I know. Talking about real estate investment in times when the investment community is obsessed with growth, tech, EVs and Gamestop-type bonanza might sound a bit odd. I understand that many people, especially those who just have tried out the (muddy) waters of stock trading, find brick-and-mortar assets to be 'not so sexy' and single digit returns laughable.
The way I see it, an investment that pays 8-10% income in a virtually yieldless world where interest rates are hoovering around (and even below) zero while also provide an upside potential of 30-80% is everything but laughable. Especially, when all this carries a significantly lower risk then the rest of the outrageously overpriced market.
Again, I appreciate that 'income' might not be the primary reason why people entering the market these days. However, this article is not for those who are in it for the excitement. Personally, when I am after some 'excitement', I fire up Super Mario. But when it comes to investing, I am more into finding places for my money where it can multiply steadily so I can sleep tight.
For those who are in the same boat, I want to share a few thoughts on why I think REITs are pretty much the number one place to be right now, to benefit from the best of both worlds (decent yield AND great upside potential).
But, before we get to the beef, here is a quick crash-course on what exactly REITs are? (if you already know the drill, just skip a few paragraphs)
Being a Landlord - On Steroids
I am not sure about you, but where I come from, people are obsessed with property ownership. In my home country, it is a century-long (mis)belief that if you don't own the place where you live, you 'haven't made it'. My parents and grandparents kept repeating the same old story that I 'must' start saving for my own place as soon as possible.
(This tendency is about to change as more and more people realizes that renting is more suitable for their needs, but that is a story for another day.)
Likewise, for many people around here, real-estate is considered as the number one investment option. If you are not only owning your place, but can manage to have other properties that you rent out to make an income, you 'really made it'.
However, as an individual, your options to rent out real-estate is pretty much limited to renting it to other individuals, sometimes to small businesses, that is not free from its own shenanigens.
Real Estate Investment Trusts basically provide exposure to all sorts of other properties (commercial, industrial etc) allowing you to play in a bigger playground that otherwise would be out of reach (unless you have a few billion spare dollars, of course).
Technically, a REIT is a type of company that generates its income from renting-out, running or investing in various types of properties (and/or mortgages). What makes them unique is that it is exempt of paying corporation tax as long as it pays at least 90% of its profits to its shareholders in the form of dividends. Many REITs are publicly traded companies, meaning that you can easily buy and sell their shares on the stock market.
In other words, when you invest in a REIT you basically de facto become a landlord to some of the world's biggest companies, including Tesla, GE, Pfizer and thousands more. In fact, in some specific REITs, the tenant is the US Government, that not only makes your investment rock-solid but you can say something like "Hey, guess what, I've got a new tenant. It is the FBI".
REITs vs Everything Else
Investing in real estate through REITs carries lots of benefits versus the traditional way of being a landlord, and also a few unique features that makes it a perfect hybrid of fixed income and growth investments.
REITs vs owning a buy-to-let property
For instance, when you are a self-made landlord you are pretty much in charge for your property. If shit hits the fan the first person who tenants call is usually you, so you can deal with the broken wasing mashine or the noisy aircon. I friend of mine told me that on one instance, the 'shit hits the fan' wasn't just an idiom but actually happened (yes, really) after which he had to put a new close in the tenants agreement about what behavior is not allowed.
As an individual, you are also inevitably prone to make bad decisions when it comes to choosing the right property to buy or negotiate with banks or other parties involved.
However, when you are invested through a REIT, the management of those properties are done by professional people who even had the 'house' as their sign in the kindergarden and who breathe real estate day-in-day-out.
Lastly, REITs are liquid assets compared to physically owning a brick-and-mortar property. There might be times when you need access to your capital and selling your REIT position takes 2 seconds while selling an apartment or house might take weeks, if not months.
REITs vs other stocks
There are two main motives why people invest in stocks. One is growth, aka price-appreciation, and the other one is income, in the form of dividends. Companies with great growth prospects do not usually pay dividends, while businesses that do are around for a while hence they have little space to expand.
REITs are unique in that sense that they have the best of both worlds, pay hefty dividends and has a decent upside potential.
Also, the valuation of real-estate businesses are more or less 'realistic', and tied to their NAV (Net Asset Value) with future cash-flows relatively easy to predict. Of course, there are over and underpriced REITs in the market, but their valutaion never really crosses to science fiction territory like other stocks tend to (especially nowadays).
Lastly, REITs can be a great alternative play to get exposure to certain industries without taking on too much risk. As the old saying goes, "If the market is excited about horses, it's time to stock up on hay".
Take the rising cannabis sector as an example. The whole pot-stock thing is in it's infancy, and picking the winner from the many start-ups can be challenging. Instead, you can simply invest in Innovative Industrial Properties (IIP) whose primary business is to lend real estate space for medical (and probably soon recreational) cannabis growers.
REITs vs Fixed-income
Probably this comparison requires the shortest explanation.
In a virtually yieldless world where interest rates are around zero and US Treasuries pay close to nothing, and where the average dividend yield of the S&P500 is a shy 1.57%, a REIT that pays well north of 5% with a relatively low risk profile is really a no-brainer.
Misconception About REITs
Interest rate risks
Probably the single biggest concern about investing in REITs is the perceived risk they represent if interest rates are on the rise. Common belief holds that because a REIT is ultimately a company that manages real-estate, the related debt and, more importantly, the cost of it can hugely impact its operations.
In plain English, if interest rates rise that makes debt repayments more expensive thus less profit for REITs. This assessment is fundementally wrong because of two things.
One, REITs have the power to raise rents, in fact, many leases has automatically executable clauses in the case if rates go up or to keep up with rising inflation.
Two, REITs are managed by people who know what they are doing. When rates are low, many REIT managers re-finance their debt, and most of these deals are a) long-term and b) at fixed-rate. So, if interest rates rise, that doesn't automatically and immediatelly gets translated into higher costs.
Fears over 2008 might repeat itself
Most investors have vivid memories of the latest financial crisis (the 'latest' that was caused by the markets themselves) and remember that all those shenanigens was revolving around mortgages.
However, such worries are hugely misplaced because the type fo REITs we are discussing here had nothing to do with the recklessness of banks back at the time, and the bubble back then was more of a derivates bubble (CDOs).
Fears of an asset price bubble
Again, there is a widely accepted (mis(belief out there that asset prices are too high and they have to come down eventually. Now, this article's isn't intended to go elbow's deep into economic stuff, but without excessively explaing it, the situation is that all the money that most of the money that have been created during the previous QEs ended up in the markets instead of in people's pockets, so this excess cash should cease to exist if we really want to see lower real estate prices.
Also, in a world where fiat money, like the US dollar, is doomed to lose its value, this dynamic on its own should be enough to keep asset prices high.
These misconceptions are a double-edged sword. On the one hand, sentiment may prevent investors to rush into REIT or, make them to jump out pre-maturely purely based on fear of rising rates, but on the other hand, these can represent huge opportunities and great discount to those who know what they are buying.
Not Every Property is Created Equal
Most people who are unfamiliar with this sector tend to look at real-estate as one big area, but the truth is that there are many different types of REITs out there based on what kind of properties they deal with. Needless to say, depending on the given times, some areas of real estate might prosper while others are being beaten down.
Consequently, current REIT valuations are all over the place, depending on the market sentiment and perception of each sector. The below graph demonstrates how optimistic/pessimistic is the market about each niche. (Premium vs Net Asset Value, as of Oct 2020)
The above list is not complete as it excludes important sectors such as data centers or infrastructure, but it gives a fair picture.
Actually, this takes us to the many different types of real estate and the REIT subsectors. . Let's take a quick look on them, including what they specialize in and what unique benefits/challenges each niche market has.
Residential REITs
Residential REITs are the closest thing what you would do as an individual landlord, but instead of owning one condo here and another there, they own entire residential developments, including single-family homes (houses), multi-family (apartment buildings) or even student houses. Their tenants are usually individuals and families, meaning that such properties require more active management than, for example, industrial counterparts.
In many countries, renting is growing very popular vs owning a property, and this tendency will likely continue because of two key factors. The extra cash pumped into the system through QE (aka money printing) that ultimately causes a significant inflation of asset prices, that makes it increasingly difficult for the average citizen to get on the property ladder. On the other hand, thanks to the increasing possibility of remote work, young professionals are less willing to anchor themself at one place and into a mortgage if they can travel, work and rent on the go.
Because of this, the future outlook for residentail REITs is quite bright, especially if we consider that after food, having a shelter is pretty much a must for everyone, making residential REITs relatively recession-proof vs other real estate.
Examples of Residential REITs: Equity Residential (EQR), Sun Communities (SUI), AGNC Investment Corp (AGNC)
Office REITs
As the name suggests, office REITs manage office space and rent it out to those, well, who need office space. Obviously. :) Those properties can range from skyscrapers to office parks, and compared to residential buildings, tenants are businesses who have significantly longer leases therefore need less management and offer more predictable cash flows.
The market is deeply divided right now about the future of office spaces. Since the coronavirus pandemic has forced millions of clerks to home-office and the new normal is more or less working so far, this makes the future need for office spaces a big question mark.
There are companies who happy to permanently operate from home, while others want their employees to return to their offices as soon as possible. The market hates nothing more than uncertainty, hence it is no surprise that office REIT valuations are the lowest among the different categories.
Examples of Office REITs: Boston Properties (BXP), Alexandria Real Estate Equities (ARE), Alstria Office REIT-AG (AOX.DE)
Industrial REITs
Industrail properties come in all shapes and sizes, from factories to warehouses to logistics hubs and pretty much everything in-between. These kind of properties bring all the benefits of the previous two categories, since industrial tenants sign up for long term leases, plus, they are significantly less effected by the pandemic. After all, it is ok to bring a company laptop home, but an industrial CNC machine hardly fits into most living rooms.
Actually, the pandemic brought a significant upside to the sector. Companies realizing that keeping their production chain focused in only one country leaves them vulnerable, consequently they look for ways to difersify their locations, creating a boost in demand for industrial real estate.
Besides that, the exponential growth of ecommerce also created extra demand for fulfillment centers as some of the biggest e-tailers like Amazon and Alibaba are becoming the biggest industrial tenants these days, but even without them, anyone who runs a webshop today adds to the growth of this sector.
Industrial REIT examples: STAG Industrial (STAG), Prologis (PLD), Liberty Property Trust (LPT)
Retail REITs - Single Tenant Properties & Shopping Malls
Retail REITs make up a significant slice of the real estate cake. If you are a retail REIT, chances are that your tenants come from all walks of life. Because of the sheer size of this category, it helps a bit if we break it up into 'single-tenant properties' and 'shopping centers'.
Single tenant properties are usually rented out to one single business, like a grocery store, gym, cinema, cultural or leisure center, restaurant, casino and so on. Just like any other commercial REIT, retail ones are enjoying more reliability on rent collection since their clients are usually blue-chip companies, but on the downside, they are fairly vulnerable to economic downturns, just as it was demonstrated by the pandemic lately.
Similarly, shopping malls also fall under the retail REIT group, but instead of having only one single tenant and consequently one lease agreement per property, obviously a shopping mall leases its spaces to hundreds of different tenants. This means that operation-wise, shopping malls require more active day-to-day management, but on the other hand, the losong of one or two tenants isn't really a big deal for them.
In terms of future outlook, retail REITs have been severely beaten down and forgotten by the market. The industry faces two different headwinds, not only by the damage caused by the lockdowns, but also the competition from online shopping that steadily takes away market share from the brick-and-mortar establishments.
Another potential risk for this sector is the highly spelalized use of certain types of buildings. While a warehouse can easily be converted to a fulfillment center, or outlet, or anything, a cinema for example can only be used for that purpose, making it harder to rent out should a tenant go bust.
Personally, I see the biggest investment opportunity in this doomed sector. Although it is true that the pandemic and ecommerce together will accelarate a shakedown in the industry (a process that started in 2015), which means that poorly managed REITs will fail and their assets and traffic will flow to the strong ones, who consequently will become even stronger.
It's also true that many businesses move online and this tendency won't reverse, but there are still lots of things that will never make this transition. Due to their nature, healthcare, beauty salons, opticians for example, just to name a few, will never go online. People will always find a reason to gather in places where day can get lots of things done in one go, therefore the future of this sector is not as gloomy as the market sees it right now.
Lastly, investors should bear in mind one very important aspect. Owning a retail REIT is not the same as owning a retail business. The REIT owns the real estate and if eventually the retail tenants fail the REIT can convert and re-use the space for any other, more sought-after purposes, such as a logistics hub, self-storage or even data center.
Examples of Retail REITs: Simon Property Group (SPG), Realty Income (O), Klepierre SA (LI.PA)
Hotel REITs
Just like with offices, the name is quite self-explanatory here as well. Hotel REITs own, rent out and manage hotels and lodging facilities of all kinds. And just like retail, this sector is also heavily suffering from the consequences of the pandemic.
Again, similarly to retail, it also has its own 'arch-enemy'. What ecommerce is for shopping centers, it is AirBnB for traditional hotels. However, the same concept stands for hotels as well, namely that if weaker players go bust, the traffic will eventually flow to the surviving ones, thus strengthening their positions.
A last parallel with the retail space: again, owning a hotel REIT doesn't mean owning a hotel company. If a REIT loses a tenant, it still owns the assets that can be used for other purposes, for example, converted to residential properties.
Digital Infrastrucure REITs
Unlike the previous sectors on this list that are fairly obvious, this industry might require a little explanation. So, what is digital infrastructure? Plainly...
Data centers, fiber-optic networks and signal towers. All those funny Youtube videos and Zoom calls have to 'live' somewhere and be transferred/streamed somehow, and this requires lots of terabytes and Gbps and other 'black magic'.
It might not be obvious at first because we just got used to be surrounded by technology, but every time you send an email you are basically using that infrastructure, just like you use the road network when you drive.
In the information age, it is needless to say that human beings appetite for data is endless. According to Google, there is 2.5 quintillion gigabytes of data is being created every single day (frankly, I've no idea how many zeros that means), so the need for real-estate that accommodates the technology to handle this digital tsunami is booming.
Consequently, while retail and hotel sectors seem to be the most behated ones right now, digital infrastructure REITs are clearly at the opposite end of the sentiment. Unless Skynet goes self-aware and destroys humanity, it is fair to expect that the demand for digital infrastructure will remain strong for decades to come, and so will be income for investors. After all, even Skynet would require a data center...
Examples of Digital Infrastrucutre REITs: Equinix (EQIX), Uniti Group (UNIT), American Tower Corp (AMT)
Diversified/Hybrid REITs
At this point it is important to mention that a significant portion of REITs do not limit themselves to one single area, neither in terms of property type not geographically.
Many of the biggest and most successful real estate companies hold a diversified portfolio with a mix of retail, industrial, commercial and speciality properties.
WP Carey's (WPC) portfolio, for example, holds about 23% of its holdings in industrial properties, and about the same portion in warehouses and in office space, with a smaller exposure to retail, but they also have about 70 government properties in Andalucia, Spain leased directly by the Spanish state.
Another example, Covivio (COV.PA), a small but promising European REIT that is well diversified between office, shopping center and hotel properties.
The list goes on and on, so when it comes to diversification, REITs can really get you covered in a wide range of areas, each with their own risks and upsides, with a varying degree of risk of course.
Beyond these basic categories, there are a few speciality REITs that can also add an extra touch to a well-thought out portfolio.
Farmland and Timber REITs
Similarly to data centers, agricultural REITs are mostly overlooked because, well, most people take them granted, and also, common belief is that farms own their land, end of story.
This might have been true about 600 years ago, and actually still is today for smaller producers, but when it comes to large-scale agriculture, land is usually leased to those who cultivate them.
Investing in farmland actually makes a lot of sense in light of the looming climate threats, because the less land is suitable for farming the higher the value of those that are. Population growth is also an upside factor, more people eats more so there is more demand for farmlands, but technological advancements like vertical farming can have an opposite effect.
Examples of Agricultural REITs: Farmland Partners Inc. (FPI), Gladstone Land Corporation (LAND)
Renewable Energy REITs
This subsector would deserve an entire article dedicated to it, purely because of the huge investment opportunity it offers. Needless to say, these days everything is about going green. If you ask me, it is about 20 years overdue, but hey, better later then never.
Let's make something clear: as of yet, there is no such thing yet as a 'Renewable Energy' or 'Solar REIT'. The keyword here is 'yet'.
However, just a while ago, there have been no such thing like a data center REIT either...
Anyway, the unique angle that renewable infrastructure can bring to the REIT space is twofold. One the one hand, it is fair to expect that at some point in the near-future, just like in other areas, the leasing and the operation of renewable energy infrastructure will become separate.
But more importantly, there is a huge potential for existing real-estate owners to tap into the opportunity offered by solar energy. Think about it. In order to generate power from the sun, you need to install panels on either rooftops or some kind of field.
For a company that already owns hundreds of thousands of squarefeet on the rooftops of their own buildings, this means they can utilize that space to generate electricity and create an extra revenue stream besides of their rent collection.
As said, more on this on a separate article...
Examples of Renewable Energy REITs: Hannon Armstrong Sustainable Infrastructure Capital
Specialist REITs
Lastly, a few words on REITs that doesn't really fit into the traditional categories, but would deserve an honorable mention.
The first such company that comes to mind is Iron Mountain (IRM), whose main business is to provide storage for paperwork and other documentation that companies are legally obliged to keep for 5-10 years, or even longer.
Most businesses simply doesn't have the space, capacity and manpower to categorize and maintain literally tons of papers, so they are happy to pay for such service. IRM saw this opportunity decades ago and built a very profitable business on it.
Nowadays, most people think the model is out-dated because, you know, paper = old = bad vs digital = modern = good. However, IRM is making a huge effort to make a transition and expand into a data center, and since almost every American business is already their customer for the paper storage, it won't be hard to get contracts for the digital side of the business.
A Few Great REITs To Consider
Alright, I guess this was enough of theory, now let's get to some actionable ideas. The below list is some of my favourite REITs. I'll post more detailed analyses on them as we go, but for now, I just wanted to give a few ideas to those who want to get to the beef right away.
Simon Property Group (SPG)
Store Capital (STOR)
WP Carey (WPC
Realty Income (O)
Digital Realty Trust (DRT)
Iron Mountain (IRM)
Harris Armstrong Sustaibale Infrastructure (HASI)
Klepierre (LI.PA)
Of course, there are dozens if not hundreds of great REITs, but personally, I prefer quality over quantity. However, if you are interested in checking out my other holdings, jump over to eToro where I regularly discuss REITs, and
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Where you can also easily copy my portfolio if you don't have time to manage your investments yourself
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Other Benefits and Risks of REITs
Being a unique class within equities, REITs come with a set of advantages and of course, not free from a range of risks of their own. Let's run down these quickly before we wrap up the story.
Inflation 'Protection'
In a world where the US government and the FED keeps jumping on the 'Print Money' button, the extra cash inevitably has to cause inflation at some point down the road. Economists do argue vigorously about this prospect, but what we can know for sure is that last time the same happened (after 2008), the freshly printed cash ended up in the markets and heavily pumped up asset prices.
If the same continues it is fair to expect that asset prices will keep rising, so anyone with exposure to such assets have every reason to smile.
The Booming Middle Class of Developing Countries
Almost every real estate is built around one or more aspects of the everyday life of middle-class people, just think about hotels, restaurant, shopping, gyms, just to name a few.
There is a clear tendency of booming growth in the middle classes of huge regions such as India, Southest Asia, South America and Africa. Urbanization is still relatively at early stages in many of these regions, meaning that if the trend continues then the demand for specialized real-estate, and thus, for REITs will be steadily growing.
Oversupply
Consequently, there is a potential risk of oversupply of certain types of real estate within a particular area, when property developers see an opportunity and rush to meet it, all at once. This often creates a situation where the fresh supply outpaces demand and pushes prices (and therefore, yields) lower.
Luckily, with a decent amount of due diligence, this risk can be minimized and those false-opportunities can be easily avoided.
A Few Closing Thoughts & My Skin in the Game
I hope I could manage to provide a primer on REIT investments and help to better understand the basics of this lucrative sector. In the next article on the topic I intend to dig deeper and cover more specific topics such as 'how to value a REIT', what the basic fundamental metrics like NAV or FFO are, and also a few tips on where to look for great investment opportunities.
I am not sure about you, but when I read an article about a certain company, or a sector, and there is a paragraph at the end starting with "I am NOT having a position in XYZ" makes me to take it with a pinch of salt. I understand it is a legal requirementm, so here comes my disclaimer, in my own words.
I am deeply invested in REITs and I have a thick piece of skin in the game because I put my money where my mouth is. The above assessment is my personal opinion and a result of my extensive research and should not be considered as investment advice.
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