The Morningstar US Real Estate Index is up 35.9% over the trailing 12 months, but that is well below the 43.9% performance of the broader U.S. equity market over the same period. While the broader equity market began to recover last summer, real estate did not begin to recover until the announcement of the successful development of a vaccine in November 2020.
Real estate trails U.S. equity index. - source: Morningstar
The real estate sector is currently trading relatively in line with our fair value estimates. Our median real estate coverage currently trades at an 11% premium to our estimate of fair value, which is in line with our total coverage trading at an 8% premium to our fair value estimates on average at the end of the first quarter. Currently, 51% of the real estate sector is trading in 3-star range, while only 5% of our real estate coverage is trading in 4-star range and none is trading in 5-star range.
Few discounts, as more than half of sector are 3-star companies. - source: Morningstar
Since the announcement of the successful development of a coronavirus vaccine in early November, the real estate sector has performed mostly in line with the broader equity market and even slightly outperformed toward the end of May. While revenue for most real estate companies are somewhat protected from short-term shocks because of long-term leases, rent collection on those leases requires healthy tenants, who in turn require people using the real estate. Once the vaccine was announced and a return to normalcy could be mapped out for tenants, investors could more reliably predict when revenue for real estate companies would return to prepandemic levels, allowing for a recovery in the share prices for the sector.
Hardest-hit subsectors have outperformed since vaccine was announced. - source: Morningstar
The hotel and retail sectors were hurt the most by the pandemic, and these two sectors have both massively outperformed the broader real estate market since the announcement of a vaccine. The vaccine allows travelers to return to hotels and shoppers to return to stores, significantly reducing the risk of bankruptcy for these companies and making the path to recovery clearer.
Both sectors have seen negative operating fundamentals for four straight quarters due to the pandemic. Still, we believe that once the vaccine is fully rolled out to the U.S. population, the hotel and mall sectors can see years of strong growth. We currently see some value picks for investors among these hardest-hit subsectors, though the recent rally has significantly reduced the discounts for these names.
Simon Property Group SPG Star Rating: ★★★ Economic Moat Rating: None Fair Value Estimate: $149 Fair Value Uncertainty: High
Class A malls continue to outperform other forms of brick-and-mortar retail. The stock has sold off significantly during the height of the pandemic as fears of the coronavirus impact on brick-and-mortar retail sales grew among investors. Simon has long-term leases with tenants, so they continued to receive rent even during the worst months of the crisis. While many weaker retailers may still go bankrupt due to the lack of sales, we think their attractive portfolio will be able to quickly fill any vacancies. Additionally, Simon recently acquired Class A mall competitor Taubman Centers, which should increase cash flows and provide more leverage when negotiating with tenants.
Park Hotels & Resorts PK Star Rating: ★★★ Economic Moat Rating: None Fair Value Estimate: $24 Fair Value Uncertainty: Very High
Spun out of narrow-moat Hilton Worldwide Holdings at the start of 2017, Park recently acquired Chesapeake Lodging Trust to add a complementary portfolio of 18 high-quality, upper-upscale hotels that should help diversify Park's hotel brands to include Marriott, Hyatt, and IHG hotels. In the short term, the coronavirus has significantly affected the operating results for Park's hotels with high-double-digit declines in revenue per available room and negative hotel EBITDA in 2020. However, as travel slowly returns to normal once the virus has passed, we think the company should see strong growth in 2021 beyond and the company should eventually return to 2019 levels by 2024.
Ventas VTR Star Rating: ★★★ Economic Moat Rating: None Fair Value Estimate: $59 Fair Value Uncertainty: Medium
Ventas owns high-quality assets in the senior housing, medical office, and life science fields. While the company's medical office and life science portfolios should be relatively unaffected by the coronavirus outbreak, the senior housing portfolio has experienced a very significant impact to occupancies as the virus has the highest lethality rate among senior citizens. However, while virus will continue to negatively affect net operating income through 2021, the industry should see strong long-term growth from the coming demographic wave of baby boomers aging into senior housing facilities.