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2 Retail REITs to Buy Now

[Updated: Mar 03, 2021 ] Feb 10, 2021 by Matthew DiLallo
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Last year was a brutal one for real estate investment trusts (REITs), especially those focused on the retail sector. The average retail REIT produced a negative 25.2% total return because many of its tenants conserved cash amid the pandemic, impacting their ability to pay rent.

However, market conditions are slowly improving thanks to government stimulus programs. With consumer balance sheets in their best shape in years and another round of stimulus likely, they could go on a shopping spree this summer as vaccines allow for a new sense of normal. That should boost the fortunes of retail REITs. Two that stand out as great options for investing in the retail rebound are Federal Realty Investment Trust (NYSE: FRT) and Realty Income (NYSE: O).

Well-positioned for the recovery

Federal Realty Investment Trust owns, manages, and develops urban, mixed-use properties and high-quality open-air shopping centers. The REIT currently has 101 properties in its portfolio across eight major metro markets.

The pandemic had a noticeable impact on Federal Realty last year. The company's rental collection rate was under pressure -- it averaged 85% during the third quarter and that same rate in October -- which weighed on its funds from operations, or FFO. Because of that, its stock lost a third of its value last year.

However, market conditions improved towards the end of the year as its rental collection rate increased while leasing volumes rebounded back to their pre-COVID levels by November. Those positive trends should continue as the retail sector's recovery accelerates in 2021, which should help fuel a rebound in its stock price. Meanwhile, the REIT sold several assets last year to bolster its balance sheet, which is already one of the best in the REIT sector. As a result, it has even greater financial flexibility to capture investment opportunities that could emerge in the coming quarters. Add that upside to a 4.7%-yielding dividend that the REIT has increased for more than 50 straight years, and it stands out as an excellent way to play the retail rebound with real estate.

Dual catalysts could drive a rebound in this retail REIT

Realty Income weathered last year’s storm better than most thanks to its focus on owning free-standing properties triple net leased primarily to essential retailers. Because of that, its rental collection rate has been in the low 90s. However, despite that relative strength, Realty Income's stock lost more than 15% of its value last year.

One of the REIT's issues is its exposure to health and fitness tenants (7.1% of its rent) and theaters (5.7%). Health and fitness tenants only paid 86% of November's rent and 82% in December, while theaters fared much worse at 12% and 11%, respectively, in those two months. However, with vaccines rolling out, people will be able to return to their gyms and see movies in the theater again. That should give these companies the cash to catch up on their rental agreements.

Meanwhile, Realty Income should get an additional boost this year from acquisitions. It bought $2 billion in properties last year and has the financial flexibility, thanks to an elite balance sheet, to continue making purchases. Those future additions should grow its cash flow, allowing it to continue increasing its 4.6%-yielding dividend, which it has done in each of the last 93 straight quarters. Add that to the upside as the troubled spots in its portfolio improve, and Realty Income's stock could bounce back in 2021.

Catalysts abound at these retail REITs

Conditions for retailers, which have improved in recent months, should get even better in 2021 as vaccines and stimulus give the sector a shot in the arm. That should boost the rental collection rates of Federal Realty and Realty Income. On top of that, both have elite balance sheets, giving them the financial flexibility to make acquisitions and supercharge their ability to benefit from the retail real estate recovery. Because of that, they're great REITs to buy while the market is still in the early stages of bouncing back.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.