The Market Crashes: Here’s What I’m Buying

DNY59

The past month has been quite volatile in the Real Estate Investment Trusts (“REITs”) market.

Just as it looked like the market was starting to rally, it was hit by another dip that put it right back into one bear market:

diagram
VNQ data from YCharts

What is causing this volatility?

In short, it appears the Fed is even more hawkish than many feared.

They are willing to raise interest rates for as long as it takes to bring inflation under control, and they will not hesitate to raise interest rates even if it pushes us into a recession. In fact, the Fed’s recent comment made it seem like a recession might even be their goal.

They try to reduce inflation by destroying demand. Powell predicted that there would be “very likely some softening of labor market conditions” and “some pain” for households and firms, but “a failure to restore price stability would mean far greater pain in the long run,” he added.

Investors fear recessions… so of course it triggered a big sell-off:

US stocks suffer biggest drawdown since June

Bloomberg

But as we explained in a recent market update, a recession could actually be a good thing for REITs (VNQ).

I know it may sound counterintuitive, but listen to me:

REIT investors are primarily concerned about rising interest rates right now, and this is the main reason REITs are down 20% year-to-date.

Interest rates are rising because inflation is high, but a recession could solve all of that. It would likely cause inflation to cool and hence interest rates to freeze and possibly even decrease interest rates.

In this respect, a recession could actually be a blessing in disguise for REIT investors. It would eliminate the market’s main concern, which is rising interest rates. REIT investors don’t worry too much about recessions anyway, as REITs are notoriously resilient (contractual earnings and low leverage).

Historically, REITs have fallen an average of just 9% during recessions. Today, REITs have far stronger balance sheets than they have in the past, their rents are rising at their fastest in years, and valuations are also at multi-year lows, which should offer better downside protection. Despite this, REITs are currently down 20%:

REITs outperform in recessions

Cohen & Steers

So bad news for the economy could be very good news for REITs.

It’s a case of short-term pain for long-term gain, and strange as it may sound, a recession could be the catalyst for higher valuations in the short-term.

This is especially true for REITs that:

  • Earn recession-proof cash flow.
  • Are already greatly reduced.
  • Would benefit a lot from falling interest rates.

We don’t normally mix trading alerts in our monthly portfolio review article, but today, for once, we’re making small additions to a number of our holdings that exhibit such characteristics.

As always, we want to remind you that we don’t have a crystal ball and cannot predict that this bear market will last long. But historically, high-quality REITs always bounce back, and those who have the courage to buy them cheaply will be richly rewarded.

Here are 3 of our favorite REITs to amass in this environment. We expect to share exclusive interviews with their management teams in the coming weeks:

#1 REIT – Essential Properties Realty Trust, Inc. (EPRT): It generates steady, recession-resistant cash flow from more than 15 year-long leases, has a clear path to long-term annual growth of 6-8%, yet is valued at just 13x Funds from Operations (“FFO”) and pays a dividend yield of 5% This year, the company has forecast even faster growth of 13%, but the market doesn’t seem to care. Between returns and growth, you can expect annual returns of 12-15%, but we also expect growth of 40% and more at fair value. We are currently working on a management interview which we expect to share with members in the near future.

Essential Properties Realty Trust Inc EPRT NYSE |  REIT Notes

Essential Properties Realty Trust

REIT #2 – STAG Industrial, Inc. (DEER): The STAG portfolio of industrial assets is currently experiencing the fastest rental growth in its history, with new leases being signed with 15-20% rent increases. Its biggest tenants are companies like Home Depot (HD) and Amazon (AMZN). Its balance sheet is the strongest in its history with significant capacity to purchase additional properties to fuel growth. Despite this, shares are down 36% year-to-date and are now trading at an estimated discount of 25% to NAV, which is exceptional for an industrial property. We expect upside potential of at least 30%, but likely closer to 50% on a future recovery. While we wait, we’re earning a 5% monthly dividend yield.

STAG Industrial E-Commerce Warehouse

STAG Industry

REIT #3 – NewLake Capital Partners, Inc. (OTCQX:NLCP): Cannabis use doesn’t change much in a recession. In fact, it can even grow like alcohol as people look for a relatively cheap escape from their daily stresses. Of course, cannabis rental companies are even more resilient as they generate steady rental income from triple-net rentals. Additionally, NLCP has almost no debt and just recently tripled the size of its credit facility, which should allow it to purchase many more assets at large positive spreads in the coming quarters. Despite this, NLCP is down 50% year-to-date as its share price plummeted along with the rest of the cannabis sector, and as a result it now trades at a dividend yield of nearly 10%. The high yield, coupled with the rapid growth prospects, could realistically give investors a 20% annual return for years to come.

Cannabis cultivation facility by NewLake Capital Partners

New Lake Capital Partners

These 3 REITs are all good examples of recession-resistant companies that are undervalued and will gain big when we finally enter a recession and interest rates stop rising once inflationary pressures ease.

We will continue to accumulate these REITs and others in many phases with small weekly additions. We think this is the best approach as we know prices will eventually recover but cannot time the market.

Will we be right on every single one of these tips? Probably not. But on average, these REITs are so heavily discounted that we should be making attractive returns even if we take a few losers along the way.

We are currently working on a series of exclusive management interviews to test our thesis and are also preparing some new investments which we will be happy to share with you in the coming weeks.

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