Amid the ravages of COVID-19, opportunity exists in REITs for investors who understand the sub-sectors of real estate, writes Jeff Olin
As investors hungry for cash sold off assets indiscriminately in March and early April, nowhere was safe. The common shares of real estate companies and REITs were no exception. The obvious victims, initially, were hotel and resorts. As panic set in and the market selloff continued, fundamentals such as relative valuations and property sectors no longer mattered – investors were selling whatever they could to raise cash.
As investors start to settle in to the ‘new normal,’ pockets of opportunity are starting to appear. Investors with the flexibility to actively select stocks based on business fundamentals – not panic or stock activity – are well placed to take advantage of lower prices created by the selloff.
As an example, REITs were down around 40% on average in March and are still currently down 25% year-to-date; some are still down as much as 80%. Despite the many difficulties brought on by COVID-19, actual property prices have not dropped to the same degree. If investors look only at activity in these securities in the markets, they are only seeing part of the picture. There are many solid companies and operators whose stock plummeted in March, despite the fact that the overall effect of the pandemic on their business was much less drastic.
There are lessons to be learned from how markets responded. In particular, we should see a stronger focus on business fundamentals, greater differentiation between securities, and, in real estate, more focus on differentiating superior and inferior property types, sectors, and valuations. Factors like geographic regions, the merits of the entity itself, financial strength, corporate strategy and management have always been important, and now are even more so.
This has already begun. In real estate, we’ll see different sectors respond and recover in different ways and at different speeds. Investors’ ability to differentiate between sectors, securities and property types, and the underlying fundamentals that accompany them, will determine how they themselves recover.
But in times like this, investors also want liquidity, which is hard to come by when investing directly in real estate. Investing in real estate securities and stocks, on the other hand, allows investors to capitalize on mispricing created by the March selloff. Investors can buy great names at a significant discount right now while also maintaining liquidity. Big institutions have already figured this out. Case in point: Blackstone has already been putting some of its $150 billion in cash into select REITs.
Another distinct advantage to investing in real estate through the stock market is that, while you can’t short a property directly, you can short a publicly traded REIT. Certain property types and regions will have both more immediate and longer-term negative fundamental and valuation hits. Select REITs are holding assets that remain overvalued, overleveraged and unlikely to recover to pre-pandemic levels. In this particular environment, the flexibility to short a security makes a huge difference. Having that downside protection is absolutely crucial.
No two sub-sectors of the real estate space will be affected the same way by the pandemic, but some will recover faster and more effectively than others. Public single-family residential rental operators in North America, for example, will come out of the pandemic stronger than many of their peers. This is largely because finances will be much tighter as millions of people see reduced wages and hours or get laid off entirely.
Retail, on the other hand, will be one of the hardest-hit real estate sub-sectors. Now that consumers have more or less been forced to turn to online shopping, e-commerce will continue to eat up more and more of the total retail sales. The flipside of this is that warehousing and storage space will benefit from increased demand. There is a limited supply of warehousing space in North America and, in many key markets, an equally limited supply of land suitable to build new space. As more consumers turn to e-commerce, the storage needs of companies like Amazon, Walmart and others will grow.
Another victim will be corporate real estate, specifically office space. While some workers will be eager to get out of their work-from-home setup and back to the office, many companies will see that they can function well remotely and will put some serious thought toward how much capital they allocate to their physical workspace.
The disparities in how the COVID-19 pandemic is affecting different sub-sectors of the real estate space illustrate just how important it is to understand the fundamentals of each distinct sector when deciding how and where to invest in real estate in this environment. Indiscriminately selling off real estate securities – or real estate itself – without considering any of these factors could mean losing out on once-in-a-lifetime investment opportunities.
Jeff Olin is co-founder, CEO and portfolio manager at Vision Capital and the manager of the Vision Opportunity Funds, award-winning alternative investment funds focused on long/short and active investments in publicly traded real estate securities.