Co-produced by Austin Rogers.
Given how poorly the stock prices for publicly traded real estate investment trusts ("REITs") have performed over the last few years, it would be understandable to believe that this sector of the market is undergoing extreme pressure that will result in a wave of bankruptcies and years of poor fundamentals.
But that is far from reality.
Don't take it from us. Listen to the world's leading commercial real estate ("CRE") experts at alternative asset management giant Blackstone (BX).
Stephen Schwarzman, CEO, and Jonathan Gray, COO of Blackstone, are both self-made billionaires, and they have been on a REIT buying spree lately:
- Preferred Apartment Communities (APTS) for $5.8 billion in June 2022
- PS Business Parks (PSB) for $7.6 billion in July 2022
- American Campus Communities (ACC) for $13 billion in August 2022
- Bluerock Residential Growth REIT (BRG) for $3.6 billion in October 2022
- Tricon Residential (TCN) for $9 billion, announced in January 2024
- Apartment Income REIT (AIRC) for $10 billion, announced in April 2024
Wait, you might think, what about 2023? Why no REIT acquisitions last year?
Last year, BX was overwhelmingly a net seller of real estate, primarily because of the need to fulfill redemption requests for its flagship private CRE fund, BREIT. What's more, interest rates continued to surge higher for most of 2023, making it difficult to price major new acquisitions.
In 2024, though, Blackstone's CEO Stephen Schwarzman says that it has become a "favorable" environment for investment again.
There are multiple reasons for this:
- The cost of capital is most likely at or near its peak level right now as the Fed has signaled that its next move, whenever that comes, will be a cut rather than a hike.
- Valuations in CRE and especially publicly traded REITs are heavily discounted right now. They have priced in all of today's headwinds and uncertainty but none of the future's growth potential.
- The development pipeline of new CRE supply has shrunk considerably due to high interest rates, which will result in a very favorable supply-demand environment (for landlords) in 2025 and beyond.
While there is an abundance of new supply coming to market this year because of favorable conditions for construction starts two years ago, these supply headwinds are virtually assured to be short-lived.
That is especially true for housing, which the U.S. has been under-building since the Great Financial Crisis 15 years ago.
Here's Schwarzman from a recent investment symposium: [emphasis added]:
"That structural shortage provides support. Right now, obviously, the public markets are focused on this near-term deceleration, particularly in multifamily because of the new supply … from some of the Sun Belt markets. … We look at that long-term structural shortage that's out there, we can buy high-quality real estate in good markets and at favorable prices that makes sense for us."
Blackstone has backed up this rhetoric recently with two major acquisitions of Sunbelt residential REITs: Tricon and AIR Communities (aka Apartment Income REIT).
While the market remains obsessively focused on near-term supply headwinds, Blackstone remains focused on the highly favorable medium- to long-term setup.
Here's what Blackstone President & COO Jon Gray had to say on the Q1 2023 earnings conference call [emphasis added]:
The other thing I'd add is on the supply front. We've seen in logistics an 80% decline in new starts. We've seen in multifamily a 50% decline in peak starts -- from peak starts as well. And so that starts to lay the groundwork. In terms of timing, I would think about this period of time is a time of seed planting that you want to be investing into this dislocation because there's a lot of uncertainty, there may be [forced sellers], there may be public companies trading at discounts. And then over time, as things start to normalize, you start to accelerate on the realization. But first, I think it's the deployment period then the realization period as you move out similar to that post GFC period, that's certainly the way we're playing it.
We all know how badly real estate, especially residential but also commercial, performed during the GFC. Indeed, the GFC centered around a real estate crash.
But in the post-recession bull market, publicly traded REITs made a resounding resurgence. From the depths of the crash to the beginning of COVID-19, REITs (VNQ) meaningfully outperformed the S&P 500 (SPY):
Could the same happen over the next decade? Yes, we think it could.
Consider this: REIT balance sheets and financial management are more conservative today than they were before and during the GFC. Leverage ratios are lower, maturities are longer, and interest coverage is higher.
And yet, U.S. REIT valuations relative to the broader market are at recessionary levels.
And this includes even expensive REITs that have outperformed the market over the last year, like Digital Realty (DLR), Iron Mountain (IRM), and Welltower (WELL).
Many individual REITs are trading close to their GFC valuation lows, representing significant discounts to both their historically average earnings multiples and their net asset values (a more accurate version of book value for REITs).
Here's Blackstone's Jon Gray again (emphasis added):
I do think when rates go up, the market tends -- the public markets tend to move much more than what we see in the private market. So for real estate, I do think that creates more opportunity for scalable deployment as some of those stocks move on, particularly if the debt market hangs in there. And so that disconnect can create opportunity.
Put differently, when interest rates rise, publicly traded REIT stock prices tend to fall far more than what their underlying real estate assets would justify.
This decoupling of fundamental asset value and equity valuation is Blackstone's opportunity to buy high-quality real estate at dimes on the dollar.
But this also represents an investment opportunity for ordinary investors like you and me. Hiding in plain sight is the fact that we small-dollar investors can buy shares in the same undervalued REITs that Blackstone is targeting for M&A -- and since Blackstone always pays a double-digit premium to the prevailing stock price, we can buy them at much better prices than Blackstone can!
Given Blackstone's stated and demonstrated desire to acquire discounted REITs, what might their next acquisition targets be?
While we wouldn't recommend investing in a REIT solely based on speculation that it might be a buyout target, we also think that potential shouldn't be totally ignored.
Early this year, Blackstone agreed to acquire Tricon Residential, a Sunbelt single-family rental REIT. Could they have an appetite for more?
Not including Tricon's portfolio, BREIT's portfolio currently boasts only 9% of assets in SFRs.
TCN's enterprise value based on its acquisition price is about $9 billion, making it by far the smallest of the three US SFR REITs. The other two are Invitation Homes (INVH) at over $28 billion and American Homes 4 Rent (AMH) at slightly above $18 billion. Both are larger than any of Blackstone's recent REIT buyouts, but the more likely buyout target would be AMH.
However, it should be noted that neither of these two SFR REITs traded meaningfully higher after the TCN buyout announcement, meaning that the market finds it unlikely that either of them will be buyout targets.
AMH currently trades at a core FFO multiple of about 20x, which is precisely the valuation at which TCN was bought out.
More recently, Blackstone agreed to acquire Apartment Income REIT and has vocalized its attraction to Sunbelt multifamily real estate. Which Sunbelt multifamily REITs are the most likely buyout candidates?
The two biggest, highest quality, and most well-known Sunbelt multifamily REITs are Mid-America Apartment Communities (MAA) and Camden Property Trust (CPT), but these two are both larger than Blackstone's typical deal size. MAA is currently over $19 billion in enterprise value, while CPT is about $14 billion.
Of these two, CPT is the more likely buyout candidate, but neither seem likely to us to accept a buyout offer.
What about smaller Sunbelt (or non-coastal) multifamily REITs? Three come to mind as potential buyout targets:
- Independence Realty Trust (IRT), Class B apartments concentrated in the Southeast and Midwest
- Centerspace (CSR), Class A and B apartments concentrated in the Mountain West and Northern states regions
- BSR REIT (OTCPK:BSRTF), Class B apartments concentrated almost entirely in suburbs of Texas.
As you can see, all three of these multifamily REITs have EVs in the range that would make them buyout candidates for the likes of Blackstone. While IRT and CSR are about the size that Blackstone typically seeks out, it should be noted that BSR's suburban, Class B apartments in fast-growing Texas markets are highly desirable and fit very well with Blackstone's stated target.
The Canada-listed REIT is trading at a ~40% discount to its internal estimate of NAV, and better yet, its management team owns over 1/3rd of the equity and is thus highly aligned with shareholders. If BSR's management team does not see a realistic path to close that discount to NAV, it seems likely that they would accept a buyout offer.
Bottom Line
Many investors today have thrown in the towel and sold their REITs, believing that the entire sector is fundamentally impaired in the face of higher interest rates.
That couldn't be further from the truth.
Fundamentals across most sectors of CRE remain strong, and REIT balance sheets are more solid today than they have been for most of their history.
Like Blackstone, we are happily buying heavily discounted shares in high-quality REITs. Perhaps we will enjoy quick gains from buyouts, like we did with our positions in TCN and AIRC.
But even if we don't, we rest easy knowing that we own quality, shareholder-aligned, fundamentally strong assets that should outperform eventually no matter what.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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