With the rise in volatility, I have increasingly seen many investors turn to cash for protection. I see it in the comment sections of various Seeking Alpha articles.
People sell stocks (SPY) to get out of the market, hoping to get back on board at lower prices after the stock market crash.
I don’t blame them for fearing a possible stock market crash. After all, we live in a world of extreme uncertainty with a huge war in Europe, a raging pandemic, rising interest rates and the threat of a near-term recession.
Despite this, I think it’s a big mistake to move your portfolio into cash and I’m here to encourage you to stay invested. There are two main reasons for this.
Reason #1: Market timing is impossible
It has been proven time and again by various studies that it is impossible to predict how the market will behave in the short term, and attempting to enter and exit the market results in far more losses than gains over time.
Consider the following study from JP Morgan (JPM) which shows that individual investors have historically only earned 2.5% per year on average, and that is primarily due to their failed attempts to time the market. If they had just held a passive REIT ETF (VNQ), they would have gained over 12% effortlessly:
You can sometimes get lucky going cash, but more often than not you’ll miss out on dividend payments and upsides, causing you to underperform in the long run.
Reason #2: inflation is out of control
While you wait on the sidelines, your money is also gradually losing its value due to inflation. We have printed a huge amount of currency since the start of the pandemic and the printing is not over:
That’s why we say money is trash. Not only are you giving up market gains, but you are also exposing yourself to large and predictable losses due to inflation.
Today, inflation is at its highest level in 40 years, with the latest reported figure at 8.3%, and many say the real figure is closer to 15%. If you invest in silver, that’s how quickly it loses value in today’s environment.
For both of these reasons, I wouldn’t move a significant portion of my cash portfolio. Many investors see it as a way to protect themselves, but I actually see it as an incredibly risky move. Money is trash…
Instead, I’m shifting more of my portfolio into defensive investments in real assets that resist recession and inflation.
You would expect such investments to trade at high valuations in today’s world, but contrary to what you might think, there are great opportunities in the REIT market right now.
Many of them are barely recovering to their pre-Covid levels, despite a significant appreciation in house prices. In other words, the stock prices of many REITs have not kept pace with the appreciation of their underlying real estate. As a result, they are now trading at discounted prices compared to their fair value.
Moreover, rents are now rising at the fastest rate in decades. Few assets offer better inflation protection than real estate and REITs today.
Currently, I have about 50% of my net worth invested in REITs, but I only hold a small amount of money for the reasons I mentioned earlier. While I can’t predict the performance of REITs in the short term, I sleep better at night knowing my capital is invested in productive, inflation-protected assets. I am convinced that this approach will result in significantly better returns over the long term.
In the following, I highlight two REITs that I purchased recently.
Armada Hoffler Properties, Inc. (AHH)
Today, most high-quality apartment REITs with real estate development capabilities are valued at historically rich valuations. This is well justified as they benefit from rapid rental growth, offer inflation protection and also benefit enormously from new development projects since the differentials between development yields and capitalization rates are exceptionally large at this time. .
AHH is the exception. It is priced at just 13.5x FFO, a 20% discount to NAV and a dividend yield of almost 5%. Just for context, most apartment REITs today are priced closer to 25-30x FFO, so there is a huge gap.
Its price is so cheap because it is not only invested in apartment communities. Historically, diversified REITs have suffered from weak market sentiment due to their lack of specialization, which has most often resulted in poorer performance.
We agree that most diversified REITs deserve to trade at lower valuations, but AHH shouldn’t.
First of all, its apartment allocation is already around 50% of its total assets.
Second, while AHH does not specialize by property type, it does specialize by region, focusing exclusively on the Mid-Atlantic/Southeast region.
Finally, and perhaps most importantly, AHH’s management has proven itself. From its IPO until the onset of the pandemic, it has been a huge outperformer, even beating Camden Property (CPT) and AvalonBay (AVB). This shows that the REIT is well managed and has a good strategy that generates alpha-rich returns:
We believe that as AHH continues to increase its allocation to apartment communities, its valuation will approach that of other apartment REITs. With its apartment rents currently increasing by more than 15%, its apartment allocation will naturally increase even if it does not buy/develop new properties.
We estimate the company has 30% upside potential, and while we wait, we get a dividend yield of around 5% that goes up. We think this is very attractive coming from a defensive and inflation-protected investment in 2022.
BSR REIT recently announced very good results. Shortly thereafter, its stock price rose to ~$22 per share, which made sense as it represented a roughly 10% premium to its last NAV estimate.
We think a 10% premium is well deserved in today’s market for a REIT that owns primarily Texas apartment communities with the potential for rapid rental growth.
But then BSR announced a capital increase of $100 million, which caused the stock price to fall below $20 per share. Such declines are very common for REITs after announcing capital increases. We believe this is an opportunity for long-term focused investors, as this capital increase is likely to be accretive and will only accelerate the company’s NAV per share growth to the future.
BSR is raising capital opportunistically after the recent surge in its share price and can reinvest it in highly lucrative value-added projects, new acquisitions and deleveraging. BSR’s management is very well aligned with shareholders and therefore we are not concerned that they will try to “grow at all costs”.
Typically, the sales that result from these capital increases are short-lived and BSR rents increase at a rapid rate. We expect its net asset value per share to approach $23-25 by the end of the year.
That’s 15-20% upside potential, and you also earn a dividend yield of nearly 3% while you wait. That’s less than what you get from AHH, but BSR also has a safer, faster-growing asset base.
Texas apartment communities are in high demand today, and we think BSR could also become the next takeover target in the REIT world. Blackstone (BX) recently announced the acquisition of American Campus Communities (ACC) in a $13 billion transaction. BSR’s much smaller $1 billion market capitalization could make it a buyout target for many private equity players looking to expand their footprint in Texas.
I am now heavily invested in real estate assets such as apartment communities, but also farmland, grocery stores, warehouses, etc. I believe they offer the best risk-reward ratio in today’s uncertain and inflationary world.