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When the coronavirus began to shut the economy down in March, shares of real estate investment trusts (REITs) got hammered.
The shares of many REITs have since recovered, along with the broader stock market. Many have called this buy-up a "real estate bubble."
Truth be told, that's probably not the case right now. But it never hurts to be ready. There are certainly a few REITs to sell now whether or not a real estate crash is in view.
This year, we saw offices empty, and many retail businesses were shuttered. It was questionable if rents would get paid, which could lead to a wave of commercial and residential real estate foreclosures.
Quick actions from the U.S. Federal Reserve and Congress prevented the worst from happening. Although some sectors such as shopping mall REITs have suffered, most sectors are seeing over 90% of rents getting paid right now.
Still, new strains of coronavirus popping up overseas could threaten these gains.
With COVID-19 spreading once again and the threats of lockdowns looming ahead, many investors are worried that we will see another massive sell-off in REIT shares.
Again, we do not necessarily think this will happen. Most REITs were in good financial condition when this started and have managed through the crisis very well.
That doesn't mean it might not be smart to sell some REITs that look vulnerable to any additional economic weakness.
If we ever approach a real estate bubble, these REITs would be the first to drop...
Why Mall REITs Are the Best of the Worst
There is no question that Simon Property Group Inc. (NYSE: SPG) is the best mall REIT in the United States, if not the world right now. Simon has Class A malls in high-income areas with dense populations. It has done an excellent job of repurposing mall space over the past few years.
Simon has even gone so far as to buy some of its tenants failing like JC Penney, Brooks Brothers, and Lucky Brands. The hope is that they and their partner can resurrect the retailers and keep them from closing forever.
They probably cannot pull it off. More than 20% of retail sales are now done online. Thanks to COVID-19, even grouchy old Uncle Elmer, who hates those new-fangled computing machines, is shopping online now. The Rubicon has been crossed, and there is no going back.
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Simon is the best mall operator, but malls are a terrible business and will not become great again in the foreseeable future, if ever.
Being the best mall operator is a lot like being the best football team in the NFC East in 2020. Being the best of the worst does not make you good.
If we see more shutdowns in the weeks ahead, we will see more retail closures and less rent collected by Simon Property Group. That could lead to a dividend cut.
The stock has almost doubled off the lows, but it won't take much bad news to send the shares tumbling once again.
Clearing Out of Big City Residential REITs
Boston Properties Inc. (NYSE: BXP) is a major office REIT in the United States. It owns some of the premier office buildings in New York, Boston, San Francisco, Washington, D.C., and Los Angeles.
These might be some of America's most highly populated areas. Unfortunately, thanks to COVID-19 and civil unrest, people are leaving as fast as they can.
Although some people are going back to their office, it is not very many. Only about 15% of buildings owned by Boston Properties are actually working in the office right now.
That is going to go down as the virus continues to spread.
Occupancy rates will continue to decline as American business rethinks its office strategy. Work from home is here to stay, and that will reduce the need for office space.
Major urban office tenants who are paying top dollar in premier cities will start considering that office space in Tampa, Denver, and Nashville is a lot cheaper than Boston, New York, and San Francisco.
We do not think that office markets will crumble forever like some of the more pessimistic REIT observers, but we do believe that office buildings in premier cities have a tough couple years ahead of them.
It makes sense to sell Boston Properties and sit on the sideline until we get better pricing.
Don't Be Fooled by This REIT's Success
Extra Space Storage Inc. (NYSE: EXR) has had a pretty good year compared to most REITs. The stock is actually up on the year as the pandemic has created demand for storage space.
In fact, it has probably had a bit too good of a year. The self-storage sector has been popular this year, and the enthusiastic buying has pushed the shares to premium valuation levels. Extra Space shares are trading at 23 times funds from operations and 22% above its net asset value.
The average REIT trades at just 13 times funds from operations and a slight discount from net asset value.
Self-storage will develop some headwinds in 2021, mainly from much higher land prices making continued expansion too expensive in many parts of the country.
The same population shift that is making life difficult for Boston Properties could hurt the bottom line at Extra Space as well. Most of the portfolio is California and northeastern urban areas that people are leaving.
Extra Space is in a good business, but it's way too expensive and could see weaker short-term conditions.
Given the stock's positive performance, it's probably a good idea to book the gains in Extra Space and wait for the next sell-off to reestablish a position.
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