The average real estate investment trust (REIT) is roughly 5% below its 52-week high, using Vanguard Real Estate ETF(NYSEMKT: VNQ) as a proxy. That's a vast improvement from where it was not too long ago, down over 20%, but investors shouldn't think the investment opportunity in REITs has passed. If you go back more than a year, you start to see that net lease REITs like NNN(NYSE: NNN) and tiny peer Alpine Income Property Trust(NYSE: PINE) still have more ground to make up.
REITs got smacked by interest rates
The past year was filled with interest rate increases. But the trend didn't start over the past 12 months -- it goes back a little further than that. For example, if you look at the past three years, you'll see that the average REIT is still down a bit more than 20% from its highs over the span. In other words, there's more opportunity here than may at first meet the eye if you step back and consider the broader picture.
Two REITs still worth taking a look at are NNN and Alpine, which remain down around 15% or so from their three-year highs. Before looking at each stock, it will help to understand why rising interest rates were such a problem for their stocks. The first issue is that REITs compete with other income options, like CDs. As rates rose, investors moved cash to virtually risk-free bank CDs because they could get yields as high as 5% without having to take on the inherent risk of owning a stock.
There are also operational issues that REITs have to deal with on the interest rate front. Most notably, REITs often issue debt when they buy assets. Thus, rising rates make it more costly to do business. Although property markets eventually adjust to higher rates, it can take a long time for that to happen. Basically, sellers tend to cling to high prices until they have no choice but to sell (usually because of maturing debt that has to be rolled over at higher rates) at whatever price will clear in the market. So there is a real business headwind today for REITs, as well.
There are still attractive options
That said, stable or falling interest rates would be a positive for REITs. Since that's exactly what the Federal Reserve indicated in its last meeting, investors are quickly jumping back into the sector. But you can still find attractive yields from interesting REITs like NNN and Alpine. Both are net lease REITs, which means they own single-tenant properties for which the tenants are responsible for most property-level operating costs.
NNN is one of the oldest companies in the net lease space, with an incredible 34 years' worth of annual dividend increases under its belt. It has a large portfolio of properties at around 3,500 assets, with a focus on necessity tenants. The average remaining lease term is over 10 years, so there's enough leeway there to survive an economic rough patch like a recession.
NNN's yield is roughly 5.3%, which is still quite attractive relative to the average REIT's 4.4% and the S&P 500 Index's 1.4%. If you prefer to own industry bellwethers, this REIT could be right up your alley -- and it still has recovery room before it gets back to its recent high water mark.
Alpine is a bit more of an acquired taste. With a market cap of around $260 million, it is an industry small fry. In comparison, NNN's market cap is $7.6 billion. So only more aggressive investors will want to look at Alpine. However, the REIT has a 6.3% dividend yield. It has increased its dividend each year since its IPO in late 2019. Although it has a tiny portfolio of just 138 properties, nearly two-thirds of its tenants are investment grade rated.
Meanwhile, the funds from operations (FFO) payout ratio is around 75%, which is reasonable and only slightly higher than the industry's larger players, including NNN and its 70% FFO payout ratio. And, at least partly thanks to its small size, Alpine trades at a discount to most of its peers while offering more opportunity for growth, because even small acquisitions can move the needle dramatically.
Two REITs that are worth a closer look
For conservative investors, NNN is probably the better choice. It is an industry-leading net lease REIT with a great track record and attractive yield. And it still has some room to run before it gets back to its previous highs. Alpine is for more aggressive investors, given its small size. But if you can handle a little more uncertainty, it has proven to be a reliable REIT and comes with an elevated yield. And, like NNN, there's still more room to go before it has recovered from the market hit related to interest rates.
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Reuben Gregg Brewer has positions in Alpine Income Property Trust. The Motley Fool has positions in and recommends Vanguard Specialized Funds-Vanguard Real Estate ETF. The Motley Fool has a disclosure policy.
