The REIT rally

0:10David Auerbach:David Auerbach, always great to have you on Investing Experts. Welcome back to the show. Great to see you, Rena. It's been way too long, it seems. It has been way too long, and it's always great to talk real estate with you. I think now is as good a time as any to get into it. For a refresher, you run Hoya Capital on Seeking Alpha and outside of Seeking Alpha. Talk to us about how you're thinking about and looking at the real estate picture these days. We have threats and talks of hikes when it comes to interest rates. How would you encourage and how are you thinking about the REIT and real estate space right now?

0:45You know, I was thinking about this. What's funny is really not much has changed since we last spoke. We're in an elevated interest rate environment. We're in an elevated 10-year treasury environment. We're dealing with market volatility. Last time, I believe it was tariffs. This time we have oil in the Middle East conflict. You know, there's always big macro headlines that are overhanging the REIT sector. But at the company level, fundamentals continue to remain fairly solid. Dividends continue to rise across the board. M &A activity continues to grow. So we think that regardless of what's going on in the macro environment, the real estate investment trust sector is still a great place to park cash and earn dividend income by frankly living our daily lives.

1:34You know, quick example, you and I are using a data center to facilitate this conversation as well as to watch it at the end of it on the backside of things. You and I didn't think about where interest rates were at, what's going on overseas, what Kevin Warsh is going to do as his first Fed meeting as the chairperson. You know, we hit the record button and we're doing our jobs. So, you know, I feel like at the end of the day, the goal really is to look at the fundamentals of the various companies and realize that by and large, companies are standing on solid footing as we speak.

2:06David Auerbach:Let me ask you, before we get into some of those fundamentals and themes and what have you, would you say that the narrative around or the correlation between interest rates and REITs has changed as time has gone on and as narratives have evolved? Yeah, so we did a little bit of work on this ahead of time because we were thinking about this. You know, we took a look at the correlation of VNQ, that's Vanguard's REIT ETF, comparing it to the 10-year Treasury. And if you look back from 23 to 25, it was pretty close in a one-to-one correlation. Rates still matter, but it doesn't seem to matter as much versus prior years.

2:46A lot has changed that with many of these REITs trading in perpetual discounts to net asset value, you're seeing management teams get very creative in trying to find ways to unlock value regardless of this higher for longer or call it high for long environment that we continue to operate it. At the end of the day, though, if you look at year to day performance, the REITs are up around 12 percent. The S &P is up about 8%. But the REITs are still underperforming the S &P by about 60, 6-0 percentage points since mid-22. So we still have a long way to go. One of two things has to happen, frankly. REITs have to rally, S &P has to sell off, or some combination of both.

3:31David Auerbach:What is your sense in terms of REITs rallying? You know, it's interesting that you asked that question, because look at today's performance as a perfect example. You know, the broader markets are down a percent or more, give or take. And yet the REITs are outperforming today. So this is one of those stories that it seems like REITs are holding up pretty well in a volatile tape. You know, we've seen headlines that VIX, the volatility index is spiking. Talking heads are focusing more on the big stories like the SpaceX IPO or Anthropic or OpenAI or some of these other things. And so, you know, in any other given environment, I think the REITs would be getting a lot more attention because we've seen a couple of different REIT IPOs come down the pipe recently.

4:20We've seen a couple of big mergers announced. And like I said, it's on these management teams to try to find ways to close that gap to their discounts to NAV.

4:28David Auerbach:What would you say or what have been some of the M &A movements that have excited you or that you feel like investors should note at the very least? From a very, very high level perspective, it seems like, and again, I want to be careful as I say this, but I get the impression that most, if not all, small and mid-cap REITs are in play in some form or fashion. Most of the M &A transactions that we've seen recently have occurred between the mid-cap REITs and the small cap REITs. The most unique example, though, was announced a couple of weeks ago where two large cap REITs, Avalon Bay and Equity Res, two of the largest apartment REIT landlords in the country, announced a merger.

5:11Now, I think that's potentially a one off. I don't think we're going to be seeing some of these mega REITs continuing down this merger path. But we have, like I said, seen a lot of these mid cap names in play. And so wouldn't surprise me if we see more private players taking public REITs out? I feel like the public to public M &A picture is going to be more fragmented than potentially the private capital sitting on the sidelines. Because again, I can go out as a private guy, acquire a publicly traded REIT with an established platform at a discount, frankly, let's say 75, 60 cents on the dollar, something like that, and have exposure to properties coast to coast.

5:54And so I feel like there's a lot of hungry money sitting on the sidelines.

5:57David Auerbach:You mentioned that we're both utilizing companies and features that have to do with REITs, but we're not thinking about interest rates and how that affects them. What would you say to the themes that we can't escape but be affected by? How is that affecting the REIT and real estate space in terms of the economy, in terms of inflation playing out? How have you seen that affect things lately? It seems like copy, paste, repeat. REITs are interest rate sensitive. Interest rates are up, Therefore, REITs are under pressure. And I always like to try to write that misconception because, again, it's business as usual.

6:36Lending windows are wide open for REITs. They're able to raise Buku's amount of capital at the lending window. With REIT performance ticking up here in the past week or so, you know, we've seen REITs kind of trickling back into starting to do forward equity offerings. I feel like a lot of these management teams and companies really just kind of put on the blinders and just focus on the operations. The headlines are always going to be out there. It's how the companies respond to those headlines. And I just want to remind, you know, any viewer or listener, with the exception of a hotel REIT that is a one-night contract, which I guess you would call the most risky contract that's out there, an apartment REIT typically is a one-year lease.

7:23offices are five to seven same with shopping centers and you can go all the way up to a ground lease which is a 99 year lease term so as a result i feel like the reeds are kind of insulated from the day-to-day headlines when these long-term leases are locked in place with sent set rent bump escalators and obviously we had today's cpi report that came out and i think again today's performance is a perfect example of that market is down on a hot inflation report and yet the REIT sector is trading higher mostly. So again, I feel like it's on the company, its management team. You know, last week was the big real estate conference in New York, the big NAE REIT conference at the St.

8:05Hilton where you guys hosted your event a couple of years ago and we had our first conversation. And the reason why I mentioned this is I was having dinner with one of my former colleagues one night and he actually presented, you know, I hadn't thought about this. So Reen, I'm going to give you a test here real quick. You ready? What's the number one rule of real estate?

8:21David Auerbach:Well, somebody once told me location, location, location, but then last week somebody told me management, management, management. Well, you kind of ruined my surprise there because you were correct. The number one rule of real estate is location, location, location. The number one rule of REITs is location, location, management. So at the end of the day, at least when it comes to the REIT industry, you've got to look towards management and see how they're kind of guiding that shift. through the open waters. And there's great management teams that have long-term track records that are out there with deep benches, as I like to say, where that person that gets promoted into the C-suite has already been at that company for 5, 10, 20 years.

9:07So they know how that company operates. They've been through different cycles. As I like to say, these management teams, no one to go on offense, no one to go on defense, no one to turn left, no one to turn right. And they're not going to let a simple headline come out from CNBC that dictates their future path.

9:24David Auerbach:What about like trends that like, let's say, have you seen reflections in the retail space of budget retailers doing better or high end retailers staying status? Have you seen anything like that, which I totally understand and agree with and hear your point about the day to day headlines, you know, not affecting things. And in general, we are too swayed by them. 100 % agree. But then there are also themes that are changing our behavior as consumers. Have you seen A, that be reflected in the REIT space and in the real estate space? And B, what companies would you highlight or the converse of that, or do you think have done a poor job at reacting if you've seen anything like that?

10:04You were talking about the retail industry real quickly. I'm guessing that meant not the retail investor, but the retail sector as a whole. Is that correct? Correct. Perfect.

10:12David Auerbach:Correct. So retail is one of the more positive sectors at the, first of all, the NAIRED conference, the tone was upbeat more so than in recent years because by and large, fundamentals are stronger than what the public markets are valuing them at currently. Retail is that perfect example because the sector is benefiting, frankly, from a lack of new supply. So with healthy tenant demand, this lack of new supply, strong leasing spreads. Tanger has been reporting double digit leasing spreads recently. You know, they're able to push rents. Retail is still a place that's, you know, out there. Remember, retail is a wide swath.

10:53You've got the discount dollar stores all the way to the luxury goods providers and everything. And a guy like Tanger, you know, which runs experiential outlet malls, whatever you want to call it, is kind of focused on all of those different tenant makeups that make up their portfolio. So they are still seeing strong healthy demand. If you look at a lot of these sectors that are out there, office is seeing a positive momentum. They're seeing more leases. There's signs of, you know, in your neck of the woods of AI firms leasing space at office because they're anticipating this growth curve that's up ahead.

11:26Residential continues to improve. The residential meaning apartments and single-family rentals. Hotels reported positive quarters. And industrial, you know, it seemed like across the board, a lot of these companies were very positive. Now, on the flip side, I wouldn't say anybody is doing it poorly. You know, we like to say that of the 20 different subsectors that are out there that make up the REIT industry, each of these subsectors is in a different stage of the real estate cycle. And I've used the analogy before with you, like the REIT industry is like your graduating class in high school. You have the top 10 percent, the valedictorian, the salutatorian, the REITs in the S &P 500.

12:06You've got the bottom 10%, the bullies, the troublemakers, the REITs that cut their dividend or the REITs that are over levered. It's that middle part of the curve that you're going to see that performance. And it's frankly, those students or companies that go under the radar that are really drawing all the attention, but don't get the news coverage that they deserve. So, you know, as an example, storage, like self-storage properties or even cold storage had been under pressure over the past, you know, call it year. But even they are starting to see signs that their fundamentals are starting to improve.

12:39By and large, fundamentals are pretty solid. And let's say they're healthier than the current market sentiment is suggesting. And should rates, should rates come down, which obviously we know that they're probably not going to, you know, this is a sector that could be poised for a setup to see a lot more consolidation and potential further growth.

13:02David Auerbach:Speaking of headlines and REITs that are affected accordingly, you know, there's news out of the cannabis sector in terms of rescheduling. True Leave, one of the major companies, just uplisted. Anything to say about IIPR, New Lake Capital, or any of the cannabis REITs in general? I can tell you that the management teams are sitting here going like this. Come on, baby. Come on, let's go. I think once that domino falls, it lifts up the vice angle and unable to invest mantra with that sector. When the banking laws are relaxed after this rescheduling occurs, and again, we could be talking still multiple months down the road.

13:50I think the key then is exchange and platform availability. You know, IIPR is a very unique beast in itself on how they were able to list versus a New Lake or some of these other players that are out there. And I think it's this visibility angle that a lot of these cannabis players are looking for because, frankly, a lot of advisors still can't touch the sector because it's not available to trade on a lot of different platforms. right now you know speaking with some of these players all i can tell you is that they're waiting for washington to tip it over and they're ready to hit the ground running once that

14:29David Auerbach:happens last time you were on you were talking about strawberry fields reed which is in the health care space and you were talking about one of the things that you liked about it was its dividend anything to say about strawberry fields anything to say about the health care space happy to hear your thoughts well a lot's changed since we last spoke about strawberry fields and that the portfolio continues to get bigger and the dividend has gone up. So that worked out well. You know, speaking of health care, we have seen two, one very big and one big IPO that occurred in the health care space in the past quarter.

15:05Janus Living, which was spun off from Healthpeak, the ticker is J-A-N, and then National Health Care Properties, NHP, which was a private to public conversion. You know, so we are seeing a lot of renewed interest in the space. Look, the sector has been very strong over the past year or two. Again, lack of new supply, the number of consumers or tenants growing into these properties as baby boomers retire, Gen X on the horizon, et cetera. You know, again, so this is a sector that has done very well. Now, in the past couple of weeks. It's been a little bit weak. But this is a sector that, again, is dominated by, you know, a Ventos, a Well Tower, and then there's kind of everybody else that's out there.

15:52And again, going back to that mid-cap example where you're talking about at the beginning, it's all these other companies that are really kind of moving that needle. Because again, when you're as big as a Well Tower is, you know, it takes a lot to move that needle and grow versus, you know, Care Trust and LTC, some of these other players, you know, if they go out and acquire a portfolio, you can actually track meaningful earnings growth from it. Again, thinking about long-term investors that play in the REIT industry, senior housing and healthcare is a great place to be, frankly, because again, you're thinking about that tenant 10, 25, 50 years from now that's going to be living in those properties.

16:28And it's a sector that's, again, ripe for development and evolution.

16:32David Auerbach:What would you say in terms of updating listeners about your two ETFs that you run at Hoya Capital, H-O-M-Z and R-I-E-T? Thanks for asking. Homes, H-O-M-Z, frankly, nothing has changed since our last conversation when it comes to homes in that home affordability is out the window. Mortgage rates remain highly elevated. The average consumer can't buy a house. And therefore, it's the residential REITs, the single family rental players, all the other companies that make up the industry that benefit from this. This is, you know, again, a sector that you have to take with a long term vision. And hopefully as the housing market continues to perk back up from this multi-year slumber, homes might be a great way to play it.

17:21Just because, again, we feel it's truly the most all-encompassing way to cover the housing industry through the home builders, through the residential REITs, through the suppliers, the home goods and furnishings such as Home Depot and Lowe's, and all the service providers, the mortgage brokers and everything that make up the industry. REIT, R-I-E-T, completely different focus. Again, this is looking at the income side of things. REIT recently passed$100 million of AUM, so we're growing there. Volume seems to be ticking up. Our dividend remains very steady. I think we're yielding around 10.5%, 11 % approximately.

18:00Annualize that we pay a dividend on a monthly basis. You know, again, the story there is figure out which of these REITs, you know, frankly, pay the highest dividends that have low leverage. It's a very unique ETF in that it combines both common and REIT preferred stocks. We do skew it towards small and mid-cap REITs, as mentioned. We've got exposure to some mortgage REITs. But our goal there is to try to capture as much income as we possibly can. And again, we've seen that kind of play out because of some of the REITs that have gone through this M &A process, as I mentioned. But if you look at Hoya, Hoya published some great research, again, a little bias.

18:38But, you know, with some of the research we put out, we have like a dividend tracker. And if you look at all the REITs that have raised their dividends versus just one or two that have cut their dividends, the goal is to see that dividend increase table continue to grow throughout the year. And it seems like we're going down that path.

18:55David Auerbach:Anything else that you would share with our audience about what you took away from the conference last week in New York? Anything that surprised you or anything that you were felt validated by? Anything else to share there? It's interesting you ask that because we just came out of earnings season in late, call it mid to late May. And you want the companies to refer to, as we just reported a couple of weeks ago, here's where we're at this quarter, you know, that they're basically telling you, again, it's business as usual. Some of these companies actually had, let's call it better May months than were anticipated, kind of setting up the stage, hopefully for a good second quarter earning season.

19:38You know, I feel like, you know, with this interest rate, Paul, that's cast over the market, you know, that a lot of these companies are talking about, yeah, but our fundamentals are solid. Our FFO is growing. Our NOI, our profits are growing. You have to kind of look through the noise to understand what's going on at the company level. But again, also noting that, As I like to say, I have no control over my ETF stock price. The REIT management teams have no control over their company share prices. All they can do is figure out ways, frankly, to boost that discount to net asset value. So what does that mean?

20:17Asset sales, joint ventures, stock buybacks, simplifying the story, being select on M &A. You know, there's a lot of different tools that these companies can use at their disposal to try to create value. Hoya, we've done a very good job of covering all of the various M &A activity that's occurring in the space. Every single day, there's a great story that's out there that 99.99 % of the time is not being covered by any of the media folks, but we are covering it because our job is to highlight all of, frankly, the good, the bad, the ugly that makes up this space and realize, how do I capture dividend income off of this story.

20:58So example, Vernado announced two big leases at Penn 2, which is in Penn Station, their office development that's out there. And Penn 2 is now 90 % leased. Thinking about it from a dividend income perspective, we have a 10-year lease locked in with two different players. Here's what the rent bump means. Here's how that's going to translate to income in my shareholders pocket at the end of the day. Number two, you know, another thing that a lot of these management companies are trying to focus on is what's the cost of borrow? I'm investment grade rated by S &P. I know that I can go out and get five-year paper at X, 10-year paper at Y.

21:38They know to the day of what the borrow rate is. And I feel like a lot of these management teams are, again, trying to go on offense with their messaging saying, look, if you're concerned about REITs being interest rate sensitive, that's great. Guess what? We don't have any debt coming due until 2029 or 2030. We're good. So let all this volatility happen out there because we're already locked in for the next few years. Remember, with publicly traded REITs, one thing that you get compared to a lot of other sectors that are out there is what I call transparency, earnings press releases, earnings conference calls, earnings supplements.

22:13They publish basically every single lease, all the lease expirations, all of this stuff. But on the other side of that coin is how approachable REIT investor relations teams are. So again, anybody listening to this, watching this can pull up their favorite REIT, look through the earnings supplement, walk away with a question, email the investor relations person at the company, and sometimes you might even hear from the top brass themselves answering that question. The companies want to answer investor questions. They are very shareholder friendly to try to satisfy all of those investor inquiries because, again, we're in an industry that's frankly dominated by news that's dropping by the second or a tweet on some social media platform.

23:00And these REITs are operating, again, with much, much different lenses than what some of these other call talking heads are focusing on.