Why I Continue to Buy REITs Instead of Rental Properties

In This Article

Final October, I wrote an article explaining why I had stopped shopping for rental properties to purchase actual property funding trusts (REITs) as an alternative. I argued that REITs have been mispriced, providing a chance for buyers to purchase actual property at a reduction to its truthful worth.

Since then, REITs have risen by 36% on common, whilst personal actual property has largely stagnated and even barely declined in worth:

I might additionally add that this is simply the common of the REIT sector, represented by the Vanguard Actual Property ETF (VNQ), which incorporates the great and unhealthy.

If you happen to have been selective and invested within the proper REITs, you possibly can have executed lots higher. For instance, our largest REIT funding throughout this time interval was Important Properties Realty Belief (EPRT), and it’s up 57% in simply 11 months:

However are REITs nonetheless a compelling funding alternative, or has the window for investing in them already closed? 

I consider the former is true.

Even after the latest rally, a variety of REITs are nonetheless buying and selling at massive reductions relative to the truthful worth of their actual property.

Take the instance of BSR REIT (HOM.U:CA), which I mentioned in final yr’s article. It’s an residence REIT that focuses on quickly rising Texan markets. It was priced at a whopping 42% low cost again in October 2023 and has recovered considerably since then, however nonetheless trades at a 24% low cost right this moment.

In different phrases, you’ll be able to nonetheless purchase an fairness curiosity in the actual property of BSR at 76 cents on the greenback, a greater deal than what you’d get within the personal market. It trades at ~6% implied cap rate, however its properties are value nearer to a ~5% cap charge within the personal market.

However I believe the times of REITs buying and selling at massive reductions at the moment are numbered. The one motive REITs are priced as they’re right this moment is as a result of the market overreacted to the surge in rates of interest.

REITs typically use little leverage, and their fundamentals haven’t been closely impacted. In reality, REIT money flows and dividends saved rising in 2022, 2023, and up to now in 2024, even regardless of the surge in rates of interest.

Nevertheless, it nonetheless prompted their share costs to crash as a result of a variety of revenue buyers offered their REITs, no matter their fundamentals, to reinvest in bonds and Treasuries as an alternative. These buyers have been by no means really all in favour of proudly owning REITs, however they’d invested in them to earn yield in a yieldless world. However as quickly as bonds and Treasuries provided a good yield, they offered, inflicting REITs to crash.

This may be very clear if you happen to have a look at the sturdy inverse correlation between REIT share costs and rates of interest on this bear market:

However we’ll now see the alternative occur as rates of interest return to decrease ranges, which is why REITs have begun their restoration.

The debt market is predicting that rates of interest will drop by roughly 250 foundation factors inside a yr from now:

This anticipation has already pushed some buyers to reinvest in REITs, and as charges steadily return to decrease ranges, I count on many extra buyers to rethink their fixed-income allocations and return to the REIT sector.

REITs are nonetheless comparatively low-cost, buying and selling at reductions to their web asset values, and it isn’t unusual to seek out good REITs nonetheless providing 5% to 7% dividend yields. 

REITs have been much less tempting when you possibly can get a 5% yield on cash market funds and short-term Treasuries, however as that turns into 2.5% to three%, REITs will change into a sizzling commodity once more. 

How A lot Upside Do They Provide?

Traditionally, REITs have usually traded at a slight premium to their web asset values, and this is sensible, given all the benefits they provide relative to non-public actual property.

You’re basically getting the very best of each worlds, shares and actual property, in a single package deal, and that’s value a premium:

Non-public Actual Property	Public REITs
Illiquid	Liquid
Concentrated	Diversified
Pricey, work-intensive administration	Price-efficient, skilled administration
Limitless legal responsibility	Restricted legal responsibility
Restricted entry to capital	Superior entry to capital
Low cost valuation	Premium valuation

But there are nonetheless a variety of REITs that commerce at a 25% to 50% low cost relative to the truthful worth of their actual property, web of debt. This is in the end why I’ve saved shopping for extra REITs as an alternative of rental properties. 

I am not capable of spend money on the equity of rental properties at a 25% to 50% low cost. This signifies that merely returning to their truthful worth might unlock 50% to 100% upside in some circumstances, and we now have a transparent catalyst for this upside to be realized. 

For that reason, I simply don’t get the purpose of shopping for personal actual property right this moment. You’re paying extra to purchase an illiquid, concentrated, personal asset that’s administration intensive and taking a better legal responsibility danger to doubtless earn decrease returns ultimately. 

Analysis research clearly present that purchasing REITs at a reduction is a technique to earn a lot greater returns:

Comply with the Leaders

However don’t take it simply from me. The main personal actual property funding agency, Blackstone (BX), which controls over $1 trillion value of property, is right this moment selecting to purchase REITs as an alternative of personal actual property. 

Earlier this yr, it purchased out Tricon Residential (TCN) and paid a 30% premium for it. Then, a couple of months later, it acquired House Revenue REIT (AIRC) and paid a 25% premium for it. Now, it is rumored to be making an attempt to purchase out a 3rd REIT, Retail Alternative Investments (ROIC), and this transfer has already prompted its share worth to surge by 25%. 

Blackstone is spending tens of billions of {dollars} to amass REITs as a result of it’s the least expensive actual property that it may possibly purchase right this moment—so low-cost that Blackstone is prepared to pay ~30% premiums to their newest share costs and nonetheless assume that it’s getting a superb deal. 

I’m following the identical method however on a smaller scale. As REITs get better, I’ll doubtless get again to purchasing personal actual property ultimately, however proper now, I can not make sense of it as a result of REITs are a lot extra enticing. 

Word By BiggerPockets: These are opinions written by the creator and don’t essentially signify the opinions of BiggerPockets.