5 Cheap Real Estate Stocks to Buy – Morningstar

Plus our stock market outlook for March.
Susan Dziubinski: I am Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. First let’s talk about what’s on your radar this week, Dave. With earnings season winding down, it’s kind of a quiet week this week, right?
Dave Sekera: Good morning, Susan. Good to see you. We finally get the chance here to catch our breath, I think for a couple of days. On the earnings front, I’d say probably the most noteworthy is going to be Oracle ORCL. We rate Oracle 2 stars. That reports here on Thursday. Then on the economic front, looks like Federal Reserve Chair Powell does testify to the Joint Economic Committee on Tuesday and Wednesday. Personally, I doubt he’ll say anything new, so I doubt there’ll be really much new news coming out of that. Really, the big item up this week is going to be on Friday, and I think the market’s going to be very closely watching the payrolls number.
If you remember, there was a huge surprise last month. The number was over half a million gain. This month, the consensus is looking for 200,000 and I think the two takeaways are going to be there is if it’s much lower, then I think that takes some of the pressure off of the Fed as far as having to tighten monetary policy higher for longer. However, if it is greater than the consensus number, then I do think that we could see some very volatile markets on Friday. In that case, then I think the market would assume that the Fed’s going to have to be more aggressive in tightening monetary policy.
Dziubinski: Let’s move on to some new research. Talk about your new stock market outlook for March, Dave, which just published on morningstar.com. After a strong start in January, stocks lost some ground in February. What are you expecting for March, Dave?
Sekera: Well, as you mentioned, earnings are for the most part behind us, and I think that means that the market’s going to shift its focus really much more to economic and inflationary indicators over the next two to two and a half months. Now on the economic side, we’re going to be looking to see if we can get a better sense as to just how long the strength in the economy is going to last before some weakness that we expect later this year. And really at the timing as far as when we could start seeing that economic slowdown. On the inflationary front, we want to determine whether or not inflation continues to keep moderating, which is our expectation, or if it could potentially remain persistently high. Inflation has been moderating, but I would say that we are still seeing some indications that it could be a little bit stickier than what we were expecting.
However, we still have the view it will moderate over the course of the year, and in fact, we think it’s going to moderate more quickly than what the market consensus is. We expect by the end of the year that in December, that year-over-year growth rate inflation will drop down to about a 2% rate. The economy has been stronger than originally anticipated, but again, we do think that tightening monetary policy will take its toll. But now we think that that slowdown for the economy’s probably going to occur more in the third and fourth quarter. Originally this year we thought it was going to be in the second and third.
Dziubinski: How do we look valuation wise from the overall stock market heading into the beginning of March?
Sekera: According to our valuations of those over 700 some stocks that we cover that trade on the US exchanges, the market right now is at about a 12% discount to our fair value. And I do think that’s a pretty attractive discount for long-term investors. But I do still caution investors are going to need the wherewithal to ride out some potentially tough markets, maybe some rough road here in the near term over the next couple of months. Again, we’re looking for when leading economic indicators this year start turning upward when we really think that we’re going to start seeing smoother roads ahead. When we break that valuation down into the Morningstar Style Box, we still think that probably some of the best positioning is going to be a barbell portfolio. Again, that’s overweight value, overweight growth; those two categories are trading at 15% and 16% discounts, respectively. And then I would recommend an underweight in core stocks. Those are trading much closer to fair value. And then I also note that we still see a lot of value in those small-cap stocks. Those are trading at about a 25% discount.
Dziubinski: Let’s talk a little bit about a few sectors that struggled in February. Energy stocks in particular took it on the chin, losing almost 7% for the month. What happened there and how does the sector look now from a valuation perspective?
Sekera: Energy, you have to remember, it’s been a very volatile sector for a couple of years now. In fact, it was actually the most undervalued sector coming into 2022. It surged over 60%. And now coming into this year, we actually noted we thought as the exact opposite, as it had become the most overvalued sector. And I think you need to take a little bit of a step back and look at what oil prices have done over the past couple of years. If you remember initially they dropped at the beginning of the pandemic. In fact, they even dropped in a negative territory, which I certainly had never seen before. They began to recover. And then we had that huge surge after Russia invaded Ukraine. And now it appears that oil has settled into a range for the past couple months in kind of that mid-$70-a-barrel area.
So, I think the mark is coming around to the realization that oil prices may not be as high for as long as what it was originally estimating. And based on our long-term analysis, we think the energy is still going to be on a downward trend. In fact, our energy team throughout all of this maintained their forecast of $55 a barrel based on their fundamental analysis. We do continue to think the oil prices will subside over the course of the economic cycle. So at this point, with the pullback here in February, we do think oil and gas and the energy sector overall, it’s trading at about a 5% premium to our fair value.
Dziubinski: Real estate was also down around 6% in February. What drove down real estate stocks?
Sekera: I always have to remember on the short term it’s often hard to point to just one specific or two specific factors that might cause a sector to sell off any one month. But in the case of the real estate, the two things I would point to here is going to be, one, that increase in long-term interest rates. We did see the yield on the 10-year Treasury rise 40 basis points over the course of the month, and it still remains on an upward slope at this point. And the other factor is going to be management guidance that we heard here in the fourth-quarter earnings. Our analyst, he does think that the guidance will probably prove to be overly conservative, and with real estate stocks having dropped as much as they did, the price/fair value, that sector has declined. So it’s now trading at a 15% discount. So, I think the combination of those lower valuations with the lower expectations now could be setting the market up for some pretty good returns for real estate and good performance over the course of the rest of the year.
Dziubinski: And lastly let’s comment a little bit on communication stocks and what happened there, Dave. It seems like returns in that sector were a mixed bag really, right?
Sekera: They were, and communications has certainly had a rough time over the past couple of years. There’s been a whole host of concerns that investors have had with that specific sector. Now, here in February we saw as the sector did drop by almost 5%. But I would note, you have to remember that sector is definitely skewed by Alphabet GOOGL. Alphabet in and of itself. Alphabet, of course, being the parent of Google, makes up 37% of the market cap of that sector and its stock did pull back about 9% here in February. And I think what we saw most recently was that stock was under pressure. Investors were just very underwhelmed by Bard, which is Google’s artificial intelligence product and platform. And I think when they’re comparing that to the others that are out there like ChatGPT and Microsoft MSFT products, they didn’t find it to be as strong as those.
Now having said that, some of the stocks in the sector like Meta META, another one that we think is significantly undervalued, did perform better, but it wasn’t enough to be able to make up the difference that we saw from Alphabet. So at this point, we do think the sector still remains at a very deep discount to our long-term valuations, trades at a 37% discount to fair value. And in fact, it’s actually the most undervalued sector by far.
Dziubinski: Dave, let’s move on to our picks portion of our program, focusing on some ideas that you have in the real estate sector. You think there are a couple of themes in this space, one being the normalization of consumer behavior. Explain what you mean by that, and what types of real estate stocks stand to benefit there?
Sekera: Well, with the pandemic still falling up further and further into the rearview mirror, and we do see more and more evidence of people’s behavior reverting back toward prepandemic norms. And one of those behaviors is going back out in person and shopping in retail locations. And as such, we are seeing traffic pick up at a lot of different malls and a lot of different retail areas that we do monitor. And then the other is in the travel industry. Now leisure travel has already largely recovered, in fact, in some areas I think it’s actually even more now than what it was prepandemic, but we’re looking for next is going to be a return for international tourist traffic as well as for an increase in business travel.
Dziubinski: Two of the names that you like to play, the first theme are Macerich MAC and Simon Property Group SPG. So we’ve talked about Macerich before. Remind viewers why you like it and then share some of your thoughts about Simon Property Group.
Sekera: Sure. So Macerich is rated 5 stars, and it trades at about half of our fair value. It also pays a 5.0%, actually 5.6% dividend yield. And Simon Property Group is rated 4 stars. It trades at a little under a 20% discount to our fair value, and that one pays a 5.8% dividend yield. And really when I look at both of these REITs, they do operate Class A malls, and in our view, Class A malls, we think have the best locations, the best retail portfolios. They’re also going to be in the best position to recapture foot traffic as shoppers return. In addition, those Class A mall operators, they’ve been in the best position to continue to redevelop their properties to become more experiential and rely less on just on retail sales.
Dziubinski: Dave, you also referred to earlier your second theme in the real estate sector relates to travel. Can you unpack that one a little bit more for us?
Sekera: Sure. So, domestic leisure travel has already rebounded back to prepandemic levels, but really where that leaves us now is we are starting to see a pretty good pickup in international tourist traffic. And business traveling has lagged that rebound that we’ve seen in the other areas. I think a lot of companies are looking at that is an area that they’ve been able to keep costs down. But I do think that they are starting to realize that as more meetings are conducted in person, that there is certainly economic value for people getting back out on the road again. We do see it uptick in conventions. Those have been cut and really reduced for the past three years. Those are starting to trade back up. And so I think we’re starting to see the pickup in those two areas. Those are the areas that we’re looking for, for stocks that we think will benefit as that travel area continues to keep getting more and more active.
Dziubinski: Specifically then with real estate stocks, a few undervalued stocks that should benefit from this travel trend are Park Hotels PK, Pebblebrook Hotel PEB, and Host Hotels HST. Give us the elevator pitch for each of these names, Dave.
Sekera: Sure. So, Park is a 5-star-rated stock, and that trades at a little over half of our fair value, pretty healthy dividend yield at about 7%. And Park is the second-largest U.S. lodging REIT that’s focused on what we call the upper-upscale hotel segment. And it’s one of those companies that we think is going to be very leveraged to the increase international tourism as that recovers because that’s usually made up of higher-end travelers. Pebblebrook is also rated 5 stars. That one trades at about a 45% discount to our fair value. And Pebblebrook in and of itself is the largest U.S. lodging refocused on owning independent and boutique hotels.
And so that one I would say is also then going to benefit from the increase in that international tourism as those tourists are very focused on kind of those boutique hotels where they can get individualized experiences. And then lastly, Host Hotels is rated 4 stars. That trades at about a 30% discount to our fair value. Pays a 2.8% dividend yield. And again, it’s one of the largest owners of luxury upscale hotels that we think will benefit as business travelers get back out on the road again.
Dziubinski: Well, thanks for your time this morning, Dave. Be sure to join us again, live on YouTube next Monday at 9 a.m. Eastern time, 8 a.m. Central time. And while you’re at it, subscribe to Morningstar’s channel. Have a great week.
David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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