A Six-Pack of REITs

08/02/2017 2:54 am EST

Focus: REITS

George Putnam

Editor, The Turnaround Letter

Real estate investment trusts (REITs), publicly-traded companies that primarily own rent-producing properties, have broadly produced lackluster returns over the past 12 months, observes George Putnam, editor of The Turnaround Letter.

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We think that at least three factors are contributing to the unimpressive performance. Concerns about rising interest rates make the higher yields on REITs somewhat less attractive.

Also weighing on returns: rising valuations and slowing earnings growth in most property categories, especially when compared to the open-ended growth potential of technology stocks.

As turnaround investors, we approach REITs differently. Rather than focusing on a particular segment of the real estate market, we look for individual REITs that have been neglected by investors but have solid value — that should prevail regardless of the overall market.

In May 2016 we highlighted six REITs that were out-of-favor but that we felt offered bargain valuations combined with catalysts for improvement.

The six REITs are DiamondRock Hospitality (DRH), Equity Commonwealth (EQC), First Potomac (FPO), Mack-Cali (CLI), Outfront Media (OUT) and Veriet (VER).

In the year since our initial recommendation, they have shown a total return on average of 13.2%. We still view these as attractive opportunities and continue to like the prospects for the six companies highlighted above.

In real estate, the mantra is often “location, location, location.” However, in REIT turnarounds, it’s “management, management, management.”

Because REIT turnarounds often involve selling illiquid real estate, they can be measured in years, not months. However, for patient investors, they can offer substantial gains while often paying attractive dividends in the meantime.

These six REITs have strong management teams and good strategies. Combined with attractive valuations, they offer the prospect of higher earnings and share prices even in a flattish overall REIT market.

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