REITs Come Back Strong and Still Have More Room To Go

New Residential (NRZ) along with just about every other REIT has been beaten down due to uncertainty during the COVID-19 pandemic. Up significantly from their $2.91 52-week low, NRZ still trades well below highs and would need another 120% increase to get back to those 52-week highs reached back in February. That may still be a long way off, but historically, the housing market has consistently bounced back from every economic downturn to date. When it seemed all hope was lost in 2008, the housing market not only came back but reached new all-time highs over one of the longest bull runs in history.

No matter the headwind the underlying fact that people need and yearn for a roof over their head will never change. The United States population will continue to grow as it has since inception and along with it the need for housing. Therefore, REITs still offer a very enticing investment opportunity as long as investors stick with quality businesses going forward (Figure 1). New Residential has long been one of those quality businesses, offering a diversified portfolio and a focus on the shareholder.

(Figure 1) New Residential Has A Proven Track Record Of Nearly A Decade Of Industry Leading Dividends and Cyclical Growth

The pandemic has brought fear throughout the sector, but with fear comes an opportunity for undervaluation. If this bump in the road proves to be a short-term blunder, NRZ may be set up to deliver significant returns over the next 1-2 years with minimal downside risk.

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Current Valuation

New Residential trades at a forward Price to Earnings ratio of around 5.2x earnings after being beaten down by the COVID-19 pandemic (Figure 2). This is even lower than peers indicating the stock is trading at an approximately 25-50% discounted value in comparison to competitors based upon this metric alone. Although REITs are often evaluated with the funds from operations metric instead. This metric along with the P/E ratio allows one to begin to see the value in the stock as New Residential returns the highest level of FFO/share despite trading at the lowest price to earnings ratio. This discrepancy is what jumps out most to me that NRZ is the most undervalued stock in comparison to competitors. The stock also has one of the best Price to Book value figures when comparing to peers as well which comes as yet another positive sign.

ChartData by YCharts

(Figure 2) New Residential Appears To Hold Significant Value When Put Alongside Competitors In A Number Of Valuation Metrics

Looking more towards growth one sees that New Residential is expected to grow at around 14.7% YoY. This is considerably faster than its competitors. Keeping an eye on this metric will be crucial during earnings going forward due to what may be a significantly changing environment for the sector.

Wall Street Analysts are behind New Residential as well with an average analyst rating of just around $10 signaling as much as 25%+ upside from current prices (Figure 3). This upside along with a rejuvenated dividend makes for a still enticing investment thesis for NRZ despite the rally that has already taken place.

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(Figure 3) Wall Street Analysts Have A Strong Buy Rating On NRZ Stock

The combination of industry-leading value, on-going momentum, potential growth, and a growing ~5% annual dividend yield makes a strong case for New Residential’s stock going forward.

Risks

New Residential currently has a debt of approximately $16.6 Billion with around $5.86 Billion of that being short-term debts. This could be an issue going forward if the overall main street market does not continue the quick rebound we have seen over the past few months.

Based upon historical data and when looking at the charts of the New Residential’s stock, it becomes apparent that there is a fairly strong line of resistance around the $6.75 mark as seen in both July and June. This would indicate as much as 15% downside risk going forward barring any further macroeconomic headwinds caused by the Coronavirus.

Investment Summary

Warren Buffett is famous for saying be fearful when others are greedy and greedy when others are fearful (Figure 4). That has held up well so far for investors during the COVID-19 pandemic. REITs have posted a nice V-shaped recovery thus far and still have the potential for further gains with minimized risk for long-term buyers.

BE GREEDY WHEN OTHERS ARE FEARFUL — silkinvest

(Figure 4) The Pandemic Brought Significant Fear To The REITs Sector As A Whole, But Also Opportunity For Investors Within The Group’s Strongest Names

With a potential upside of as much as 25% in as little as one year due to enhanced value, ongoing sector momentum following a major pullback, leading growth, and that upward trending 5% dividend yield, New Residential looks to be a solid investment going forward. In my opinion, there is still as much as a 15% downside risk there if the rebound turns sour, and this should be taken into account when weighing risk-reward strategies.

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The 100% dividend raise not long ago comes as a signal that management believes the business is back on the right track. Further dividend raises and a decrease in short-term debt would be two of the best upside indicators and catalysts going forward in my opinion as these would be pretty good signs that the smoke has cleared.

Finally, the company’s diversified portfolio is made up mostly of MSRs & Servicer Advances (54%), Residential Securities & Call Rights (19%), and Residential Loans (15%). The profitability of these depends largely upon volatile rates. As both the housing and overall market trends back to normal, we will see these rates tick upwards again as well. The downtrend also allows the opportunity for new investments at discounted prices if NRZ can find the cash to take advantage. In summary, the downturn caused by the coronavirus has created temporary headwinds but opens up the opportunity for long-term growth at these discounted prices.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NRZ over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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