Real Estate Bonanza

REAL ESTATE. It’s this week’s investment outlook. To be honest, frank, and blunt- real estate investing is hard. It is the American dream, but it comes with a down payment, closing costs, maintenance, multiple financing cycles, tenants, and plumbing-just to most likely earn an inferior return in the long run.

Rentals are work-intensive, concentrated, illiquid, and legal liabilities.

• But isn’t owning an investment property, a real tangible asset, a good thing?
• Doesn’t real estate never go down?
• Isn’t it better to have a fixed, steady, rental income every month?

The answer to these questions are yes! Yes, real estate is tangible, always “in your hands”, and provides a rental income. But for most young people, or anyone without a minimum $150k, it’s impossible to invest until later stages of your career.

Well… not true. Any average investor can invest in real estate through the stock market. Buckle up.. its time to learn about REITs!

What’s your idea of a perfect investment?

That’s a tricky question, but those looking for superior income, along with reasonably good price appreciation prospects over time — and with only modest risk — will certainly want to consider apartment communities, industrial buildings, shopping centers, and other similar real estate investments. While some time ago, these highly profitable investments may have been reserved for high net worth individuals and institutions, it is today easier than ever before to invest in real estate through high-yielding real estate securities or REITs.

Why Real Estate?

1. Superior Total Returns: From 1968 to 2009 the average rate of appreciation for existing homes increased around 5.4% per year. Meanwhile, the S&P 500 averaged an 7.5% return; small cap stocks averaged 11.5% per year. The rate of inflation was around 4.6%. We don’t expect real estate investments to grow much more than inflation. But numbers don’t tell the whole performance story. You also have to look at the impact of tax advantages, income yield, and the fact that real estate investments often allow for significant leverage (you can finance a home purchase, putting no more than 20% of your own money down, for example). Of course, if you buy real estate directly, you also need to factor in your time in managing the property and maintenance and repair costs. Comparing the rates of return has to include all these elements.
2. Steady Cash Flow: Income generated by real estate is by nature more consistent and predictable thanks to long lease terms — reducing investment risk.
3. Real Assets: Every investment is backed by REAL TANGIBLE assets, and not some speculative high-tech company with questionable “intangible” assets.AKA DOGE COIN.

Why REITs?

1. REITs are passive, diversified, liquid, and can be bought at below fair value.
2. Rentals are work-intensive, concentrated, illiquid, and legal liabilities.

Moreover, because REITs enjoy significant economies of scale and higher growth, they have outperformed the average returns of private landlords by 4% to 6% per year in the long run:

What are REITs?

The term Real Estate Investment Trust, or REIT in short, was originated in 1960 by the United States Congress and has since been adopted all around the world to describe a special tax-advantaged vehicle for collective real estate investments.

Just like mutual funds, they allow investors of all kinds to invest in real estate without actually having to go out and buy, manage, and finance properties themselves. Besides, most REITs are publicly traded on a stock exchange and allow investors to participate in the ownership of large scale, well-diversified real estate portfolios in the same way investors would invest in any other industry — through the purchase of stocks.

It provides a unique vehicle to gain exposure to real estate in a liquid and cost-efficient manner. It combines the positive attributes of stocks (liquidity and low transaction cost) with the benefits of real estate (stability of cash flow and high total returns).

REITs are structured as corporations, but unique to REITs is that they are exempt from corporate income taxes as long as they comply with specific rules to qualify as a REIT. According to NAREIT, a REIT must:

1. Invest at least 75% of its total assets in real estate.
2. Derive at least 75% of its gross income from real property rents, mortgage interest income, or real estate sales
3. Each year, pay at least 90% of its taxable income to shareholders in dividends.
4. Have a board of directors or trustees.
5. A minimum of 100 investors must own shares in the REIT.
6. 50% or less of its shares may be held by fewer than six individuals.

These rules are there to protect shareholders, assure discipline in capital allocation, and reduce conflicts of interest between the manager and shareholder.

Today REITs have grown in popularity to the point where U.S. REITs as a body own over $3 trillion in gross assets. Furthermore, they come in all shapes and sizes, ranging in size from a few million dollars worth of assets to large portfolios with tens of billions of dollars. While there are several diversified REITs that invest in different property sectors, it has become increasingly popular for REITs to specialize in individual asset classes. Some of the most common REIT categories include:

• Office REITs
• Industrial REITs
• Net Lease REITs
• Apartment REITs
• Single Family House REITs
• Manufactured Housing REITs
• Shopping Center REITs
• Mall REITs
• Specialty REITs
• Hotel REITs
• Healthcare REITs
• Diversified REITs
• Data Center REITs
• Self Storage REITs
• Infrastructure REITs
• Mortgage REITs
• Timberland REITs
• Farmland REITs
• And many more…

Each sector has its unique risk and return characteristics and picking the right sector at the right time can determine the success of a REIT investor.

Why Invest in REITs?

Over the past decades, REITs returned 15% per year on average and outperformed all other asset classes by a large margin:

REIT investments have been enormously lucrative to investors who got in early and knew what they were doing. In addition to the greater total returns, REITs pay higher income, are less volatile, and provide valuable inflation protection and diversification benefits.

1. REITs Are Historically Undervalued: After a three year period of under performance, the REIT market is priced for a strong recovery. This recovery began in 2019, but even today, REITs remain priced at just 16x FFO, a slight discount to NAV, and a historically large yield spread relative to the US treasury.
2. REIT Fundamentals Remain Strong: The pandemic will cause temporary pain but as we put this crisis behind us, the growth will resume, and balance sheets are stronger than ever before. Investment spreads on new acquisitions are healthy, and cap rates have further compression potential, which would lead to higher property values.
3. REITs Offer a Superior Mix of Income, Value, Growth: When you earn a 5% dividend yield, all you need is 5% annual growth to reach double-digit total returns. Add to that a few percentage points from valuation expansion and you can fetch 12%-15% annual returns. REITs can realistically achieve this and have done so over the past many decades. With other sectors, we are much less certain about future returns.
4. REITs Are in the Right Place at the Right Time: In a world of decelerating economic growth and 0% interest rates, investors are shifting capital from higher-growth cyclical investments toward defensive income investments. We expect REITs and other real assets to benefit from this change in market leadership.
5. REITs Outperform in Late Cycle and Recessions: Over the past 30 years, REITs have outperformed the S&P 500 by 7% per year during late-cycle periods on average. And they have provided nearly 2x greater downside protection during recessions.

Regardless of what the market brings to us, REITs have the potential to outperform in the long run.