The real estate sector has been one of the worst-performing areas of the stock market in 2020, with the COVID-19 pandemic sending shockwaves throughout the commercial real estate industry. The types of properties that rely on people physically going to them have been especially hard hit. As of July 29, Vanguard Real Estate ETF (NYSEMKT: VNQ) is down by nearly 12% for the year, while the S&P 500 is higher by about 1%.
Now, some types of real estate investment trusts (REITs) have done quite well. Data center REITs, which have actually benefited from the stay-at-home economy, are handily outperforming others, with some of the largest players in the space up by 30% or more this year alone. On the other hand, some REIT subsectors -- like hotels -- have done terribly, with many leading companies losing half of their value or more since the pandemic began.
If you're not willing to make speculative investments in the really beaten-down areas of commercial real estate, and you don't want to pay the sky-high valuations of the best performers, there are some great stocks in the middle of the pack. Two in particular investors should take a closer look at are Realty Income (NYSE: O) and MAA (NYSE: MAA), both of which are down by double digits this year (18% and 14%, respectively) but have-rock solid businesses nonetheless.
The right kind of retail
Retail REITs are one of the subsectors of real estate that has performed dreadfully, but Realty Income isn't your typical retail REIT.
If you aren't familiar, Realty Income is a net-lease REIT that invests primarily in freestanding (single tenant) retail properties. Think of buildings occupied by drug stores, convenience stores, warehouse clubs, and dollar stores, just to name a few. Most of the company's tenants operate businesses that are recession-resistant, not particularly susceptible to e-commerce disruption, and important for our immediate purposes -- "essential."
In addition, net-lease tenants sign long-term lease agreements (think 15 years or more) that require them to pay for property taxes, building insurance, and most maintenance costs -- essentially shifting the variable expenses of property ownership to the tenant. All Realty Income has to do is get a tenant in place and enjoy years of steady and rising income. That's why the company has increased its dividend for 91 consecutive quarters and recently made its 600th consecutive monthly distribution.
With all of that said, Realty Income hasn't exactly been immune to the effects of the pandemic. About 13% of its rental income comes from fitness centers and movie theaters, which obviously aren't doing well right now. There's also some exposure to restaurants, day care centers, and a few other types of businesses that have suffered recently, and this is why shares are still trading for a significant discount to pre-pandemic levels. However, this is a solid company that should be just fine when the dust settles, and the current price could be a nice long-term buying opportunity.
Affordable suburban apartments could be a winner
The COVID-19 pandemic has given residential real estate investors concern that Americans will begin to move away from dense and expensive cities in large numbers. Not only have the stay-at-home orders of the past several months given many urban residents the desire for more space, but living in an expensive city could become less desirable as more companies embrace permanent remote-work arrangements.
While this may turn out to be a negative catalyst for some urban apartment REITs, it may actually be a net benefit to apartment REITs focused on less expensive and suburban markets, like MAA -- formerly known as Mid-America Apartment Communities. The company owns apartment communities in the Southeast, Southwest, and Mid-Atlantic regions, with more than 102,000 apartment homes in its portfolio. Top markets include Atlanta, Dallas, and Charlotte, just to name a few.
The company has been rather unscathed by the pandemic so far, collecting or agreeing to defer 99.5% and 98.8%, respectively, of April and May rent (and the deferred amount was very small). Most of MAA's properties are in locations with above-average job growth and where the cost of living is rather affordable. The company currently has $490 million of development in its pipeline, plus extensive opportunities to redevelop its existing properties to create value for shareholders.
In short, MAA is trading at a nice discount, but the numbers show that it really shouldn't be. Investors who want to add some residential real estate exposure may want to take a closer look.
Time to buy?
To clarify, I'm not saying that these stocks are going to have a smooth ride from here on out. If the economic effects of the pandemic turn out to be worse than expected, I'd fully expect their share prices to take a hit. And regardless of how the pandemic plays out, I'm expecting a very turbulent ride in the stock market for the duration.
So don't buy stock in these REITs because you want them to go up this month -- or even this year. Instead, buy them because they are rock-solid businesses trading at a discount that should provide you with steady income year after year as well as excellent growth over the long run.