The Bear Market is In for Real Estate: 3 Most Promising REITs

Key Points

• The real estate industry faces increasing headwinds from a macro and micro perspective. However, the residential space provides the more attractive discounts today. 
• These 3 REITs have one thing in common: their robust business model and growth potential are being underrated by markets, though some players are beginning to jump ahead of the turnaround. 
• Understanding that these trusts are designed to eat inflation for breakfast, investors looking for safety and income growth potential will feel comfortable adding these to their 'potential buy' watchlist.

A bear market can be defined in many ways, typically subject to the person or asset experiencing it, and most market participants prefer to stand in the corner of denial rather than face the environment.

The commonly used Wall Street definition will be applied to today's market to avoid confusion. While stocks overall, as measured by the S&P 500 index, are still healthy, some sectors are in a bear market, defined as a 20% pullback from recent or all-time highs.

Starting one of the backbones of America's economy, the real estate sector is experiencing heavy contractions today on the residential side. As defined in the Vanguard Real Estate ETF NYSEARCA: VNQ and its decline of more than 30% from its peak of $116.7 a share, investors now have a whole sector ripe for stock-picking.

There are clear indicators that can - and should - guide everyday investors, alongside big money, into the following REITs (real estate investment trusts) and gain proper exposure to the ensuing bottom in the industry.

Equity LifeStyle Properties 

Leaning on the latest ISM PMI data for the U.S., both manufacturing and service-based reports mention a weakening in residential real estate. No matter what the dynamic is within each trust and what the future may hold, markets will treat each member as equal and sell them off equally.

Equity LifeStyle Properties NYSE: ELS has retreated by as much as 26.5% from its peak of $88.7 a share, throwing this portfolio of residential properties into a bear market discount. Investors today can gain some cheap exposure to double-digit upside across the board.

According to the latest investor presentation, management points to this company growing its dividend payouts by a total CAGR (compounded average growth rate) of 21% from 2006 to 2022.

Today's 2.75% dividend yield may be below inflation. However, shareholders can lean on the fact that management will increase their income enough to beat any inflation environment in the long term.

Income growth is not the only metric set to experience further double-digit growth, as analyst ratings point to a consensus price target of $73.5, which would need to bring a net upside of 12.8% from today's prices to prove these analysts right.

Considering that real estate across the nation is becoming cheaper, in part driven by the higher mortgage costs as a result of the FED interest rate hikes, Equity LifeStyle can use part of its $200 million average free cash flow to buy properties and add further rental income and value to their portfolio. 

It goes beyond saying that, as fewer people are in the market to buy or sell a home because of the pricing and financing cost forces at work, renting is the only alternative upon which Equity - and the following REITs - are positioned to rally behind.

American Homes 4 Rent

In a similar fashion, American Homes 4 Rent NYSE: AMH is one stock that has fallen by as much as 36% from its peak, though recently showing some signs of recovery. 

The slow and steady recovery for the stock stems from the market realizing these trends of a bottoming in the industry; in a fundamental sense, this can be seen within the company's financials as well.

A 68% jump in earnings per share over the past twelve months should have been enough to bail shareholders out of the bear market. Typically, EPS drives stock prices when all else is equal.

Therefore, American Homes should have risen by a similar amount; the stock has fallen behind the S&P 500 by 13.2% during the same period.

With an average occupancy of 97% throughout the portfolio, it is a matter of time before the market realizes the actual value of this steady income growth stock. Within the latest quarterly results press release, management highlights a new joint venture that may signal this realization taking place.

American Homes has entered into a $625 million deal with J.P. Morgan Chase & Co NYSE: JPM, stipulating that the two entities will construct and operate new residential units.

This deal not only scales the company's operations further but also places a quality 'stamp' that may attract other partners in the future, bringing higher upside than the stock is being given credit for today.

Equity Residential 

Equity Residential NYSE: EQR recently lost its CEO, Sam Zell, as the real estate investing mogul passed away. However, it will become evident that the old leadership's skillset and decades of experience in creating value through the many business cycles are reflected in the company today.

This is yet another REIT suffering from a 33.6% selloff from its recent peak prices, throwing it deep into bearish territory and providing an attractive acquisition opportunity for those who can spot it. Where can this value be built from? How about revenue growth and stability, for starters?

Unsurprisingly, analysts are placing a consensus price target of $69.9 a share for this stock, implying it should rise by 11.6% to meet it.

During the latest quarterly results, this company reported 96% occupancy with rental income projections to grow by 5.5% to 6.25%, relative to the industry average of only 3.25%. The best part? You can get paid a dividend yield of 4.2% while you wait out the bottom.