The real estate sector performed exceptionally well in 2019 with a 28% total return for the year. As a result, it's understandable if many real estate investment trusts, or REITs are starting to look a little expensive.
However, while the overall sector has performed incredibly well, there are still some attractive bargains to be found. Here's why Healthpeak Properties (NYSE: PEAK) and Empire State Realty Trust (NYSE: ESRT) could be worth a look with 2020 rapidly approaching.
New name, new company
Until recently, Healthpeak Properties was known as HCP, so if you haven't heard of it, that may be why.
Healthpeak is one of the largest healthcare-focused REITs in the market, but has undergone a significant transformation over the past few years. First, it spun off its skilled nursing assets. Then, it strategically disposed of some of its riskier and non-core assets, and also worked to considerably reduce its leverage. The name change represents the last step in the repositioning. If you compare the company's balance sheet and portfolio before and after the transformation, you'd understand why the name change was deemed necessary.
Healthpeak now focuses on three core segments of the healthcare real estate industry. Senior housing, life science, and medical office properties each make up about one-third of the company's rental income. The balance sheet is finally where the company wants it to be, and Healthpeak is now ready to re-enter growth mode.
There are two major catalysts investors need to keep in mind. First, there's likely to be a steady rise in demand for healthcare properties, particularly medical offices and other outpatient facilities, not to mention senior housing. The massive baby boomer generation is entering their senior citizen years, and people are opting to utilize outpatient care more and more. Plus, life expectancies have risen considerably, which is expected to create rapid growth in the oldest age groups (the sweet spot for senior housing).
Second, there's a ton of room for consolidation in the healthcare real estate industry. There is about $1.1 trillion of healthcare real estate in the U.S., and only about 15% of it is REIT-owned. Much of the rest (including a disproportionately large amount of the medical office market) is owned by the physicians and hospitals who practice in them.
Healthpeak currently has a $1.1 billion development pipeline and acquired more than $2 billion of senior housing and life sciences properties in 2019, and this could be just a starting point.
A beaten-down REIT with irreplaceable assets
Office REIT Empire State Realty Trust has not been a great performer recently. While the overall REIT sector was up by 28% in 2019, Empire State is actually down by about 1%. However, the company could be ripe for a turnaround.
As the name implies, this is the company that owns the iconic Empire State Building. It also owns a portfolio of office buildings, mainly in Manhattan and the surrounding area, that have some retail space as well.
There are a few reasons why the company has struggled lately, and why brighter days could be ahead. For one thing, the Empire State Building Observatory, which is a major source of revenue for the company, has been open but the 102nd-floor observation deck (the higher of the two) has been closed for renovations. It recently reopened, and the early reviews are very positive.
Furthermore, New York office space has been under pressure lately, especially when it was revealed that most new supply absorption has been a result of troubled WeWork. Now, Empire State has zero exposure to the co-working company in its portfolio, but overall, the New York office market isn't terribly robust right now. If the tide turns, Empire State will be well-positioned to benefit.
Additionally, like many of its peers, Empire State has been having a difficult time finding ways to grow. With one of the lowest leverage ratios in its peer group, investors have been waiting for the company to put some money to work through acquisitions, or even share buybacks. Once it starts having more success in this department, investors could immediately become more optimistic.
Invest with the long term in mind
As a final thought, it's worth emphasizing that REITs like these two are best suited for long-term investments. With interest rate fluctuations, economic conditions, and other factors, there are simply too many reasons why REIT prices can be volatile in the short run. However, these are two solid businesses, and should do quite well over the long run. In short, I'm not sure that investors who buy these will be happy six months from now, but I'm quite confident they'll be happy 10 years from now.
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