Real estate investment trusts (REITs) have gotten rocked this year, tumbling more than 20% on average. That's due in large part to the sell-off in the broader stock market and rising interest rates.
The slump in the REIT sector has been indiscriminate, with investors selling first and asking questions later. Because of that, some beaten-down REITs are starting to look like even more compelling investment opportunties. Three Motley Fool contributors think Alexandria Real Estate Equities (ARE -1.21%), AGNC Investment (AGNC -0.32%), and Prologis (PLD -0.96%) could be ready to roll in the coming months.
Alexandria Real Estate Equities is growing its revenue, raising the rent
Marc Rapport (Alexandria Real Estate Equities): Alexandria Real Estate Equities is an office REIT, which isn't a sector that looks particularly promising right now, in general. But this is not your typical office landlord.
Alexandria owns and operates more than 74 million square feet of clustered lab and office space serving the life science, technology, and agriculture technology industries in and around New York City, suburban Maryland, Seattle, North Carolina's Research Triangle, Boston, San Francisco, and its hometown of San Diego.
The company's revenue comes from a collection of more than 1,000 tenants, with more than 50% of that from investment-grade or publicly traded large-cap occupants, and 86% from its 20 largest tenants who fit in one or both of those categories. That list is a who's who of industry leaders such as vaccine makers Pfizer and Moderna. Alexandria just completed a new headquarters building for the latter in Cambridge, Massachusetts.
The soundness of that business shows in its second-quarter numbers, which were just reported. Alexandria reported the third-highest quarter of leasing volume in its nearly 30-year history, and was able to raise the rent by 33.9%, its most ever. With a portfolio now about 95% occupied, revenue was already up 26% year over year. And with another 7.8 million square feet either under construction or about to begin -- and 78% of that leased or in negotiations -- the cash flow is expected to continue growing sharply.
Dividend growth also is good, with 13 straight years of increases under its belt, putting the yield at about 2.96%. Analysts rate the stock a "moderate buy" and give it a consensus price target of $193.40, which would be a 21% jump from the $160 or so the stock is selling for now.
Alexandria stock is still down about 28% year to date, but has rallied nearly 9% in the last month and it's reasonable to expect more good returns to come.
Things are looking up for the mortgage REIT sector
Brent Nyitray (AGNC Investment): The past two years have been exceptionally difficult for the mortgage REIT sector. First, the mortgage REITs suffered margin calls in the early days of the pandemic, which forced all to cut their dividends and many to have a near-death experience. Then once the smoke cleared, they were buffeted by prepayments, as borrowers refinanced their high-yielding mortgages en masse. Finally, they have been sold off in anticipation of higher interest rates and the potential for the Federal Reserve to sell off its holdings of mortgage-backed securities.
The market seems to be signaling that the Fed will raise the federal funds rate another 100 basis points (or 1%) and then hold it there. This means the tightening cycle is in the final stages.
A neutral Fed policy will be a positive for the mortgage REITs, especially agency REITs like AGNC Investment. AGNC focuses almost exclusively on mortgage-backed securities that are guaranteed by the U.S. government. This means that even if the economy enters a recession and borrowers start missing their payments, AGNC will still get its principal and interest. It won't bear much in the way of credit losses.
Another positive for the company is that refinance activity is at multidecade lows. Refinance activity is a negative for the stock because it means the company will lose higher-coupon mortgage-backed securities and be forced to reinvest the proceeds into lower-coupon mortgage-backed securities.
AGNC Investment has maintained its monthly $0.12 dividend ever since cutting it in 2020 from $0.16. At current levels, the stock has a yield of 11.4%. As a general rule, I like to buy mortgage REITs when they are trading at a discount to book value per share, and AGNC is still trading above. There is still risk to the stock; however the biggest ones (prepayments and the Fed) are abating pretty quickly. The more intrepid income investors should put this name on their watch list.
What demand slowdown?
Matt DiLallo (Prologis): Shares of leading industrial REIT Prologis have tumbled more than 20% from their recent high. The primary culprit was a report that e-commerce giant Amazon had more warehouse space than it currently needs. That sent shockwaves throughout the warehouse industry, suggesting that red-hot demand was about to cool off.
However, Prologis isn't seeing any evidence of slowing demand. Quite the contrary. The company signed 51.3 million square feet of leases in the second quarter at rates 45.6% above the rent on expiring leases. These leases also pushed its occupancy level up to 97.6%. The REIT noted that while demand from e-commerce companies has slowed, other industries are more than picking up the slack. Because of that, the company increased its rental growth projection from 20% globally to 23%, with even faster growth in the U.S.
Even without that rent growth, Prologis has significant embedded upside. Given the long-term nature of its contracts, rental rates on existing leases are 56% below current market rates. Because of that, the company estimates it can grow its same-store net operating income by 8% annually through 2025 with no further rent growth as leases expire and it captures market rates.
However, that's only one growth driver. With vacancy levels near record lows, the company continues investing in high-return developments. On top of all that, it recently agreed to acquire fellow industrial REIT Duke Realty in a $26 billion deal. The acquisition will be accretive in the first year. It will also enhance Prologis' long-term growth potential since Duke has a wide gap between its existing leases and market rates. Duke also has an extensive development pipeline.
Put everything together, and Prologis has lots of upside ahead. The REIT can grow at an above-average rate for years, even if rents flatline. Meanwhile, there's further upside if they keep rising, which seems likely.
