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BALTIMORE (Stockpickr) -- With real estate prices starting to heat up again, investors had better start paying attention to real estate investment trusts, better known as REITs.
But by and large they’re not. In fact, investors still hate REITs right now -- and they’re betting against them en masse.
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Real estate investment trusts are still among the most heavily shorted classes of investments as I write, a fact that’s especially surprising given the income characteristics of REITs in this toxic, low-rate environment. REITs are obligated to pay out most of their earnings in the form of dividends, a legal structure that actually makes many of them better income-generation instruments than real estate instruments (more on that later).
So today, we’re focusing on five big REIT names that could be primed for a short squeeze. In case you’re not familiar with the term, a “short squeeze” is the buying frenzy that ensues when a heavily shorted stock starts to look attractive again to investors, causing share price to skyrocket. One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.
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Naturally, these plays aren’t without their blemishes -- there’s a reason (economic or otherwise) that these stocks are being heavily shorted. But for investors looking for exposure to a speculative play with a beefier risk/reward tradeoff, these could be powerful upside plays for the coming year. And my research shows that buying the biggest, most heavily-shorted stocks has historically led to superior returns.
Without further ado, here’s a look at our list of REIT short squeeze opportunities.
$9 billion technology REIT Digital Realty Trust (DLR) is one of the most unique niche REITs on the market today -- and arguably my favorite name in the category. But it’s not other investors’ favorite name. With a short interest ratio of 18.3, it would take close to a month of buying pressure for shorts to exit their bets against DLR. That makes it a prime short squeeze candidate right now.
Digital Realty Trust is unique in that it’s a technology REIT. The firm owns 16.8 million square feet of datacenters, internet gateways, and tech firm office buildings spread across the country. Exposure to such an in-demand, specialized type of properties presents a major tailwind for DLR right now -- particularly in the datacenter business, which has been growing at a fast pace as consumers’ appetites for hosted data continues to grow.
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Because DLR’s properties are so specialized, it boasts stickier tenants than most REITs can. Most often, datacenters are built to suit a tenant’s specific technology needs, so any tenant that wants to bear the costs of breaking a lease have to bear the additional switching costs of replicating their previous setup. Those high switching costs should continue to provide a nice backstop for Digital Realty Trust right now.
And DLR’s nearly 4% dividend yield should be a nice backstop for investors -- particularly since short sellers have to pay it back.
Plum Creek Timber
Plum Creek Timber (PCL) is a unique REIT name too -- the $6.7 billion firm owns timber producing properties, as well as a wood product manufacturing business. Only the timberland business falls under REIT rules, with logging operations treated as a traditional taxable corporation. For all intents and purposes, though, PCL’s bread and butter remains its timberland, particularly as PCL works to earn more money through recreation, development, and conservation efforts than through logging.
All in, Plum Creek owns 6.6 million acres of timberland spread across 19 states, making it one of the largest private landowners in the country. The sheer scale of Plum Creek’s holdings make it unique -- and that’s a big reason why the firm has been exploring nontraditional uses for its land portfolio. Logging removes considerable value from its land, whereas recreation, for instance, adds to the value of PCL’s land per acre.
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PCL has done some things to ruffle some investors’ feathers in recent years -- and to stoke short sellers. One of the biggest is the fact that PCL has been slowly liquidating land to generate cash for its dividend, rather than relying on more perpetual sources of profitability. While concerns are warranted, investors need to remember that PCL has only been covering its dividend shortfall during a challenging time for its alternative income strategies.
The concerns seem overblown at this point, especially given the fact that the stock’s short interest ratio has ramped up to 14.5. At that level, it would take three full weeks of buying pressure for shorts to run from this stock.
If you’re looking for a consistent, monthly income check, look no further than Realty Income (O). Realty income is one of the largest commercial REITs in the country, with more than 2,600 properties in 49 states. The firm is known for its monthly dividend payouts, currently yielding an impressive 4.27% annually.
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Realty Income is essentially the prototypical commercial REIT. The firm leases properties to tenants using long-term triple net leases, which give the firm consistent, predictable income growth without needing to worry about variables such as maintenance, property taxes, or insurance -- tenants are responsible for those costs. In many ways, that makes Realty Income a better income generation instrument than a proxy for the real estate market that many investors are looking for when they buy shares.
Conservative business practices -- such as buying existing properties with proven performance, and mitigating the risks of leasing to retailers with limited financial wherewithal -- have helped the firm thrive post-recession. That’s not enough for short sellers though. With a short interest ratio of 11.9, it would take Realty Income more than two and a half weeks for shorts to cover their positions.
That outsized short interest makes this stock a prime short squeeze condidate right now.
Like Realty Income, Regency Centers (REG) is a commercial REIT. The firm’s strategy is built around investing in neighborhood shopping centers anchored by supermarkets, with 50 million square feet of leasable space in all. Regency’s shopping centers are hand-picked by demographic -- the firm focuses on properties that are surrounded by affluent shoppers, efforts that are rewarded when the firm collects fees from strong tenant store performance. That’s helped push REG’s dividend payout to an annual 3.75% yield right now.
While the firm’s shopping center positioning meant that it got hit harder than other, similarly positioned REITs in the aftermath of the recession (and structural elements made the firm more attuned to the ebb and flow of the commercial real estate market), Regency has largely bounced back at this point.
As with its shopping center locations, the firm courts quality in its clients. A post-recession effort to increase the overall creditworthiness of tenants has been a success thus far, materially reducing the risks of landlording over retail space. Despite all of those tailwinds, shorts have bid regency to an identical short interest ratio as Realty Income Corp: 11.9.
Last up is Douglas Emmett (DEI), a residential and office building REIT that owns properties in Los Angeles County in California as well as Honolulu. Offices are the vast majority of Douglas Emmett’s revenue, with around 2,200 individual office leases making up approximately 85% total sales.
There are some big benefits to that geographic concentration. Most important, management knows its market. That expertise has helped Douglas Emmett capture above-market rates for its properties in many cases, and helped to offset some of the risks of putting all of the firm’s eggs in one or two geographic baskets. Now that commercial real estate values appear to be turning the corner in high-demand sections of California, DEI should be able to shake some of the headwinds that have left investors anxious.
It’s also positive that DEI has limited exposure to residential space – residential tenants are less sticky and laws are designed to protect tenants much more than landlords. While renting apartments in sought after zipcodes makes DEI’s residential exposure more attractive than most, it’s best kept limited to less than 15% of the firm’s total business.
A short interest ratio of 11.6 means that it would take weeks for short sellers to exit their DEI position, a fact that makes this stock a prime short squeeze candidate.
To see this week’s short squeezes in action, check out the REIT Short Squeezes portfolio on Stockpickr.
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At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.