If I Could Only Own 4 REITs, It Would Be These

I want to start here by saying that I would not want to own just 4 real estate investment trusts, or REITs.

It is just not enough to properly diversify the risks of individual positions.

If just one of your picks ended up becoming a loser, it would be very hard to make up for the losses with the other 3 holdings.

Therefore, if I could only own 4 REITs, my picks would also be different than if I could own a diversified portfolio of 25 REITs.

I would focus on safer REITs that offer the most likely path to long-term outperformance and would stay away from riskier bets like Medical Properties Trust (MPW), Uniti Group (UNIT), NewLake Capital Partners (OTCQX:NLCP), etc.

Here are the 4 REITs that I would buy today:

Camden Properties Trust (CPT)

I believe that CPT offers the best risk-to-reward of the multifamily sector at the moment.

It is not the cheapest.

It is not the safest.

And it is not growing the fastest.

But CPT offers the best combination of value, safety, and growth at its current share price.

Starting with value, CPT is today priced at an estimated 6.7% implied cap rate and a 35% discount to its NAV. That valuation is a bit higher than that of smaller, more heavily leveraged peers like BSR REIT (OTCPK:BSRTF) and NexPoint Residential Trust (NXRT), but the difference isn’t significant at the moment.

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Historically, the valuation spread has been a lot larger during most times given that CPT is a large-cap blue-chip with an A-rated balance sheet and it is able to develop its own assets. Those things warrant a premium, but the market isn’t giving CPT the credit that it deserves.

Then moving to safety, you could argue that Mid-America Apartment Communities, Inc. (MAA) is a bit safer because it uses less leverage than Camden. Its debt-to-EBITDA is nearly a turn lower than that of Camden. But, on the flip side, Camden has a slightly safer portfolio because it focuses on more affordable Class B properties that are likely to be less cyclical. MAA focuses more on Class A communities, which are today more heavily impacted by the new supply hitting the market.

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All in all, there is no major difference in terms of safety. Both are amongst the safest apartment REITs, but Camden is a lot cheaper than MAA as if it was much riskier, which is not the case.

Finally, in terms of growth, Camden is also holding its own.

It is at a disadvantage right now because the sunbelt markets are oversupplied, and this is hurting its near-term growth prospects. However, even under these tough market conditions, the coastal apartment REITs really aren’t performing much better, and yet, they are priced at a large premium relative to Camden.

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So, all in all, CPT is today the best pick in the apartment sector in my opinion.

Its valuation is heavily discounted because it focuses mostly on the sunbelt markets which are today oversupplied, and it has a bit more leverage than some of its larger peers.

But the market appears to have overlooked that its focus on Class B properties is protecting it from the oversupply, and the impact is temporary anyway.

Right now, CPT is priced at a similar discount as the smaller and more heavily leveraged apartment REITs, when in reality, it should trade in line with its large-cap sunbelt peer MAA, and only at a small discount to large-cap coastal peers like AVB.

I predict that as growth reaccelerates in the coming years, CPT will regain its premium and be one of the best performers in this property sector.

Just returning to its NAV would unlock over 50% upside potential from here and while you wait, you earn a 4.2% dividend yield and the management keeps creating value for shareholders by developing new properties at high initial yields.

Big Yellow Group Plc (BYG / OTCPK:BYLOF)

I have held shares of Big Yellow for nearly 10 years and consistently bought more of it at every dip.

My first purchase was the following the crash caused by Brexit, and it has been one of the best investment decisions I’ve ever made.

In short, I think that Big Yellow has a clear path to earning above-average returns with below-average risk over the next decade or two.

It is the leading self-storage REIT in the UK, and it is capitalizing on the growing popularity of the concept on the European continent by developing new properties at a high initial yield of 8-9%, earning it huge spreads over its cost of capital.

It has been doing so for a few decades now and has managed to earn nearly 16% average annual total returns in the process.

But the self-storage market is today still in its infancy in Europe. There is about 10x less storage space in the UK when compared to the U.S. and growth opportunities are abundant.

Today, it has 11 big development projects underway, which should expand its portfolio size by ~15-20% in the coming years, and it is looking to acquire additional sites to keep growing.

Historically, this strategy has allowed them to grow their FFO per share by >10% annually, and yet, they are today priced at a 4.5% dividend yield and a 20% discount to their NAV.

Therefore, I think that the risk-to-reward is very compelling if you have a long-time horizon.

Essential Properties Realty Trust, Inc. (EPRT)

I would want to own some net lease properties as well.

This was my favorite property sector back when I worked in private equity because these properties would commonly allow you to earn equity-like returns with bond-like risk.

The lease terms are very long at 10+ years, the tenant is responsible for all property expenses, and the rents are hiked 1-2% annually regardless of how the economy is doing.

Realty Income (O) has mastered the art of net lease investing and done very well for its shareholders over the long run:

But EPRT is an improved version of Realty Income that should generate materially higher returns over time.

It went public about 5 years ago, and it has since then generated 4x higher total returns than Realty Income:

It is able to earn these much higher returns because of two main reasons:

(1) It is a lot smaller in size and as a result, every new acquisition really moves the needle for them. This has become an issue for Realty Income because of their massive size:

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(2) It follows a unique approach that allows them to earn much larger spreads over their cost of capital. Instead of targeting properties that are leased to big-name tenants like CVS (CVS) and Walmart (WMT), EPRT is instead going after net lease properties that are leased to smaller middle market tenants. There is much less competition for these assets, and it allows it to get higher cap rates (averaging 8% in the last quarter), higher rent escalations (nearly 2%), and stronger lease terms that mitigate risks (master lease protection, corporate guarantees, longer terms, etc.).

The combination of smaller size and larger investment spreads has historically allowed EPRT to grow a lot faster than its peers like Realty Income, and I see no reason why this would change any time soon.

Normally, such a large growth advantage would warrant a higher valuation multiple, but today, EPRT is priced at a similar valuation as its close peers, and therefore, we expect its outperformance to continue.

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With a 4.5% dividend yield, and a mid-to-high single-digit growth rate, EPRT can consistently earn double-digit total returns with limited risk, and it could enjoy another ~20% of upside as interest rates return to lower levels in the coming years.

That makes it very attractive from a risk-to-reward perspective.

Corporación Inmobiliaria Vesta, S.A.B. de C.V. (VTMX)

Finally, I would want to own some industrial real estate in my portfolio and right now, the best opportunity is arguably in Mexico.

VTMX is the first and only Mexican REIT to be listed on the NYSE, and it owns a vast portfolio of class A industrial properties in some of the fastest-growing regions of Mexico:

The REIT enjoys fantastic prospects because of the growing trend of near-shoring that’s leading to significant demand for industrial space in Mexico. For the first time last year, Mexico overtook China as the single largest source of imported goods into the U.S., and the trade relationship is expected to keep growing at a rapid pace:

This provides a big opportunity for VXMT to develop new properties and currently, it can get a >10% yield on cost, which represents a big spread over its cost of capital.

VTMX has a unique competitive advantage in that it has access to capital in the U.S. at a reasonable cost, and it can then reinvest it in Mexico at very large spreads. Moreover, the majority of its leases are in USD and with big-name tenants like Amazon (AMZN), Nestle (OTCPK:NSRGF), and Foxconn (OTCPK:FXCOF), which mitigates currency risk.

Its current rents are also deeply below what comparable properties would charge in the U.S., providing an opportunity for strong same-property NOI growth for years to come as more and more companies move supply chains to Mexico to be closer to the U.S.

All in all, we believe that VXMT should be able to grow at a far faster pace than its US industrial peers, and yet, it is today priced at a lower valuation multiple:

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Keep in mind also that the above multiple is overstated because VTXM owns a vast landbank and has many development projects underway that currently aren’t earning any cash flow.

The combination of a lower valuation and faster growth prospects should lead to substantial upside over the next 5-10 years.

Closing Note

I would not want to own just 4 REITs.

But if I could only own 4 of them, I would focus on REITs that have exceptional business models. CPT, BYG, EPRT, and VTMX are good examples of that.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.