Many REITs are on a tear since the beginning of the year, and I’ve written critically in the recent past that the huge rallies seen in many REIT had gone too far, too fast. After considerable retracements over the past several weeks, are these REITs finally ripe for the picking?
Were the astounding rallies a mirage?
REITs aren’t supposed to be construed as growth stocks. The investment case for REITs has traditionally been focused on the reliable income they provide.
At the same time, over the past year many publicly-traded REITs have skyrocketed in price, defying their slow-and-steady reputations. One of the most popular REITs in existence, Realty Income Corp (NYSE:O). shows a chart more befitting of a high-flying technology start-up than a yawn-inducing REIT.
Realty Income Corp (NYSE:O) ended 2012 as a $40 stock. By May, it reached $55 per share. That means in just five months, Realty Income Corp (NYSE:O) racked up 37% gains, which don’t even include the generous dividends that REITs like Realty Income are known for.
This perplexing case of a REIT skyrocketing in value wasn’t a one-off. This was a pattern seen broadly throughout the REIT landscape.
Health Care REIT, Inc. (NYSE:HCN), which, as you can probably infer, manages health-care related properties including hospitals and senior living communities, also shot up in value to begin the year.
Health Care REIT, Inc. (NYSE:HCN) began 2013 trading for $61 per share, then shot up to nearly $80 per share in just a few months’ time.
Of course, as a company’s share price climbs, so does its valuation. And, since REITs historically have grown profits at modest paces, I became worried about the lofty prices investors became all-too-willing to pay for these stocks.
When I last wrote about Realty Income Corp (NYSE:O) and Health Care REIT, Inc. (NYSE:HCN), both stocks were trading for alarmingly high valuations. On a price-to-FFO (funds from operations, a metric commonly used in place of EPS for REITs) basis, Realty Income Corp (NYSE:O) and Health Care REIT, Inc. (NYSE:HCN) traded for 27 and 22 times trailing FFO. And, indicative of REITs’ slow-growing nature, both stocks traded in excess of 20 times forward FFO as well.
The joyride didn’t last very long. Many REITs sold off when interest rates began rising last month. Fears of Fed tapering served as further fuel on the fire, and before long, Realty Income and Health Care REIT fell back to more reasonable levels.
At their current levels, Realty Income Corp (NYSE:O) and Health Care REIT, Inc. (NYSE:HCN) have retraced much of the gigantic gains seen this year. Their dividend yields are approaching 5% again, the level I personally prefer to see for REITs.
And, their valuation multiples are now much more reasonable. For example, Realty Income expects at least $2.37 per share in funds from operations in 2013, meaning new investors are paying 18 times this year’s FFO. For Health Care REIT, Inc. (NYSE:HCN), shares can be had for 16 times forward FFO.
I’d be particularly interested in Realty Income under $40 per share, and it’s getting close to that level.
A REIT with the best of all qualities
One REIT that sat out the eye-popping rally is Digital Realty Trust, Inc. (NYSE:DLR), a REIT focused on real estate properties for the technology sector.
Shares of Digital Realty Trust, Inc. (NYSE:DLR) have actually fallen quite considerably over the past two years. The stock exchanged hands for $80 per share in July 2012, but has steadily fallen over the past 52 weeks to its current level of $65 per share.
This dramatic decline came in spite of strong underlying fundamentals. Digital Realty reported 19% higher revenues in its recently released second quarter report. On top of that, the company realized 12% growth in FFO, year over year.
This combination of a falling stock price and strong growth can be summarized with one word: opportunity.
Digital Realty Trust, Inc. (NYSE:DLR) expects, at a minimum, $4.74 in per-share funds from operation in 2013, meaning investors can scoop up shares of this high-quality REIT for just 13 times this year’s FFO.
The stock pays a strong 5% dividend and is very cheap when compared to other REITs. I recently initiated a position in Digital Realty under $60 per share, and will look to add to my position should the stock revisit that level.
Realty Income Corp (NYSE:O) and Health Care REIT, Inc. (NYSE:HCN) are great stocks as well, but they’re not quite cheap enough yet. On further declines they’d be much more interesting, but for now, Digital Realty looks like a REIT that is simply too cheap to ignore.
The article Which of These REITs Is Cheap Enough to Buy? originally appeared on Fool.com and is written by Robert Ciura.
Robert Ciura owns shares of Digital Realty Trust. The Motley Fool recommends Health Care REIT. Robert is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
