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REITS to Consider as U.S. Housing Market Tumbles

REITS Investing

As the dust settles and markets digest a dire realization, housing markets - which seemed to be the focus for investors and home buyers alike during the 2020-2022 period - are becoming an area of peril for some residents following the largest decline in value since 2008

Investors would be well served to keep in mind that while the pie may have shrunk for the nation as a whole, some of its pieces have taken a bigger share of the feast, when the market undoubtedly recovers in due time these larger pieces will be right there to enjoy the excess of an upcycle. 

Regions shrunk and expanded

Breaking down the preliminary results for the 2022 United States building permits survey by state, there are a couple of trends that become palpable if not highlighted on their own. The major trend is the share of national permits by region and state, where the South and Mid South take the bulk of the building activity in the tune of 73% of overall national permits. New York and California take the backseat for the preliminary annual permits, representing approximately 18% of permits. 

So why are permits flows important? Well as permits get approved they usually point to a healthy series of industries which all revolve around credit and financing to function properly. From a construction loan all the way to a mortgage, more permits signify a healthy credit market held up by the reinforced pillar of housing buyer demand. 

These permit flows however are only the beginning stage of an underlying major move, which developed all throughout the year in migration terms. With these hotter states providing a value proposition in more square footage for less money and lower taxation for individuals and businesses alike despite the lower typical wage rate.

These migration patterns, people leaving New York and California to move into the "Sunbelt" region caused a buying and selling spree from and to these respective regions thus affecting prices and demand. While these patterns are natural and happen every once in a cycle, the latest one has been amplified by the FED stimulus and dirt cheap money through rock bottom interest rates. This amplification, or the proverbial pendulum swinging too much one way, will likely cause an equal or greater swing to the opposite direction. 

Opposite poles, same planet

Some habits never really go away, and never do some portfolios either. Companies like Highwoods Properties (NYSE: HIW) have historically focused on buying income-producing residential real estate in areas like Florida, Texas, North/South Carolina with these three major hubs representing 60% of their 2021 Net Operating Income (NOI).

This firm has been beaten to only 7.3x its five year average free cash flow, carries still responsible Net Debt/EBITDA ratios for a lower capitalization REIT focused on acquiring and expanding rather than maintaining as well as implying a near 20% upside according to analyst consensus price targets.

Great exposure to these highly growing markets has been unfairly discounted along with the whole market and industry since the Vanguard Real Estate ETF VNQ (NYSE: VNQ) has declined only a fraction of what Highwoods has despite the latter deriving its NOI from the fastest appreciating markets. 

Moving to a recognized household name, Essex Property Trust (NYSE: ESS), whose Net Operating Income is highly dependent on established markets like New York and California, as of 2021 these regions delivered approximately 81% of the firm's NOI. Essex, despite its 36% drawdown from the 52-week high stock price, still trades at a three year average free cash flow multiple of 19.9x making it significantly more expensive than its Southern counterpart; keeping in mind that housing market dynamics should fundamentally dictate the opposite. Looks like fundamentals do still matter after all, since analyst price target consensus also reflects a lower - almost half - upside in the stock.

Income and appreciation

When investors think of real estate, the legendary tag team of rental income and price appreciation takes the podium, however not many are aware these benefits can also be achieved through a properly selected REIT, which by law is required to pay out 90% of net profits to its shareholders in the form of dividends while also providing the liquidity that equities provide unlike a hard asset. 

Income generation potential has to go to Highwoods which currently yields a 7.4% yield, while also providing the upside potential already mentioned. Compounding this return over a few years, knowing that tailwinds are also at play over a longer time frame can really justify opening a slot for this stock in any investor's watchlist. 



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