Real estate has been one of the hardest-hit sectors of the stock market during the COVID-19 pandemic. While the S&P 500 benchmark stock index is flat for the year, the Vanguard Real Estate ETF (NYSEMKT: VNQ) — a good benchmark for the sector — is down by more than 13%.
Some real estate stocks have fared far worse, and while many are certainly beaten down for a reason, there are some that could be excellent long-term investments at their current prices. Two real estate investment trustsstyle=”text-decoration: underline”> in particular that look interesting are STORE Capital (NYSE: STOR) and Equity Residential (NYSE: EQR), which are down by 37% and 32%, respectively, so far in 2020.
The right kind of retail
STORE Capital (which stands for Single Tenant Operational Real Estate) is a net-lease REIT, specializing in retail and service-industry properties. Essentially, this means that the company invests in freestanding (single-tenant) properties, where the tenants sign long-term leases and are responsible for paying property taxes, insurance, and maintenance expenses. In a nutshell, the net-lease model is designed to produce stable and growing cash flow year after year.
The COVID-19 pandemic certainly threw STORE Capital a curveball. While much of the portfolio is occupied by so-called “essential” businessesstyle=”text-decoration: underline”> like auto repair centers, medical and dental businesses, and pet care businesses, much of it is not. Specifically, restaurants, day care centers, health clubs, movie theaters, and family entertainment centers occupy one-third of STORE’s portfolio, and these businesses were largely shuttered (or extremely limited) as the pandemic began. And many were unable or unwilling to pay rent during the shutdown periods — which is why STORE’s stock price took such a hit.
However, while STORE might face a tenant bankruptcy here and there, the vast majority of its portfolio will be just fine. STORE focuses on top-notch tenants that are financially secure national brands, and the numbers are already looking strong. The company recently announced that it had collected 85% of its July rent as of the 17th of the month, and deferral agreements have been reached for all but 2% of its expected rental income for the month, meaning payment will come at a later date.
STORE Capital is certainly lower for a reason, but there’s also a reason it’s the only REIT that Warren Buffett added to Berkshire Hathaway’s (NYSE: BRK.A)(NYSE: BRK.B) stock portfolio. The business is set up to be a long-term income and growth machine. And from a long-term perspective, that reason still applies.
A time-tested REIT with durable advantages
Equity Residential is one of the oldest REITs in the business, founded in the 1960s by legendary real estate investor (and current chairman) Sam Zell. The company is a residential REIT, specializing in apartment buildings in urban and high-density suburban locations. At the end of 2019, Equity owned 309 apartment properties with nearly 80,000 total units.
Equity’s business model is simple. It buys, sells, and occasionally builds apartment buildings in some of the most desirable real estate markets in the United States, with the goal of optimizing long-term value creation.
Now, Equity’s business hasn’t exactly been immune to the COVID-19 pandemic. Its properties are located in urban, high-cost markets, and the company could potentially lose tenants if people move to the suburbs in large numbers like many experts predictstyle=”text-decoration: underline”>, or if a prolonged recession makes its apartments tougher for tenants to afford. Through June 1, Equity saw new leases fall by nearly 5% year over year in the second quarter, and while occupancy remains strong at 94.9%, that’s significantly lower than the 96.2% occupancy rate at the beginning of 2019.
From its 1993 IPO through the end of 2019, Equity produced a 2,269% total return for investors — more than double the return of the S&P 500 during the same period. While the COVID-19 pandemic certainly resulted in a backwards step, this is still a time-tested model that should be just fine over the long run.
Time to buy?
Both of these companies are certainly facing some short-term headwinds. If the U.S. recession ends up being worse than feared, it could cause pain for some of STORE’s more vulnerable tenants, and Equity could experience an uptick in vacancies and see its pricing power erode.
On the other hand, both of these are rock-solid businesses that are well capitalized and should be just fine over the long run. While both stocks could produce quite a roller coaster ride for investors in the near term, they could be excellent long-term bargains, but only if you’re a patient investor with at least a moderate level of risk tolerance.