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2 Retail REITs to Buy Right Now

Nov 03, 2020 by Matt Frankel, CFP
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Not only has retail been one of the worst-performing real estate investment trust (REIT) subsectors during the COVID-19 pandemic, but the recent rise in coronavirus case numbers has put even more pressure on most retail REITs.

To be sure, there are some retail REITs I would definitely stay away from in the current environment. Regional mall operators, shopping center REITs that aren't focused on grocery-anchored properties, and any retail REIT with limited liquidity are three examples of good types to avoid. On the other hand, there are some retail REITs that should make it through the pandemic just fine and could be excellent stocks to buy for the long term at their current prices.

The right kind of retail

Realty Income (NYSE: O) is a different kind of retail REIT. It invests in single-tenant properties and avoids the most vulnerable types of retail. Nearly all of the tenants in its 6,500+ properties are recession-resistant, immune to e-commerce headwinds, or both.

Specifically, Realty Income focuses on three types of tenants:

  • Non-discretionary: These businesses sell things people need, no matter what the economy is doing, and are largely considered essential businesses (meaning they stayed open even when state economies shut down). Think of drug stores and convenience stores, two of Realty Income's largest tenant types.
  • Discount-oriented: Businesses that focus on discounted merchandise usually do quite well in recessions, as people tend to look for bargains, and these types of businesses also tend to offer deals that the best e-commerce competitors can't match. Two good examples are warehouse clubs and dollar stores -- anyone who has visited one of those businesses recently knows they aren't struggling like many other retailers are.
  • Service-based: Businesses that sell a service, not a product, are naturally immune to e-commerce headwinds. And this has been the portion of Realty Income's portfolio that has been most affected by the pandemic. Specifically, Realty Income owns a fair amount of properties occupied by fitness centers, movie theaters, and other such businesses. The hard-hit businesses make up a relatively small percentage of the portfolio, but this is the primary reason the stock is down more than 30% since the pandemic started.

Realty Income is one of the most rock-solid REITs of any kind (not just retail). It pays a 4.9% dividend yield and has a phenomenal track record. Since its 1994 NYSE listing, the company has increased its dividend over 100 times and has delivered 15.3% annualized returns, handily beating the S&P 500.

Outlets are doing quite well

Tanger Factory Outlet Centers (NYSE: SKT) is by far the riskier of the two REITs detailed here, but it's certainly one that could thrive in the post-pandemic retail environment. And with shares more than 60% lower than their 2020 highs, it could be worth a look for long-term investors with a relatively high level of risk tolerance.

To be sure, there are some major headwinds facing Tanger's business. Several of its major tenants, including Ascena Retail Group (the company's second-largest tenant of all), J.Crew, and Brooks Brothers, have filed for bankruptcy this year, and they likely aren't the last. So, Tanger's vacancy rate is likely to rise significantly as these bankruptcy restructurings play out.

However, the news isn't all bad. Tanger's rent collection increased from 40% in the second quarter to 85% in August, and it has likely increased even further since then. Virtually all of Tanger's tenants are now reopened, and in August and September, the company reported customer traffic that was approaching 90% of 2019 levels.

Outlet shopping is a form of discount-oriented shopping, and just like the discount-focused tenants I discussed with Realty Income, Tanger's properties aren't terribly vulnerable to e-commerce competitors. And while vacancies may rise in the short term, Tanger has reported interest from several large-scale retailers (like furniture brands) that could help fill space. Long-term, there could be significant growth potential, as the outlet shopping industry is rather small in size and could actually benefit from the decline of full-priced, mall-based retail.

Expect a roller coaster ride

To be clear, I'm suggesting these two REITs because I think they'll produce excellent returns over the next five or 10 years, or beyond. Neither is low risk in the short run, and Tanger is one I would put in the "high risk" category even from a long-term perspective. In short, no stock that is capable of multiplying your investment is without significant risk. The COVID-19 pandemic remains a very fluid situation, and there's likely to be quite a bit of volatility as it evolves.

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Matthew Frankel, CFP owns shares of Realty Income and Tanger Factory Outlet Centers. The Motley Fool recommends Tanger Factory Outlet Centers. The Motley Fool has a disclosure policy.