Now that REITs are priced at historically low valuations, there’s growing interest from contrarian investors who look to capitalize on deeply-discounted opportunities.
I know this because I run a REIT-dedicated investment service (called High Yield Landlord) and in the past month alone, we have added ~200 new members.
It’s exciting to see these investors take advantage of the historically low prices. The last time REITs were so cheap, it was in 2008-2009, and they nearly tripled in the following two years as they recovered:
Today, many REITs are trading at even lower valuations than back then and offer similar upside potential. But before you jump in and take positions, you must first learn the basics to avoid making stupid mistakes.
I have been perfecting my REIT investment strategy for over a decade now and I guarantee you that investing in individual REITs is a tough game. The REIT market is very vast and versatile. And while some REITs offer extraordinary returns, others can be real landmines, especially in this environment.
Those who invested in PLD earned very attractive returns over the past years. Those who bought PLYM instead have done very poorly.
How to you pick the winners and avoid as many losers as possible?
That’s the question I will try to help you with today. Below we share a few tips that we include in our 10-Module Course to REIT investing available at High Yield Landlord.
Tip #1: Never Buy Only for Value
There exist significant valuation disparities from one company to another in the REIT sector. As an example, PLYM always has traded at a sizable discount relative to PLD.
It’s very tempting to buy the seemingly-discounted REIT with the higher dividend yield and lower valuation. However, very often, this lower valuation is nothing more than a mirage because it’s justified.
In the case of PLYM, its assets are of much inferior quality than PLD, and even more importantly, its balance sheet is much riskier, especially in today’s environment.
Yes, it’s cheap, but cheap can very easily get cheaper when you are dealing with high leverage and challenged assets.
The point here is that nine times out of ten what looks like a good deal really isn’t when you dig deeper below the surface.
Tip #2: Don’t Ignore the Price Tag Either
Value is not everything, but it should not be ignored either. There are a lot of REIT articles on Seeking Alpha that only discuss the fundamentals and do not even mention the price tag.
Both should go hand in hand and be assessed in relation to each another.
A good example today is EPR Properties (EPR). The company is deeply challenged due to missed rent payments in the wake of the coronavirus crisis. Many analysts are citing this as a reason to stay away from the REIT.
But investing is more complex than that. We all know that EPR has pain ahead of it, but at what price is it today trading?
Offered at a 17% dividend yield, 5x normalized FFO, and a 60% discount to NAV, the company is extremely discounted and at this price, it may be an attractive long-term opportunity for contrarian investors.
At the right price, even a challenged REIT can become a great investment. Similarly, at the wrong price, a high-quality REIT can become a poor investment. Don’t forget to check the price tag!
Tip #3: The Right Balance Sheet for the Right Assets
Most often, the biggest losses in REIT investing are the result of buying into companies with a balance sheet that is poorly suited for its assets.
As an example, you would not want to own highly leveraged hotels. Hotels are very cyclical, and therefore, they require a strong balance sheet to survive times of crisis. Yet, many hotel REITs were greedy over past years and now pay the consequences today.
As an example, Ashford Hospitality Trust (AHT) has dropped from $6 per share to a penny stock in just one year, and the leading reason for this collapse is overleverage.
Charlie Munger famously said that there are only three things that can bankrupt a smart person: “Liquor, ladies, and leverage.” Make sure that your REITs have the right balance sheet to support its assets. Some REITs can handle more leverage than others.
Tip #4: Management is More Important Than Anything Else
In the short run, the performance of a REIT is mostly driven by its asset quality, its existing leases, and its balance sheet.
However, the longer you wait, the more the performance will be a function of management quality. A good manager will create significant value beyond what is achievable to private investors and earn a higher valuation for the company.
On the flip side, a poor manager always will find a way to destroy value, whether it’s by lack of skills or poor alignment with shareholders.
There are a lot of REITs that are very cheap on the surface, but we would never invest in them simply because their managers are not trustworthy. All they care about is earning their fees, and if that comes at the cost of returns, then so be it. You cannot expect good long-term results from a conflicted REIT.
On the other hand, if a REIT has a great manager that we trust, then we are willing to deal with other issues because we are confident that the manager will be able to resolve these problems and create value over time.
As an example, UMH Properties (UMH) today suffers a relatively poor market sentiment due to the lack of growth in FFO per share metrics. We believe that the management is about to turn things around as growth starts showing in these numbers, the market will eventually reward the company with a higher FFO multiple. We are confident about this because the management is highly skilled, they have the right game plan, and they are well aligned with shareholders.
Tip #5: Think Like a Landlord, Not Like a Trader
Finally, and perhaps most importantly of all, you should always think like a landlord when investing in REITs. This means that you should buy REITs as if you were buying rental properties. You should buy it for the income, ignore the day to day fluctuation, and then wait patiently for long-term appreciation.
Similarly to buying a fixer-upper, you may look for a REIT with certain temporary issues that are fixable over time to create further value and earn higher returns. In the end, you always are buying real estate, and therefore, you should think like a property owner. This will help you identify the right opportunities and remain patient during times of market turbulence.
REITs have always generated very attractive returns in the long run and those investors who were patient have been richly rewarded: 15% annual average returns over the past 20 years:
Too many REIT investors make the mistake of thinking like traders. They buy and sell way too frequently. And therefore, they never get to see the long-term returns.
Investing is 90% temperament and 10% intellect. If you invest in REITs thinking like a trader, you are assured to do poorly in the long run.
A fantastic example is Bill Ackman’s investment in GGP ahead of its bankruptcy in 2008. Bill Ackman was convinced that GGP had enormous value that was not correctly reflected in the market price. He started buying at ~$1 per share, lost nearly 80%, but he never lost trust because of his long-term focus, and ultimately, the investment paid off big time as the company recovered after its bankruptcy.
Bill Ackman was thinking like a landlord who was buying real estate. The rest of the market was thinking like traders and panic sold. Having a landlord mindset can help you identify great opportunities that other short term oriented investors will never see.
REIT investing may seem very simple on the surface. But in reality, it’s very complex and you need to have the right expertise and access to insights to succeed at it.
REITs are extremely opportunistic right now and we have rarely been this bullish on future prospects. You should be interested in them, but don’t rush it and jump in head first without the right preparation.
There exists ~200 REITs, but only ~10% of them are worth buying. To sort out the worthwhile from the wobbly, and avoid costly mistakes, invest first in your own education and only then, move forward with your REIT investments.
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Disclosure: I am/we are long UMH; EPR. 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.