REIT Valuations Attractive After Large Sell-Off

By Mani
Updated on

REIT valuations have become increasingly attractive over the last several months, points out Citiin its recent research report.

Michael Bilerman and the team at Citi believe some compelling NAV discounts across a number of quality assets may attract capital.

Essex bidding for BRE Properties

Citi analysts cite a recent Bloomberg article pointing out that apartment REIT Essex Property Trust Inc (NYSE:ESS) has made a bid for peer BRE Properties Inc (NYSE:BRE) The analysts believe that an ESS/BRE deal would make sense and would clearly benefit from significant operational and G&A synergies to create an approximately $16 billion West Coast giant.

Citi analysts wonder whether the Bloomberg article is just speculation of a deal or if Essex Property Trust Inc (NYSE:ESS) would be willing to go hostile.

According to the Citi team, at the current Properties Inc (NYSE:BRE) share price, they believe the downside of a deal not occurring could outweigh the upside in a bid and have completely removed the analysts’ prior large overweight position in their REIT model portfolio.

By using NAV, AFFO and FFO multiple valuation methodologies and considering Essex’s heavy West Coast exposure, Citi analysts pegged Essex Property Trust Inc (NYSE:ESS)’s target price at $160. The analysts used similar methodologies to arrive at BRE’s target price at $51. However, Citi analysts point out that if private market cap rates expand more than the analysts’ anticipation, both the stocks could underperform the target price.

Overweight on apartment stocks

Citi analysts have been overweight on the apartment stocks all year based on valuation. However the stocks have fallen out of favor based on decelerating same store growth, which nonetheless is still above REITs and the historical multifamily average.

The analysts point out that even after the recent gains, apartment stocks trade at an average implied cap rate of about 6% against a private market of about 5%, with almost all the companies at meaningful discounts.

Citi analysts particularly like Post Properties Inc (NYSE:PPS) and Home Properties, Inc. (NYSE:HME), both of which are Buy rated. Furthermore, the analysts believe a number of the blue chip REITs are at low implied cap rates and they represent sizable discounts to private market values for quality core assets.

Bull and bear case for REITs

According to Michael Bilerman and team at Citi, the bull case for REITs is that the underperformance on interest rate concerns is only temporary. The analysts believe a stronger economy in 2014 would mean better real estate fundamentals implying stronger rent growth and greater availability of capital. These could mitigate the impact that higher rates would have on cap rates.

Citi analysts believe the bear case for REITs is that the stocks are leading indicators and are correctly pricing in what will be a rise in private market cap rates over the next 12 to 18 months.

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