As the growth-stock market turns and inflation runs rampant, it probably makes sense to add some value to your portfolio. Even better, undervalued real estate stocks can provide some protection from inflation as well. As inflation drives up the price of everything, real estate prices go up too, and real estate companies benefit.
The three real estate stocks we’ll go over in this article look undervalued right now, and two of them, as Real Estate Investment Trusts (REITs), also pay strong dividends. Let’s discuss how undervalued Annaly Capital Management (NLY 1.63%), Vornado Realty Trust (VNO 0.51%), and CBRE Group (CBRE 0.80%) are and why.
Annaly Capital Management
Annaly is a mortgage REIT. It borrows money with short-term loans and invests it in mortgage-backed securities and mortgages. Ninety percent of its assets, $76 billion, are in liquid mortgage-backed securities. It also diversifies from the mortgage income stream with mortgage servicing rights.
The REIT has a clear interest rate risk. Its assets have a fixed long-term rate, and its capital source, mostly debt, is short term. When interest rates go up, its profit margin shrinks. This fact has driven its price down. Over the last year, it’s down 25%.
The dividend yield is up to 15%. Price/book value is down to 1. Price to earnings (P/E) is down to 3.91, and even forward P/E (adjusted for the interest rate risk) is just 6.58 . The question is whether the REIT can sustain itself through the interest rate storm and keep paying its hefty dividend. I think the answer is yes.
Management has instituted a hedging program that covers 109% of its assets. The jump in interest rates this year was no surprise and they prepared for it. Most of the assets are covered with interest rate swaps. Interest rate swaps allow Annaly to secure a fixed low rate for the term of the swap.
The best-case scenario is that higher interest rates end up as a positive for Annaly. If the REIT is diversified enough with servicing rights and hedged enough to keep the cash flowing, increased interest rates will hold its prepayments down. Prepayments are a problem for it when rates are low but not when they’re high because homeowners can’t refinance.
Vornado’s dividend yield isn’t quite at the level of Annaly’s, but at 5.85%, it’s still high. Its price to book, at 1.39, and price to cash flow, at 9.83, are well below the five-year averages of 2.46 and 15.10, respectively. Why is Vornado cheap?
Vornado is an office and retail property REIT that is focused on New York. The exodus of employees from the city has led to a revenue drop of $400 million (from $1.9 billion to $1.5 billion) since 2019, and a 48% drop in the stock price. The stock price drop isn’t unwarranted. Vornado’s revenue was dropping even before the pandemic, and we don’t know yet whether New York will ever return to its former office building glory.
Here’s what Vornado is doing to turn the tide. Earlier this year, it started an agreement with Sharebite to provide free food for tenants at its 33 Manhattan office buildings. Vornado hopes that this will help entice workers to want to work from the office and in turn entice businesses to keep renewing leases.
Additionally, it is currently renovating what it calls the office building of the future In New York’s Penn District. The building has three levels devoted to the tenants’ employee’s self-care, including workout, dining, and lounge facilities. The 57-floor office building has already secured several long-term tenants.
Finally, the tide may already be turning for Vornado. The REIT closed on 272,000 square feet of leases in Q1 2022. The leases had a weighted average term of 8.8 years and a 6.5% average price increase. Net income from the quarter, of $26.5 million, was far higher than it was in the same quarter of 2021, $4 million.
CBRE isn’t a REIT like the first two stocks, but it certainly has exposure to the real estate market. It is the largest real estate services company in the world. It works with 90 of the companies in the Fortune 100. It has clients in 100+ countries and over 500 offices across the world. CBRE mainly provides sales and lease brokering but has shifted strategy toward a more diverse product offering since the Great Recession in 2007.
It’s done well over that period. Return on equity is usually over 20%, revenue is growing, and the stock price has crushed the S&P 500 over the past five years.
It could be a value now because the stock has fallen about 25% year to date because of real estate market fears: When interest rates go up, businesses can’t pay as much for real estate and CBRE’s revenue falls.
Right now, the stock trades for 14.03 times earnings and 0.95 times sales. Its five-year averages are 20.10 and 0.97, respectively. Excepting the pandemic crash, its P/E has only been that low once in the past ten years.
If your analysis just included CBRE’s most recent earnings result, you wouldn’t be worried. Net revenue was up 30%, Core EBITDA was up 56%, and Core EPS was up 72%. Those core numbers are non-GAAP (generally accepted accounting principles), but even the GAAP counterparts were up more than 40%. The commercial market was setting records earlier this year, and CBRE was too.
The key for CBRE is whether its success will continue if and when the commercial market falls off. The good news for the company is that it doesn’t only do sales brokering. Lease prices are going up everywhere, and CBRE will be there to broker the deals. Additionally, as rates continue to rise, some business owners won’t be able to refinance balloon payments and will look to CBRE to get the best deal for their properties.
Bargain hunting can be rough
No one said bargain hunting is easy. Each of the three real estate stocks here is cheap for a reason. Annaly is sensitive to interest rates. Vornado obtains 90% of its profits from New York. And CBRE may be facing a down year in the real estate market. This is where you have an edge. If these stocks perform better than expectations, the stock will soar because only the worst case is priced in right now.