September 29, 2022

6 Undervalued REIT Stock Picks to Boost Returns

  • Todd Kellenberger is a REIT client portfolio manager at Principal Global Investors.
  • He told Insider that six non-traditional property picks are producing benchmark-beating returns.
  • Kellenberger also said he selects REITs based on the qualities of the company and their location.

Retail investors should shrug off recent concerns about a real-estate-market bubble and continue to buy REITs, according to Principal Global’s Todd Kellenberger.

“Demand is exceeding supply, and you have accommodative monetary policy, you have open well-functioning low cost of capital available,” Kellenberger told Insider in a recent interview. “There’s definitely reason to believe that it is an opportune time to be investing in real estate markets today.”

That’s good news for Kellenberger, who manages Principal’s $25 billion

client portfolio. A REIT (real estate investment trust) is a company that owns income-generating properties. Individual investors can buy individual shares of REITs on a stock exchange, which makes them more liquid than traditional real estate investments.

Kellenberger trades REITs for Principal, a top-10 global real estate fund with almost $100 billion under management. He said that when selecting investments, he looks for one thing above all else: quality.

“We look for assets that are rich with the amenities that tenants desire, but also companies that are steered by strong management teams, strong balance sheets, and corporate governance,” he said. “We look to pay below average prices or valuations for those companies.”

Location is another important driver for Principal Global. In the US, rents have fallen in the traditional economic centers New York and San Francisco as workers have moved further away from the office to take advantage of the work-from-home trend.

“The old adage that location matters continues to be just as important today,” Kellenberger told Insider. “You need to continue to emphasise owning assets in very relevant long-term locations with multiple demand drivers, whether it’s migration, employment, or economic activity.”

While he is optimistic about the real-estate sector’s long-term health, Kellenberger said that certain sectors are currently underperforming. He said that REITs holding hotels and offices have underperformed during the coronavirus pandemic.

“You have areas of the market that have been negatively impacted in a big way and there are some real long-term risks,” he said. “But certain areas of the market are really benefiting in a big way from structural or secular drivers of demand.”

Kellenberger said that investors should concentrate on REITs that hold six under-the-radar property types, all of which are outperforming expectations in the current market. He said that while the global REIT market is priced for “upper single-digit type returns”, these investments could beat that benchmark.

REITs to buy

Kellenberger said that REITs that finance and operate single-family rentals (SFRs) are currently the most attractive investment. SFRs are single family houses that tenants rent, rather than own outright.

“REITs that own large portfolios of single-family homes and rent them out are institutionalizing what smaller players have done for a long time,” Kellenberger said. “We’ve seen strong demand trends that have accelerated due to work from home, where people are no longer worried about a commute and are seeking more of a suburban location.”

The two largest SFR REITs are Invitation Homes (INVH) and American Homes 4 Rent (AMH), according to Seeking Alpha. These two firms respectively account for 58% and 34% of housing in the sector.

Manufactured housing REITs are also appealing for investors, according to Kellenberger. These trusts own and operate a lot where a tenant can set up a prefabricated house.

“This is the kind of niche area that from a real estate investor perspective has been very attractive because you have very low capital expenditure,” Kellenberger told Insider. “The tenant brings the house – that makes it a very high cash flow generating type of business.”

Equity Lifestyle (ELS), which has a market capitalization of $16 billion, and Sun Communities (SUI), which is valued at $23 billion, are the two largest players in this sector.

connect homes prefab homes

Manufactured housing REITs invest in lots for pre-fabricated homes.

Connect Homes

Kellenberger added that self-storage REITs are another emerging investment area, particularly in Europe.

“There continues to be strong growth and expansion of self-storage facilities across cities in Europe and the UK,” he said. “We’re seeing strong demand for people wanting to rent out those facilities for a variety of reasons – maybe you’re moving and you need to store your stuff, maybe you cleaned out a second bedroom to make an office because you’re working from home, maybe you’re running a small business and you need some extra storage space.”

The self-storage REIT market is currently dominated by a ‘Big Five‘, according to the property website Million Acres. The largest of those is Public Storage (PSA), which has a market capitalization of $57 billion and trades on the New York Stock Exchange.

REITs investing in life science offices are also benefiting from current demand drivers, according to Kellenberger. This refers to office space featuring labs and medical research facilities.

“Biotech and pharmaceutical companies are performing very specialized work, particularly in innovation hubs like MIT in Cambridge,” Kellenberger said. “Large universities retool these types of assets.”

The largest publicly-listed REITs in this sector are Alexandria Real Estate Equities (ARE), Healthpeak Properties (PEAK), and Ventas (VTR), according to the advisory firm Newmark.

Kellenberger told Insider that data center REITs continue to be attractive investments. He said that the pandemic has strengthened these companies.

“There’s a very strong fundamental story where REITs are helping to provide the infrastructure for our virtual world,” he said. “We use IT systems every day, both in work and personally; REITs are some of the largest owners of data center assets in the world and have strong global relationships with major corporations that need to lease that space.”

There are currently five publicly-traded data center REITs that investors can buy. The two largest by market capitalization are Equinix (EQIX), which lists on the Nasdaq, and Digital Realty Trust (DLR), which lists on the NYSE.

Data center

Kellenberger said that data center REITs have benefitted from the work-from-home trend.

Thomas Trutschel/Photothek via Getty Images

Lastly, Kellenberger said he’s been looking into the wireless tower REIT sector. Like data centers, these have been boosted by online and remote working, as well as the ongoing 5G rollout.

“These companies own the towers, and wireless carriers like Verizon or AT&T are leasing enough space to put up their antennas,” he told Insider. “5G is causing more and more leasing activity from carriers to put new technology on towers – it’s another area that has a very steady, consistent structural and secular growth trajectory, and we like it a lot.”

According to Seeking Alpha, the two largest publicly-listed REITs in this sector by market capitalization are American Tower (AMT) and Crown Castle (CCI). Those two companies have a market share of 49% and 35% respectively.