We continue to take advantage of the recent REIT market sell-off by gradually adding to some of our favorite investments that have become particularly opportunistic.
As I explained in our previous trade alerts, we are not attempting to predict when the market will bottom. Interest rate volatility has caused REIT valuations to drop sharply, and it is entirely possible that they could fall further in the near term.
But we also recognize that many REITs are now priced at exceptionally attractive valuations from a long-term perspective, and we expect these investments to produce very attractive returns over the coming years.
In fact, we do not need to make particularly aggressive assumptions to see how compelling the return potential has become. Consider a REIT that offers a 5-6% dividend yield, grows its cash flow by about 4% annually, and benefits from another 5-10% of annualized upside as its valuation gradually recovers. Put these together, and you get roughly 15-20% average annual total returns over the recovery period.
This may sound ambitious, but given how heavily REIT valuations have been discounted, I think it is a very realistic scenario for many of the REITs that we are buying today. We do not need exceptionally strong growth or a return to historically high valuations to achieve these kinds of returns. A gradual normalization of valuations, combined with steady growth and dividend income, could be enough.
In fact, REITs have historically delivered even stronger returns following periods when they traded at substantial discounts to their net asset values:
Rather than trying to time the bottom, we prefer to make small weekly additions with greater discipline, focusing on those REITs that have suffered the steepest declines despite maintaining strong fundamentals.
This week, we are buying more shares of Healthcare Realty Trust (HR), our favorite medical office REIT.
