Real estate stocks have definitely gotten volatile lately. There are some particularly risky real estate stocks to take a second look at.
The issue, of course, has been the rise in interest rates. With the U.S. economy heating up, the Federal Reserve has been taking steps to make sure that inflation does not get out of hand. But monetary policy can be tricky. If the Fed misjudges the economic statistics, there could be a deceleration in growth or even a recession.
Although, interestingly enough, even if these scenarios do not happen, higher interest rates will still likely have a negative impact on real estate stocks. These companies generally borrow large amounts, so there could be lower profits. Real estate companies may also be less attractive in terms of their yields. For example, investors may instead put their money in rock-solid Treasuries.
OK then, what are some of the real estate stocks to avoid for now? Well, let’s take a look at three:
Risky Real Estate Stocks #1: CBL & Associates Properties
The ecommerce megatrend spearheaded by Amazon.com, Inc. (NASDAQ:AMZN) is wreaking havoc on the traditional brick-and-mortar retail industry. It seems every week there is a new bankruptcy.
Keep in mind that malls are owned by REITs (Real Estate Investment Trusts), which pay 90% or more of their income in dividend distributions. Until the past few years, these stocks were fairly reliable sources of cash flows.
But no more. A prime example of this is CBL & Associates Properties, Inc. (NYSE:CBL). Not only is the company a large operator of mall properties but it also has lower-tier properties. Basically, CBL has been getting squeezed.
During the latest quarter, the CEO talked about how it has had to deal with the bankruptcy of the Bon-Ton store chain. True, the company has been scrambling to replace the vacancies, such as with Prime 22 Steakhouse and Dave & Buster’s Entertainment Inc (NASDAQ:PLAY). Yet this process has been disruptive.
In light of all this, it is tough to be bullish on CBL’s prospects. On a year-over-year basis the occupancy rate has declined from 92.1% to 91.1% and it seems likely that things will not improve any time soon. The company’s CEO has also been quite sober. In the latest earnings call, he noted: “One of our major goals for the year is to stabilize our operations and cash flow…”
Risky Real Estate Stocks #2: Redfin
Redfin Corp (NASDAQ:RDFN) is a New Age real estate brokerage firm. Instead of relying on commission-based agents, the company has employees that are compensated based on factors like customer success. Redfin also relies heavily on technologies, such as mobile apps and machine learning to provide more relevant listings.
With this efficient business model, the company has been able charge fairly low fees, at about 1% to 1.5% of the value of a home. By comparison, a traditional brokerage has commissions that range from 2.5% to 3%.
But Redfin’s unique approach may not be enough. The fact is that the company generates much of its business from residential transactions, which can be subject to boom-bust cycles. Let’s face it, the rise in interest rates poses the risk of a slowdown.
Note that Goldman Sachs Group Inc (NYSE:GS) has recently downgraded Redfin shares, from “neutral” to “sell.” Yes, part of this is due to the potential headwinds in the real estate business. But GS also thinks there is more emerging competition. Consider there is a trend towards so-called iBuyer efforts, which is where a firm buys homes directly.
And venture capitalists are pouring money into this sector, as seen with startups like Opendoor and OfferPad. All in all, it is likely to get more and more intense for RDFN.
Risky Real Estate Stocks #3: ANNALY Cap Mgmt
Whenever interest rates increase, there is usually pressure on mortgage REITs (also known as mREITs). These companies hold mortgage securities and pass along the income to investors.
Already, the mREIT’s category has taken a hit. But this may not be the end of it. Keep in mind that the Federal Reserve has indicated that the policy is to raise interest rates for the next couple years.
So one mREIT operator to be skeptical about is ANNALY Cap Mgmt/SH (NYSE:NLY). Even though the yield is a juicy 11.45%, it may not be sustainable. It’s probably instead an indication that Wall Street is skeptical.
To see why, it’s important to understand the core dynamics of NLY’s business model. The company borrows money on a short-term basis and then uses the capital to buy fixed-rate mortgages. But with the rise in interest rates, there has been pressure on margins. What’s even worse, the longer-term rates have not moved up as much.
Something else: During 2013, NLY had to cut its dividend yield. And unfortunately, the stock plunged a grueling 40%. In other words, NLY stock has quite a bit of sensitivity to interest rates.
Tom Taulli is the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
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