REITs Are Boring And Boring Is Good

Summary

• REITs have underperformed since 2022 rate hikes, but Hoya Capital’s David Auerbach says fundamentals are strong, especially among small and mid-cap names offering attractive yields.
• Interest rate sensitivity in REITs is often overstated.
• Earnings season highlights include strength in senior housing, data centers, and retail REITs, while office and lab space face challenges.
• Hoya Capital’s HOMZ and RIET ETFs’ diversified exposure, focus on holistic housing and high-yield, low-leverage REITs, respectively.

Rena Sherbill: Welcome back, David Auerbach, Chief Investment Officer at Hoya Capital. Great to have you back on Investing Experts talking REITs. Welcome back to the show, David.

So bring us up to date. We’ve seen a lot of underperformance in the previous years from the REIT space. There’s some promise of some higher performing stocks when we look at that space. What are you thinking about? What are you looking at? And maybe bring us up to date about how investors should be thinking contextually about the REIT space.

David Auerbach: A lot to spend right there in that one question we could probably spend an hour just on that alone. Let’s just take a step back here.

If you look back to when the Fed started hiking interest rates back in March of 2022, the REITs have underperformed the S&P (SP500) by about 70 percent. So to say that that’s a massive sell off is an understatement. If you go back to the global financial crisis under performance, that was around 20 percent.

So as a result, REITs are no doubt very cheap, but it does constrain them because it means that there could be high costs of capital. External growth is somewhat difficult to come by. However, if you peel back the layers of the onion, what you’ll see is that by and large, fundamentals are very solid across the board.

If you take the whole REIT asset classes, I like to say in conversations, the REIT sector is like your graduating class of high school. You have the top 10%, the REITs that are in the S&P 500, the valedictorian, the salutatorian of your class. Then you have the other side of the curve, the bottom 10%, the bullies, the troublemakers, the REITs that cut their dividends or the REITs that are over levered.

But what we like to do is focus on that middle part of the curve, the 150 students that go under the radar that don’t draw attention, cause conflicts or anything. And that’s really in the small and mid cap REITs.

That’s where you’re going to see some of these opportunities, especially when you look towards more yielding income oriented investments, where we do see those opportunities.

The end investor wants a company to do four things at the end of the day, really four things. Grow revenues, grow profits, grow dividends, and grow annual guidance. If a company is able to do those four things, regardless of what macroeconomic headlines are being thrown their way, you would assume that that company is on solid footing.

Now, like every other sector that’s out there sure there’s a couple of bad apples as part of this entire bunch but the broad entire scope of the universe most of those four things are happening on a quarter after quarter basis here’s how to look at this we just wrapped up third quarter earnings and i know we’re going to get into it but if the companies that provide 2025 earnings guidance, more than two thirds have raised their guidance.

More than a third of these REITs have raised their dividends this year. And more than 60 % of the companies raised their net operating income guidance for this year. And this is in the wake of tariffs rising at our high interest rates, a 10-year treasury that continues to remain elevated, treasury rates remains elevated. All of these macro factors are being thrown at the company.

So at the end of the day, an investor wants a management team, whether it’s Jensen Huang at Nvidia, Tim Cook at Apple, or David Simon at Simon Property Group. They want that management team to put the blinders on and focus on ways on how they can grow revenues while cutting expenses in the hopes of maximizing profit or net income that is passed through to shareholders in the form of dividends.

Rena Sherbill: I wanna get to the dividends in a second. I’m curious though, because of this rate environment and this questioning, by the way, for a deeper dive into the question of how the rate environment is affecting REITs, on December 9th, you are going to be part of a webinar with Daniel Snyder. So look for that, that’s at 2 p.m. Eastern on December 9th.

But in this rate interest conversation where there’s the promise of lowered interest rates after a couple of years of higher interest rates, how does that figure in and how does that play into how you strategize looking at REITs in general? And then in terms of the dividends, how does that affect things?

David Auerbach: A great question and you know from a very high level I want to start out by saying there’s this misconception that I like to say that REITs are interest rate sensitive.

Going back to what you learned in your finance class we were always taught that REITs are kind of like that contra beta to the market as in when the market is up REITs are down when the market is down REITs are up and now coming out of COVID for the past few years it seems like everything trades a lockstep with each other.

Number two, when they say that REITs are interest rate sensitive, I call BS on that because really when I think about REITs, I think about the end consumers that use these REIT-owned properties every single day.

But I think one other key piece that is kind of getting overlooked is that many of these REITs have, you know, investment grade ratings from a lot of the ratings agencies, Moody’s, S&P, Fitch. So they know what the borrowing environment looks like.

In a given day, the CFO knows what the lending environment looks like. And can I borrow your paper today at five, 5.05, 5.1. It’s not like that that window moves very much on a day to day basis. Again, it’s in those times of volatility where you see those big jumps. But let’s get back to your question.

We know that there is going to be a more, we’ll say dovish incoming Fed chairperson next year. We don’t know who yet, but we know that the goal is to bring in somebody that’s going to be much more favorable and let’s say aggressive in cutting interest rates. Therefore, those tailwinds should benefit the REITs sector as that happens. But it’s more than that. REITs are compared to fixed income.

Thus why REIT yields are always closely scrutinized versus the 10-year treasury because they kind of trade in lockstep with each other. So if the average REIT dividend yield is around 4 % right now, while the 10-year treasury trades north of 4%, that would technically make fixed income a more attractive investment vehicle. But if you, there’s a couple different ways to look at this.

That 4% number that I’m giving you is basically a market cap weighted number. So the biggest of the biggest reads, the American Towers (AMT) of the world, the Prologises (PLD) of the world, frankly, aren’t yielding that much, which is why here at Hoya, again, we find the value in the small and mid cap reads moving down that ladder.

So if you equal cap weight all of those reads, that yield goes towards around 6% or so. And thus, again, on an equal basis, REITs would be more attractive than fixed income. And as Fed cuts rates, one would hope the 10-year Treasury number goes lower as well. And thus, that spread between REIT dividends and fixed income would continue to widen.

Rena Sherbill: Speaking of dividends, we saw a bunch of dividend hikes in October that we just got that report out recently. What would you say to your point about dividends and that there should be improved reasons to be bullish on REITs? What would you say contextually about the dividend hikes that we’ve seen?

David Auerbach: I want to bring in dividends with other things that a lot of the REITs have been doing to unlock value. Again, if we go back to the start of 2022, when the Fed started hiking interest rates, we’ve seen 36 different companies that have basically gone away, merged, liquidated, explored options, trying to unlock value.

In the past quarter alone, we’ve seen 10 different REITs go through that same process. While going back to 2022, we’ve only seen 10 new REITs come to market.

So at this point, management teams are trying to figure out ways to unlock value for shareholders since most of these REITs are trading at discounts to net asset value. But to answer your question about dividends, that’s why this kind of plays hand in hand with what I was just explaining. Because if you go back to pre-COVID, right before COVID started, again, and I know we’re talking about something from five years ago, but a lot of these sectors are still compared about how are they performing versus pre-COVID.

And the way to say about the REITs was, before COVID, the REITs were basically at the top of the market. Leasing wasn’t an all-time high, rental rates were an all-time high, dividends were at an all-time high. The REIT sector was just firing on all cylinders. COVID hits, REIT sector goes in the tank for a variety of reasons. Fed starts hiking interest rates. REITs are out of favor.

But let’s go to the fundamental side of the equation. Here we are five years later. The REITs are putting up fundamentals that surpass what they were doing at their COVID peak, their earnings, their growth, but their dividends have not caught up to where they were pre-COVID for a variety of reasons. But I would say,

One of the specific reasons as to why a lot of the REITs have not gotten so aggressive on hiking is because I feel like some of them are retaining cash for a rainy day. Is it better to raise my dividend by a penny or two pennies across, again, millions of shares of stock, or is it better to retain that capital to find the right opportunity that comes along?

Most, if not almost every single one of these companies, their earnings that they’re making are dramatically covering their dividend payment versus a handful of options where, excuse me, a handful of companies where the dividend is not being covered by earnings.

So the takeaway here is that the REITs that continue to grow still have ample capacity to continue to raise their dividends.

Rena Sherbill: And what names would you put to that? What names would you put in that column and what names would you put in the other column?

David Auerbach: It’s kind of hard to forecast who will continue and all that type of stuff. It’s very hard to kind of gauge. But a couple of that would stand out.

A good example would be like Simon Property Group (SPG). Simon just raised their dividend. I believe it’s for the 11th time coming out of COVID. That’s one example.

You have companies like Welltower (WELL) that have grown their market cap by over 5x in the past half decade and they’re one of the very, very few REIT stocks that’s actually trading at a premium right now.

I think it’s really on a case by case, sector by sector basis. Another company that stands out as far as dividend growth is a small cap health care REIT called Strawberry Fields (STRW).

Strawberry Fields is a company that’s more than doubled the size of their portfolio. And frankly, their dividend has doubled in size as well. I think a good way to look at dividend growth is looking towards the companies and the fundamentals and seeing how they are growing.

Meaning, if we have gone out and acquired, I’m just throwing random numbers out there. If we’ve increased our portfolio revenue by 25, 50%, dot, dot, dot, one would assume that the dividend is going to go up by a corresponding amount as well. So really look towards the internal and external growth of these companies and their earnings to kind of get a gauge on what’s being pushed through.

Then there’s other companies that pay consistent monthly dividends, Realty Income (O), Agree Realty (ADC). The list of the companies are out there, but it’s slow and steady, tried and true.

I interviewed the CEO of AGNC Mortgage (AGNC), a mortgage REIT just a couple of months ago, and he was very transparent saying, look, David, we’re a mortgage REIT. Mortgage REITs go under the radar. They’re always kind of under the gun.

And guess what? We’ve never cut our dividend. We’ve maintained our monthly dividend through COVID and beyond. We’re plotting along because our customers are Fannie and Freddie and government-backed securities. And so we’re able to continue to do business as usual.

So I think we could play this on a case-by-case, company-by-company level. I will say, again, to be fair and balanced, one company to keep an eye on that might cut their dividend, and they’re kind of implying as much, would be Alexandria (ARE).

They had a very disappointing third quarter earnings report. And they are kind of guiding towards a 2026 dividend cut. If you read through some of the materials they’ve published here in the past few weeks.