Real estate has been one of the strongest performing sectors in the stock market in 2019. Falling interest rates and investors looking for safe income streams are great boons to real estate stocks.
However, not all types of real estate investment trusts (REITs) have performed well. Retail REITs have struggled as e-commerce headwinds have caused havoc throughout the industry. Recession fears have hurt hotel REITs thanks to the cyclical nature of their properties.
|Company (Stock Symbol)||Property Type||Dividend Yield||P/FFO|
|Simon Property Group (NYSE: SPG)||Retail||5.2%||12.8|
|Apple Hospitality REIT (NYSE: APLE)||Hotel||7.3%||9.6|
The best mall operator in the industry. Period.
Many investors don't want to go anywhere near the retail sector, especially when it comes to malls and shopping centers. And who could blame them? Another major retail chain seems to declare bankruptcy or a wave of closures on a daily basis these days.
Simon Property Group (NYSE: SPG) is different. The company (which is one of the largest REITs in the world) operates a portfolio of shopping malls. And not just any malls -- Simon's malls are among the most valuable and heavily visited malls in the world.
For example, the company's Sawgrass Mills mall in Florida is estimated to be worth more than $4 billion alone. Five of the 10 most valuable malls in the U.S. are in Simon's portfolio.
Because of its scale, Simon has tremendous financial flexibility. This is the main reason it has an advantage in the evolving retail environment. One of Simon's main strategies is creating mixed-use spaces in its malls.
For example, they might incorporate offices, hotels, entertainment venues, and more into a property to boost foot traffic and create revenue that's immune to e-commerce disruption. And Simon's deep pockets let it pursue these opportunities as it sees fit.
In fact, Simon views the closures of Sears and J.C. Penney stores in its properties as a major opportunity. Those closures let the company add mixed-use features at a much lower cost than building new spaces from the ground up.
The proof is in the numbers. Despite the general downward trend in brick-and-mortar retail, Simon's tenants actually saw sales grow by 3.5% over the past year. In a nutshell, Simon is valued cheaply like most retail REITs but isn't in trouble at all.
Mid-market hotels can be a great hospitality investment
Hotels are an extremely cyclical type of real estate. Unlike many other types of commercial properties where tenants sign multi-year leases, hotel "tenants" rent space on a daily basis. Not only does this cause vacancy rates to spike when the economy turns sour, but recessions cost hotels their pricing power, reducing revenue from the rooms that are occupied.
Investors know this, and recent recession fears have driven many hotel REITs lower. However, one you might want to look at is Apple Hospitality REIT (NYSE: APLE), which focuses on "select service" hotels. Think of these as mid-range hotels -- more luxurious than bargain hotel chains, but without the amenities of luxury hotel brands.
Just to give you an idea, Hilton Garden Inn, Hampton, and Courtyard by Marriott are some of the brands you'll find in Apple Hospitality's portfolio.
Here's why I like Apple Hospitality right now: The company is priced for a recession, and we might certainly get one. However, there are a couple of reasons Apple Hospitality should make it through a recession better than most hotel REITs.
For one thing, select-service hotels get a relatively high percentage of revenue from business travelers, and business travel tends to be less sensitive to recessions than discretionary consumer travel. Also, during recessions, while consumers tend to spend less on vacations, select-service properties get a bit of a trickle-down effect as travelers who typically stay in luxury properties scale back their spending.
Finally, Apple Hospitality's dividend is well-covered by its funds from operations (FFO). The $1.20 annual payout rate represents less than 70% of its FFO, which is quite low for a REIT. Even if Apple Hospitality's revenue drops significantly, its dividend should be safe.
These REITs aren’t without risk
As a final thought, it's important to point out that while I love these two REITs as long-term investments, there could (and probably will) be significant volatility over the next few years. The retail industry is a long way from being adjusted to its new normal, and if a recession hits, I'd expect the share prices of hotel REITs to be adversely affected.
I wouldn't advise anyone to buy these REITs with money they need within the next few years. But these cheap, high-dividend REITs make excellent investments for money you won't need for a decade or more.