Real estate investment trusts (REITs) have delivered strong performance this year. Through the end of June, the average REIT has generated a more than 21% total return. That's outpaced the S&P 500's roughly 15% total return.
Despite that strong performance, analysts at Baird still see opportunities across the sector. Three that they don't want investors to miss are REITs focused on the net lease, manufactured housing, and shopping center sectors. Here's where they see some of the best upside potential in those property types over the next year.
Betting on a recovery
Baird sees select opportunities in the net lease sector. In particular, it likes gaming REITs and those with high exposure to tenants with investment-grade credit ratings.
Baird's analysts believe that gaming REITs are among the best-positioned for inflation. For example, it noted that VICI Properties (NYSE: VICI) has contractual rental rate escalators tied to the Consumer Price Index, making it a better hedge for prolonged inflation than other REITs. Baird also likes MGM Growth Properties (NYSE: MGP) because it believes the REIT could make more acquisitions in the future, which it sees as a potential catalyst.
In addition to gaming REITs, Baird likes net lease REITs that focus on leasing to investment-grade tenants because they have a greater financial capacity to meet their financial obligations like paying rent. It highlighted Agree Realty (NYSE: ADC) and Four Corners Property Trust (NYSE: FCPT), which both focus on owning freestanding retail properties.
Baird noted that Agree Realty, which gets 67% of its annual base rent (ABR) from investment-grade tenants, has a superior cost of capital. That allows it to execute on a healthy deal volume. The retail REIT expects to purchase between $1.1 billion and $1.3 billion of real estate this year. It focuses on essential retailers like dollar stores, convenience stores, grocery stores, and tire and auto service centers. Meanwhile, the restaurant-focused Four Corners also gets 67% of its ABR from investment-grade tenants.
With both REITs focused on retail properties less susceptible to disruption from e-commerce, they should thrive as the pandemic subsides.
Affordable housing with recreational upside
Baird also likes the manufactured housing sector, which is drawing more big-name investors due to its steady returns. It favors Equity LifeStyle Properties (NYSE: ELS) and Sun Communities (NYSE: SUI).
Sun Communities offers more growth potential due to its active developments and acquisition focus. The REIT recently made a big splash by purchasing marina operator Safe Harbor Marinas for $2 billion in cash, adding 99 marinas to the company's portfolio of manufactured home communities and RV parks.
Meanwhile, Equity LifeStyle has a "high-quality portfolio that can produce above-average growth," according to Baird. That was evident in the second quarter. The REIT's core portfolio grew its income from property operations by 16% during the period as it bounced back from some pandemic-related headwinds in the year-ago period.
A retail recovery play
The final REIT segment where Baird sees opportunities is shopping centers. While the pandemic hit this sector hard, these REITs should benefit from a good organic growth tailwind as they lease up vacant space and cash in on investments in mixed-use development projects. Baird favors Retail Opportunity Investments (NASDAQ: ROIC) because it focuses on grocery-anchored shopping centers on the West Coast. It has the most pricing power in the sector and can monetize densification projects at its shopping centers.
Also of note, shopping center REITs have been a hotbed of M&A activity this year. Kimco Realty (NYSE: KIM) agreed to buy Weingarten Realty Investors (NYSE: WRI) to create the largest shopping center REIT. Meanwhile, Kite Realty (NYSE: KRG) is merging with Retail Properties of America (NYSE: RPAI) to become the fifth-largest shopping center REIT. These deals could spur additional consolidation in the sector as more shopping center REITs join forces to increase their scale and reduce costs, looking to deliver greater value for shareholders.
Opportunity abounds across the REIT sector
REITs have been in rally mode this year as commercial real estate starts recovering from the pandemic's impact. However, several compelling opportunities remain, with Baird highlighting net lease, manufactured housing, and shopping centers as sectors that could outperform over the coming year. Because of that, REIT investors will want to take a closer look at those property types.