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The ongoing bear market is already 15 months old, with no end in sight right now. It has been particularly painful for investors, not only for their paper losses but also for the continuous erosion of the real value of their portfolios due to sky-high inflation. Real Estate Investment Trusts (REITs) have underperformed the broad market by a wide margin due to the impact of high-interest rates on their interest expenses. As a result, some REITs have become exceptionally attractive from a long-term perspective. In this article, we will discuss the prospects of three REITs that are likely to offer excessive returns to patient investors in the upcoming years, namely Realty Income (O), Life Storage (LSI), and SL Green Realty (SLG).
 

Realty Income

Realty Income is a retail REIT that is well known for its exceptional dividend growth history. The trust owns more than 4,000 retail properties.

Many investors dismiss retail REITs due to the secular shift of consumers from brick-and-mortar shopping to online shopping. However, these investors should not dismiss Realty Income, which continues to thrive in the current business landscape. Realty Income owns retail properties that are not part of a wider retail development, such as a mall but are standalone properties. As a result, the properties of the REIT can attract several types of tenants and hence the company is essentially immune to the secular decline of brick-and-mortar retailers.

The key competitive advantage of Realty Income is its competent management, which has great expertise in identifying high-return properties. The strength of the business model of Realty Income is reflected in the exceptional growth record of the trust. Realty Income has grown its FFO per unit every single year over the last decade, at a 5.5% average annual rate. It has achieved such a consistent growth record thanks to the acquisition of high-return properties and predictable rent hikes year after year.

Moreover, Realty Income has proved extremely resilient to recessions. In the Great Recession, while other REITs cut their dividends, Realty Income continued growing its dividend. The REIT has raised its dividend for 100 consecutive quarters.

Moreover, Realty Income is currently offering a nearly 10-year high dividend yield of 5.2% and is trading at a nearly 10-year low price-to-earnings ratio of 15.2. The exceptionally cheap valuation of the stock has resulted primarily from the impact of inflation on the present value of future cash flows and the effect of high-interest rates on interest expense.

However, the Fed has prioritized restoring inflation close to 2% as soon as possible. Thanks to its aggressive policy, the Fed is likely to accomplish its goal sooner or later. Whenever inflation subsides, Realty Income is likely to offer excessive returns to patient investors. Its reliable and growing dividend makes it easy for investors to wait for their thesis to play out.   
 

Life Storage

Life Storage, which was founded in 1985, is a leading U.S. owner and operator of self-storage properties, with more than 1,000 locations in 34 states.

Self-storage REITs have outperformed all the other categories of REITs by an impressive margin over the last two decades. The vast outperformance reflects the favorable demand-supply characteristics of this type of property. Even better, as there are no signs of fatigue on the horizon, self-storage REITs seem to have ample room to grow for many more years.

Life Storage has exhibited an exceptional performance record. It has grown its FFO per unit by 11.3% per year on average over the last decade and by 14.6% per year on average over the last five years. More importantly, it has consistently grown its FFO per unit, with a decrease in only one out of the last ten years.

Moreover, Life Storage has proved essentially immune throughout the coronavirus crisis, as it has posted all-time high FFO per unit in each of the last three years. It is also on track for another record year in 2023. This performance is in sharp contrast to other REITs, which have not recovered from the coronavirus crisis yet.

Notably, in February, Life Storage received an offer to be acquired by Public Storage (PSA) for $11 billion in an all-stock deal. However, Life Storage rejected the offer, claiming that it was too low for the potential of the REIT. We agree with the management of Life Storage and expect the REIT to keep growing its FFO per unit significantly for many more years. Given also the nearly 10-year low price-to-FFO ratio of 17.7 of the stock, we expect Life Storage to high reward patient investors in the upcoming years.
 

SL Green Realty

Founded in 1980, SL Green Realty is a REIT that is focused on acquiring and managing commercial properties in Manhattan. It is the largest office landlord in Manhattan, with 61 buildings that have a total surface area of 33 million square feet.

SL Green Realty has been severely hurt by the coronavirus crisis, which has resulted in a work-from-home trend. The pandemic has subsided since last year but occupancy of office space in New York remains near historic lows. Consequently, there is an unprecedented tenant-friendly environment, which has led SL Green Realty to offer material concessions to its tenants.

The persistence of the work-from-home trend has increased the uncertainty over the future growth prospects of SL Green Realty. However, we expect this trend to attenuate in the upcoming years, as the economic slowdown will probably increase the negotiation power of employers over their employees.

Notably, due to the business headwinds facing SL Green Realty, the stock is currently trading at a 10-year low, at an all-time low price-to-FFO ratio of 4.0, which is much lower than the 4-year average FFO multiple of 9.9 of the stock. Whenever the occupancy of office space in Manhattan begins to normalize, SL Green Realty is likely to offer excessive returns to its unitholders.
 

Final Thoughts

The entire REIT sector has underperformed the S&P 500 by a wide margin over the last 12 months (-26% vs. -13%), primarily due to the effect of high-interest rates on the interest expense of most REITs. As usual, the sell-off of the REIT sector has punished, not only the vulnerable REITs but also some REITs with very strong business fundamentals. Realty Income, Life Storage, and SL Green Realty have become extremely cheap and thus they are likely to highly reward investors in the upcoming years.

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