibbling.
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Five Morningstar Favorites
Morningstar has cited five undervalued REITs it favors. Two of them hold shopping malls.
With the pandemic waning, “we see more evidence of people’s behavior reverting back toward pre-pandemic norms,” said David Sekera, senior U.S. market strategist.
“One of those behaviors is going back out in person and shopping in retail locations. As such, we are seeing traffic pick up at a lot of different malls and retail areas.”
The other three REIT picks own hotels. “Leisure travel has already largely recovered,” from the pandemic, Sekera said. “In some areas it’s even more now than what it was pre-pandemic.”
And “what we’re looking for next is a return for international tourist traffic and an increase in business travel,” he said.
Here are the five favored REITs:
- Macerich (MAC), a mall REIT. Yield: 5.84%
- Simon Property Group (SPG), a mall REIT. Yield: 5.97%
- Host Hotels (HST). Yield: 2.84%
- Park Hotels & Resorts (PK). Yield: 7.2%
- Pebblebrook Hotel (PEB) . Yield: 0.27%
Macerich: Morningstar analyst Kevin Brown puts fair value for the stock at $26.50. It recently traded at $11.75.
“Macerich has successfully repositioned the company over the past decade as a true owner and operator of Class A regional malls,” he wrote.
“While Macerich is still dealing with the fallout of the coronavirus pandemic, fundamentals have begun to rebound.” Specifically, “foot traffic has since returned to near pre-pandemic levels,” Brown said.
“Macerich's revenue is protected by long-term leases, and occupancy has started to recover. Class A malls will remain dominant in brick-and-mortar retail, eventually returning to their prior occupancy and rent levels.”
Park Hotels: Brown puts fair value for the stock at $26.50. It recently traded at $13.95.
Park Hotels & Resorts is the second largest U.S. lodging REIT, focusing on the upper-upscale hotel segment.
“In the short term, the coronavirus significantly impacted the operating results for Park's hotels,” Brown said. But the rapid vaccination rollout “allowed leisure travel to quickly recover, leading to significant growth in 2021 and 2022,” he said.
“The company should continue to see strong growth, as business and group travel also recover to pre-pandemic levels, with Park eventually returning to 2019 levels by the end of 2024.”
