It has now been three months since Russia began its illegal and gruesome invasion of Ukraine.
This is causing huge uncertainty on European soil with rising energy prices, increased inflation and a high risk of a recession. Ukraine also borders many NATO countries, increasing the risk of World War III and even nuclear war if things escalate beyond Ukraine’s borders.
Naturally, this affected the European stock market much more than the US market. Investors sold because the combination of high inflation, recession and war is not exactly the right recipe for a bull market.
But in every crisis, there are opportunities.
Today, the European REIT market is the cheapest it has been in a long time and there are plenty of opportunities for investors who can see beyond this crisis and think long term.
Most REITs own assets that are at least somewhat recession-proof and provide inflation hedging benefits. A good example would be apartment communities financed by long-term fixed rate debt. Their performance may suffer a bit in the immediate term due to the war in Ukraine, but for the most part the need for these properties does not go away. Their value will continue to rise with inflation while inflating their mortgages.
Yet these assets are now being sold at significant discounts to their fair value on the European REIT market. We accumulate them at High Yield Landlord because we believe that ultimately it will be a case of short term pain for long term gain. Russia’s invasion of Ukraine was a massive failure, weakening Russia and strengthening the West. NATO countries are now stronger than ever, and even Finland and Sweden are expected to join the alliance. At the same time, Ukraine has already won the war against a large-scale invasion and continues to show heroic resistance in the east and south of the country.
There will be a lot more pain before it’s all over, and I don’t want to downplay the gravity of the situation, but I’m optimistic that this whole crisis won’t escalate to NATO countries, which are now stronger than ever, reinforcing my conviction to buy REITs that operate in these countries at today’s discounted prices.
Below, we highlight two of our top picks:
We recently initiated a new position in Germany’s largest apartment REIT entity: Vonovia. It is primarily traded in Germany under the symbol VNA, but it also has an ADR listing in the United States under the symbol VONOY.
Why invest in Vonovia?
We believe it is the cheapest prime apartment REIT in the global REIT market today.
In terms of quality, Vonovia is the German equivalent of something like AvalonBay Communities (AVB) or Camden Property Trust (CPT) in the United States.
It is the largest and best performing apartment property company in Germany, with a market capitalization of over €30 billion, an excellent track record (13% growth in FFO per share since IPO), high quality properties (2.4% vacancy rate), steady organic growth, a platform to develop new properties and add value to existing properties, and a strong balance sheet (credit rating BBB+ credit).
Despite this, it is today valued at an estimated 45% discount to NAV, which is truly exceptional as it has historically traded at a 10% premium to NAV on average.
Please also note that this is not just my estimate, but is based on the estimate of independent and professional real estate appraisers. Unlike in the United States, German REITs must publish their NAV estimate according to IFRS accounting rules, and their latest assessment places their NAV at €66.73, an additional increase of 13.5% in 2021, compared to a price current €36 per share, down 40% since September.
After trading at new all-time highs in 2021, its price is again close to its pandemic low:
Looking at its valuation from another angle, it is currently valued at 13x FFO, which equates to an FFO yield of almost 8%, and it pays a dividend yield of 4.7% with a payout ratio of 61%. . It’s very cheap compared to its American counterparts, and it’s even cheaper when you consider that the cap rates and interest rates are lower in Germany.
Why is the stock price dropping so much?
Why is it trading at such a low valuation?
There are several reasons we discuss in our full investment thesis, but the most important are probably the following:
The first is obvious: Russia’s invasion of Ukraine. This is causing significant inflation in energy prices and utility costs, which are paid by the tenant, and management believes this will limit its ability to pass rent increases in 2022 and possibly 2023.
Second, Vonovia completed a massive deal in late 2021, acquiring Germany’s second-largest apartment REIT, Deutsche Wohnen. Vonovia issued a large number of shares to complete this transaction, but only received a quarter of the cash flow from Deutsche Wohnen. As a result, its FFO per share fell 4% in 2021, prompting many investors to sell the stock.
We believe this provides an opportunity for long-term oriented investors.
In the near term, Vonovia’s market sentiment is likely to remain challenged as its rent increases are unlikely to keep pace with the rate of inflation. However, apartment communities remain some of the best inflation hedges in the world, and despite the lag, history shows that rents eventually catch up with a rate of inflation.
Additionally, the guidance for 2022 is exceptionally strong as it now includes the full contribution of its latest acquisition. It is expected to increase its FFO per share by 18% from its previous peak in 2020, and an additional 5% once synergies are taken into account:
This direction was discussed on March 18, so weeks after Russia invaded Ukraine. It clearly shows that the drop in FFO per share in 2021 was an anomaly and was only caused by the massive issuance of shares. It will be fixed in 2022, and we think that will serve as a powerful catalyst for the title.
Of course, we can’t predict how Vonovia will perform in the short term, but with a 45% net asset value discount and growing at such a rapid pace, we believe it offers an exceptionally attractive risk-reward ratio at the current time.
As stated earlier, this is a blue-chip that deserves a more reasonable valuation. Its top-notch nature is well reflected in the company’s track record, which you can see below:
AS Tallinna Sadam (TSM1T) (OTCPK:TSMTF)
Tallinna Sadam, our Estonian real estate investment, is still priced near its all-time low, and recently we bought more shares of it.
For those of you who don’t know Tallinna Sadam is the owner of the port of Tallinn, which is the capital of Estonia. But above all, it also owns all the valuable land surrounding the port:
The main reason we invested in Tallinna Sadam is not its port activity. This is because we believe these sites are very valuable and will eventually lead to a big upside when Tallinna Sadam finally sells or leases them to property developers.
As we explain in our investment thesiswe believe that Estonia offers an incredibly attractive opportunity for real estate investors.
Indeed, prices are still relatively low, but the country is rapidly becoming Europe’s Silicon Valley and, as a result, its property prices are skyrocketing.
This year, growth will slow due to the war in Ukraine, but the long-term outlook remains unchanged.
Estonia has become a paradise for digital entrepreneurs and attracts many people who move there to run their businesses. I know this because I did it myself in 2018 with my research company.
Today, Estonia has the most start-ups per capita in Europe and the most unicorns (tech start-ups valued at over $1 billion) per capita worldwide. Last year, it was ranked 1st with 7 unicorns for 1.3 million inhabitants. Less than a year later, he already has 10!
Estonian tech start-ups are doing so well that they are running out of people to hire. This is one of the reasons why Estonia embraces so many Ukrainians with open arms. Ukrainians are renowned for their IT talent pool, and that’s exactly what Estonia needs. So far, more than 40,000 refugees have already arrived in Estonia and it is estimated that they could accommodate up to 50-100,000 refugees in total before the end of the war. This is enormous for a country of 1.3 million inhabitants.
Not all of these refugees will stay in Estonia, and not all of them bring with them computer skills. However, I suspect that many of them who have computer skills will decide to stay because Estonia has great opportunities for them.
The impact of refugees is already being felt in the real estate market. Already a month after the invasion began, apartment rents were up 15-20% year-over-year and the growth has continued ever since:
So the real estate aspect of our investment in Tallinna Sadam is still very much alive. Owning shares in the company allows us to have an interest in the city’s major waterfront sites which are rapidly increasing in value.
Today we can buy this interest at a deeper discount because the company’s port will suffer in the immediate term until the Russian freight is re-routed.
It’s not ideal, but since we’re long-term oriented and our thesis is all about real estate anyway, it could be seen as a blessing in disguise.
We expect a 50% upside, and while you wait, you also earn a dividend yield of nearly 6%.
Crises create opportunities.
At the start of the pandemic, REITs were extremely cheap in the United States, and many of our investments doubled or even tripled in value during the recovery.
Today, the war in Ukraine has created similar opportunities in the European REIT market, and we expect similar gains in the years to come.