Real estate boom-and-bust cycles are repetitive, and I’m afraid that we look set for another. What’s my premise? Well, the interest-rate cycle has topped out, and the U.S. Treasury yield curve is inverted, which usually means an economic slowdown is set to occur. Moreover, commercial real estate prices are on a steep decline while mortgage rates remain exorbitant.
Real Estate Investment Trusts, or REITs for short, could see exponential drawdowns due to additional market-based risk factors. For instance, term and equity risk premiums have started climbing in the past month, suggesting dampened valuations are due.
Of course, REIT as an asset class isn’t homogenous; therefore, we will likely see some separation within the group. My forecast is that the work-from-home phenomenon will add pressure to office REITs, while the aforementioned business cycle issues could damage certain retail REITs.
With the aforementioned considered, here are three REITs to sell before it’s too late.
Orion Office REIT (ONL)
Orion Office REIT (NYSE:ONL) is a suburban REIT emphasizing investment-grade tenants and low portfolio concentration risk. Although Orion’s business model served it well pre-pandemic, a regime change has occurred, leading to higher work-from-home and shared office space numbers than before.
Some might say that Orion’s eight-to-twelve-year lease terms, annual escalation agreements, and Sun Belt exposure make it a strong buy. However, I believe its occupancy rate of 80.5% is staggeringly low and will continue to be that way, given the work-from-home phenomenon. This could lead to a less competitive market, resulting in discounted dispositions of key assets.
The fund’s third-quarter earnings results substantiate my argument.
Orion achieved $22.3 million in funds from operations but slumped to a net loss attributable to common shareholders of $16.5 million. Additionally, Orion disposed of three properties for $15.4 million and entered an agreement to sell nine more properties for $46.6 million. Lastly, the REIT’s quarterly results revealed an elevated debt-to-EBITDA ratio of 4.09x, adding more fuel to the flame.
At face value, ONL REIT may seem undervalued. I mean, it has a price-to-funds from operations ratio of merely 2.66x and a dividend yield of 8.49%. However, the fund’s fundamentals aren’t copacetic. As such, we could be looking at a value trap here.
SITE Centers Corp (SITC)
SITE Centers Corp (NYSE:SITC) invests in high-productivity shopping centers, specifically targeting wealthy suburban centers. This asset is not a bad long-term play at all. However, systematic risk looks set to dominate proceedings, leaving the REIT vulnerable in the short term. Additionally, as discussed later in the text, SITC REIT is relatively overvalued, raising the odds of unwanted mean-reversion.
According to Trading Economics, U.S. retail sales jumped off a cliff in January, declining by 0.8%. Inconsistent retail sales paired with elevated property risk premiums will likely add continuous strain to retail REITs, which, as an asset class, has fallen by nearly 5% year-over-year. Although Site Centers has outperformed its peer group by rising more than 8% year-over-year, it possesses a price-to-adjusted funds from operations ratio of 20.22x, 49.60% higher than its five-year average. Therefore, a strong argument for a pullback exists, especially given the REIT’s recent $6.97 million fourth-quarter revenue miss.
Lastly, it’s possible that many of SITC REIT’s investors could divest from the entity and allocate toward SITE Centers’ spin-off, Curbline. Curbline is set to list in mid-to-late 2024 as a vehicle containing SITC REIT’s convenience stores, which have been highly profitable to date. Curbline’s lease rate is 1.8% higher than SITC’s, its annual base rent per square foot is $17.5 richer, and its target market’s average household income is $6,000 better off. Therefore, a migration of SITC’s existing investors would not be surprising.
American Strategic Investment Co. (NYC)
American Strategic Investment Co. (NYSE:NYC) owns eight properties mainly occupied by investment-grade tenants, including CVS (NYSE:CVS), City National Bank, and Cornell University. The REIT’s portfolio is 85.1% occupied, with an average remaining lease term of six years. Moreover, the REIT prides itself on achieving a 100% cash collection rate, which illustrates the credibility of its tenant base.
Sounds good, right? Not exactly. As mentioned before, office and retail REITs are under the pump, given systemic headwinds, and NYC REIT is no different, shedding more than 15% of its market value since the turn of the year. Furthermore, the REIT remains unprofitable. It sustained a loss of $9.4 million in its third quarter and slumped to $2.5 million in funds from operations, leaving its investors with no residual earnings value to speak of.
NYC REIT has a promising capital structure comprising a 41.7% net leverage ratio with a debt financing cost of 4.4%. Therefore, future profitability isn’t out of the question. Nevertheless, regardless of the quality of its asset base, rental escalation in today’s fragile economy is unlikely. Therefore, I’m bearish on NYC REIT!
On the date of publication, Steve Booyens did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
