The financial crisis brought on by the COVID-19 pandemic this year has been rough on the real estate investment trust (REIT) sector. For a short time in the spring, the financial markets went into a bit of panic mode and started calling in loans, creating an illiquid situation for some as available credit to manage the situation deteriorated.
Mortgage REITs (and their stocks) bore the brunt of the damage, but retail REITs have also struggled because many of their tenants have been shut down due to coronavirus-related travel and health restrictions and haven't been paying rent. Things are now somewhat better settled and, while the COVID crisis isn't over, businesses are reopening and more rents are being paid.
If this recovery trend continues, these two REITs are worth keeping an eye on as potential winning investments.
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1. Store Capital: Tenants are reopening and paying rent
Store Capital (STOR +0.00%) is a triple-net-lease REIT that focuses on stand-alone buildings with single tenants. (In fact, STORE is the acronym for "single-tenant operational real estate.") Like most REITs, Store Capital was hit with rent deferrals when COVID-related shutdowns rendered many tenants unable to pay their rent. While April and May were tough, collections have been steadily improving, and the company recently reported that it had collected 86% of August rent and had paid down its revolving credit lines. No rent deferrals have been requested in August.
As expected, Store Capital reported a drop in earnings for the second quarter. Adjusted funds from operations (AFFO), which is the best way of measuring a REIT's income, fell 5% to $108.7 million or $0.44 per share compared to $114 million in revenue or $0.50 per share in the year-ago quarter. The company declared and paid its normal $0.35 per share dividend. Dividend cuts have been all too common in the REIT space, so this is a good sign.
Warren Buffett, who has been a major shareholder, took advantage of the COVID-19 crisis to increase his holding in the stock by 31% and now owns just under 10% of the company. That vote of confidence from a well-respected billionaire investor should be noted by those looking into purchasing the stock.
2. New Residential Investment: A big change in business model
New Residential Investment Corp. (NRZ +1.60%) is a mortgage REIT that went through a wholesale change in its business model during the COVID-19 crisis. Prior to COVID, New Residential was at the forefront of the nonqualified mortgage (non-QM) market, which describes mortgages that fall outside Fannie Mae's guidelines (and therefore aren't government-backed). The fallout in the mortgage market in March and April basically froze the securitization market, which meant mortgage bankers like New Residential had a lot of newly originated mortgages that they couldn't easily sell because they were considered higher-risk mortgages. Margin calls ended up forcing the company to sell off assets, and New Residential made the commitment to get out of the non-QM lending market and to focus entirely on mortgages that can be guaranteed by the government.
The opportunities in garden-variety refinancings are plentiful right now. Most mortgage banks are operating at capacity, experiencing record volumes and margins. Rocket Companies (RKT +3.97%) recently did an initial public offering, selling $1.8 billion of stock to the market. The timing is certainly good for origination.
My question is whether New Residential can quickly retool to a government-guaranteed model. Developing relationships with the big lenders that were never in the non-QM business will take some time. If New Residential can ramp up quickly, it can take advantage of this once-in-a-decade market boom before the refinancing trend winds down.
The non-QM business is sitting dormant at the moment because of the current economic uncertainty, so New Residential might as well adapt to the environment it is presented. It could always return to the non-QM space if circumstances change. This would give the company additional growth potential, along with a more diversified business model.
