It certainly hurts to see your portfolio’s value dropping during a correction or bear market, but investors can take heart in the fact that pullbacks are among the best times to load up on high-quality stocks.
Real estate investment trusts (REITs) look particularly attractive right now because they provide consistent and reliable income with higher than average dividend yields. Three Motley Fool contributors believe that these REITs in particular appear poised for unstoppable growth over the next few decades, and all of them are trading at serious discounts.
Dominating data centers
Liz Brumer-Smith (Digital Realty Trust): Helping aggregate, store, and transmit data, data centers have quickly taken on central roles within the infrastructure that supports our digital world. Digital Realty Trust (DLR -0.04%), is one of just two remaining data center REITs and the seventh-largest REIT by market capitalization.
With interests and ownership in more than 290 facilities in 50 major metro markets across six continents, it’s one of the largest data center providers in the world. Its 4,000-plus clients include major cloud service corporations, social media companies, and content streaming services.
The last few years were strong for Digital Realty Trust. Its funds from operations (the preferred metric for gauging a REIT’s profitability) grew by around 22% over the last three years. Its bookings reached record levels in Q1 2022 while its rental rates have maintained a steady growth of around 3.3% on average.
The company has expanded its footprint globally, adding to its presence in South Africa through the acquisition of Teraco, and most recently forming a joint venture with Mivne to add new hubs in Israel and the Mediterranean.
Data center demand is already high, but it’s only going to grow as the use of 5G, artificial intelligence software, autonomous vehicles and other technologies expands. This will create tremendous growth opportunities for Digital Realty Trust. Its share price is down 29% year to date, and it trades at around 12 times its funds from operations, so it’s favorably valued for its performance. The combination of Digital Realty Trust’s growth potential and its dividend, which yields 4% at the current share price, makes this REIT a promising stock to consider adding to your portfolio now.
Return of “The Gravedancer”
Mike Price (Equity Residential): Billionaire real estate investor Sam Zell has found ways to profit during every type of market you can think of. These days, he’s no longer involved in the nitty-gritty, day-to-day operations of his REITs, but he still owns plenty of shares and plays a big role in setting their strategies as chairman.
Zell’s residential REIT, Equity Residential (EQR 1.81%), owns 80,581 apartment units across 311 communities in 12 geographic markets. As of May, its units were 96.9% occupied, and in Q1, its funds from operations grew by 15% year over year. Yet the stock is down by more than 20% so far in 2022.
Basically, Equity Residential has fallen along with just about every real estate stock. Interest rates are rising, and the market is worried about the ability of REITs to obtain favorable financing and continue to grow.
I don’t buy it.
First, rising interest rates are a plus for Equity Residential. If higher potential mortgage payments prevent people from buying houses, that means they’ll probably have to keep renting. This would increase demand for the REIT’s properties and allow it to raise prices in line with inflation.
Second, Equity Residential’s current strategy involves moving out of old tier 1 cities and into faster-growing ones like Denver and Dallas. This means it won’t need the same level of financing that it would for new growth; it can use the equity from the buildings it sells to fund new purchases.
So is it time to buy this REIT now? Its valuation certainly looks appetizing. It trades for 20.6 times earnings, down from its 5-year average of 33.7 times. The strength of Zell’s name usually adds a price premium to Equity Residential, and since 2017, it has only ended a year trading below 30 times earnings once — in 2020.
Equity Residential owns a high-quality portfolio of multifamily assets poised to benefit from inflation, and it’s positioned to withstand even a prolonged recession. Zell earned the nickname “The Gravedancer” in the 1970s when he took advantage of distressed property sales across the U.S. If the economy heads in the same direction now as it did then, buying shares of Equity Residential will give you the opportunity to ride along as he and his team continue to buy up valuable assets.
This homebuilder is locked in a recession-resistant niche
Kristi Waterworth (LGI Homes): Although Redfin sounded an alarm this week about home purchase agreements falling through at some of the fastest rates ever, that one piece of data hardly paints the whole picture of what it’s like to be a publicly traded homebuilder in America today. Despite the scary-sounding news, homebuilders remain in a strong position to continue to both grow and thrive, considering that the country is still short by millions of housing units relative to its needs. The National Association of Realtors has said the current gap between supply and demand is “so large it would take more than a decade to close, even if new-home construction accelerates.”
That’s why I’m looking more and more at investing in homebuilders. High on my list is LGI Homes (LGIH 0.27%). It isn’t just another sticks-and-bricks builder. LGI Homes focuses a lot of its energy on a couple of vital market niches: entry-level housing and senior housing. Its homes had an average sales price of $341,495 in Q1, versus the average national $368,200 price tag for existing single-family homes during the same period.
Because it offers competitive pricing in niches where available housing is often in short supply, LGI Homes has been able to continually increase its annual closings. Since 2014, it has grown that metric by just over 1,000 homes each year, with sales rising from 2,356 in 2014 to 10,442 in 2021. Revenues also continue to grow, and despite higher labor and materials expenses, its gross margins have remained fairly steady between 23.7% and 26.8% across that period.
With $53.3 million in cash on the books, $2.3 billion in inventory, a net-debt-to-capitalization rate of about 40%, and a market cap of over $2 billion, this just-barely midcap builder will continue to provide much-needed new homes to buyers across the nation as it expands its reach into more markets, regardless of wider real estate trends.