Last year was another strong one for the stock market. The S&P 500 was up 23%, while the Nasdaq Composite rallied nearly 29%. Many stocks gained even more.
However, not all stocks have participated in the market rally. In particular, the real estate investment trust (REIT) sector has fallen behind largely due to the impact of higher interest rates. I believe that headwind will finally fade this year, which should spark a rally in the REIT sector.
My two highest-upside stock picks in the space are Medical Properties Trust (MPW +1.31%) and Rexford Industrial Realty (REXR 1.62%) due to their extra upside catalysts.
On the road to recovery
Medical Properties Trust has battled a barrage of tenant-related issues over the past few years. The healthcare REIT saw two of its largest tenants file for bankruptcy. As a result, it hasn't been collecting rental income on a meaningful portion of its portfolio.
Those financial problems have coincided with surging interest rates, which have made it very difficult for the REIT to address its debt maturities. These issues have weighed heavily on its stock, which has lost 80% of its value over the past three years.
NYSE: MPW
Key Data Points
On a more positive note, Medical Properties Trust regained control of its real estate from one bankrupt tenant last year. It has replaced that tenant with five new operators that will start paying rent this year. Rates will steadily escalate, reaching the fully stabilized level by the end of next year (at 95% of the former tenant's rate).
The REIT has also worked very hard to bolster its liquidity. Last year, it raised about $3 billion via asset sales and loan refinancings. That has enabled it to repay $2.3 billion of debt over the past two years. Meanwhile, it has the liquidity and capital sources to address its future debt maturities.
Medical Properties Trust still has another tenant bankruptcy to work through this year, but its portfolio and financial situation are stabilizing. Its rental income should steadily rise over the coming quarters, further enhancing its financial flexibility.
Add in the potential for lower interest rates as the Federal Reserve continues cutting them, and it should be a lot easier for the REIT to refinance debt in the future.
These catalysts should start taking the pressure off its stock price this year, which could steadily send its shares higher.
A small speed bump
Shares of Rexford Industrial Realty slumped more than 30% last year and have fallen almost 50% over the past three years. That's largely due to a slight easing in the Southern California industrial real estate market, which is Rexford's sole focus.
Co-CEO Michael Frankel discussed those market conditions on the industrial REIT's third-quarter conference call: "With regard to general market conditions, increased levels of global unrest, uncertainty related to the presidential election and an uncertain economic outlook continue to weigh on markets and business decision making. Although our infill Southern California industrial market continues to demonstrate superior long-term tenant demand fundamentals, current leasing activity reflects some tenants taking longer to make decisions."
NYSE: REXR
Key Data Points
As a result, vacancies ticked up a bit, weighing on growth in same-property net operating income (NOI), which only rose 2.7% in the period. However, rents have risen so much in recent years that it has still been able to lock in much higher rates as legacy leases expired (comparable rents on new and renewal leases increased 39.2%).
The REIT also benefited from new investments (acquisitions and repositioning/redevelopment projects). Those growth drivers boosted the NOI of its portfolio by 17.6%, while its funds from operations (FFO) increased 13.1% (and by 5.4% per share after factoring in the impact of share sales to fund new investments).
Rexford is facing some near-term headwinds, but it sees much better days ahead. It believes the Southern California industrial market will rebound as the economic and political environment stabilizes.
However, even if rents don't grow, the REIT's embedded growth drivers -- repositioning/redevelopment projects, rental increases (e.g., securing much higher market rents as existing leases expire and with embedded rental increases in current leases), and secured acquisitions -- will add 34% to its NOI over the next three years. There's ample upside to that number if market rents resume their rise and the REIT secures additional accretive acquisitions.
I believe that a resumption of market rent growth in Southern California and lower interest rates could help send shares of Rexford much higher in the coming quarters.
The potential for big-time, bounce-back years
Interest rates and other negative impacts have weighed heavily on shares of Medical Properties Trust and Rexford Industrial Realty over the past couple of years. I expect those to fade in 2025. Because of that, these REITs have some of the highest upside in the sector this year.
