What are REITs?

My strategy

For most investors REITs are unknown, but it´s such a simple investment case that every dividend investor should feel comfortable joining the table when REITs are the discussion topic. In this blog post I want to tell you about REITs, what it is and how it works. Remember to subscribe to my page if you like the post, and please comment if you found it readworthy. I really appreciate if you do. If you are not familiar with my blog or who I am, I´m Stockles, and I´m primarily a dividend growth investor. But, I believe I have a modern and sustainable strategy. It basically consist of three main ideas:

What is Dividend Growth investment?

Dividend growth investment (DGI) is about buying big and well driven company at a fair or undervalued price. Normally with a somewhat small dividend, everything around 1,5 – 4 %. The idea is that even though the yield at the moment is small, it will get bigger over time. This is okay because the company increases their dividend a lot (maybe 5 – 10 %) each year  (annually increase). So in time the yield on cost will be very small compared to the future yield.

Combining DGI with Value

The second strategy is combining DGI with value investing. As I have written in a former blog post, http://www.stockles.com/2017/01/22/valueinvesting-vs-dividend-investing/, I believe that there is nothing wrong with owning a great company that focuses on increases their intrinsic value by taking care of their own profit.

High Yield

The last spice to my strategy is that I want to have companies with high yield. This is the most dangerous part of my investment strategy,. That´s because it´s easy to feel intrigued to chase stocks  that pays high dividend, say 10 – 25 % yield. I know this sounds great, getting 25 % of your investment back each year through dividend. But the thing is that some of these companies are paying more than they can afford, they take loans to pay dividend and therefore always increases their debt.

But then we have REITs , high yielding stocks that should be considered more safe than other high yielding stocks.

So, what is a REIT?

 

REITs (Real estate investment trusts) were created by law to help investors take part in the real estate world without having to buy a house or store. The Congress (yes, it started in America) mandated these real estate companies should pay out dividends. But, the Congress gave REITs a huge advantage. In exchange for paying out 90% of their net income to investors, REITs does not have to pay taxes at the corporate level. To maintain their special status, REITs have to keep at least 75% of their total assets in real estate. They also derive 75% of their gross income from rents. For us individual investors, the high yield is awesome, but for the company, it´s even better. The legislation effectively created a permanent financing advantage for REITs. Because of the tax advantage, REITs can finance property more cheaply than can tax-burdened corporations.

However, there is rain to every sunshine story. In this case, it´s the cash flow. Since REITs are required by law to pay at almost all of their income, and therefore cut a lot of their cash flow. REITs’ legal structure does create some downsides. Because they’re required to pay out almost all of their cash flow, REITs don´t have their pocket filled up by $$$.  That again decreases the level of investment they can do, so they have to use loans and create debt for themselves to be able to invest. Unfortunately, but understandable, REITs are among the most leveraged public companies. But it shouldn´t make you look away yet, because REITs are also among the best companies when it comes to having a stable cash flow. Meaning debt is normally manageable.

REITs have four ways of operating:

  1. Managing their properties
  2. Buy properties at attractive prices
  3. Sell properties at attractive prices
  4. Financial operating

A,B,C are don´t need any explanation, but D does:

The keyword is interest rates. When rates fall, REITs refinance in order to lower interest expenses. When rates goes up, they need to pay more in interest. But REITs use what is known as laddered debt, (google for more information), so they are able to manage higher expenses.

Two things to look for when buying REITs

  1. The NAV measure: What NAV tells us is what the company = REIT would be worth if they sold all of their owning at once. Of course this measure is somewhat hard to measure perfectly, but it gives a clue to what the company is worth. Buying REITs under NAV or close to NAV is always something to prefer.
  2. FFO measure: Funds from operating is a measure on cash flow, and very useful for REITs, because as we have talked about, the cash flow is the main “issue” with REITs. The normal FFO is around 8 – 20.

NB: As I started saying, the congress requires REITs to pay 90 %. This is not FFO, it´s net income! FFO is normally much bigger than net income due to the fact that the profit property companies record is smaller than the true value. This is because property increases over time, and therefore they are able to produce more income as time goes by. The keyword here is that human dies, but property stays.

 

In short I love REITs because of this:

  • the cash flow is very accurate and measurable
  • Instead of being a landlord, and does a lot of work to maintain that status, I just buy REITs which really is the same, without the struggle of papers and formalities.
  • Instead of buying one estate, I buy parts in 400 +++ estates
  • The point above is important, because it means diversification. REITs normally own properties around the world, or at least in different areas in the country (say the states), and in different sectors, so the company will always have someone paying them.
  • The estates are rented by great companies that has no issue paying their rent (meaning it´s not the average Joe that get´s to rent a property owned by a REIT company
  • The Yield is around 4 % or more, meaning that it´s bigger than inflation, around %, so every REIT investment is profitable in the long run.
  • Growing yield means more yield for me. Hurray!
  • It´s long term, so you don´t need to be stressed about finding the perfect price. Take a bite now, and add more when you can afford so.

Different kinds of REITs:

  • Residential— Owner of apartments, manufactured housing, and now single-family housing.
  • Retail— Assets include all kinds of retail properties: shopping centers, malls, and big-box stores, among others. Some REITs focus on specific property types — for example, grocery-anchored shopping centers — to help reduce cyclically.
  • Office— Assets include office properties, and the REIT may be focused on a specific tenant or geographic area.
  • Health care— This is among the most stable REIT sectors, since demand is constant, and government funding and private funding remain stable and are even growing, though at a relatively low-level. Assets include skilled nursing facilities, senior living communities, and hospitals.
  • Industrial— Assets include a range of industrial properties, including warehouses, storage facilities, and other types of distribution centers.
  • Self-storage— This has been a fast-growing subsectors in the past few decades, as houses overflowing with stuff move to self-storage facilities.
  • Lodging— Lodging REITs own hotels and then frequently contract out management. Results fluctuate highly across the economic cycle, and this is probably the most cyclical of all the REIT subsectors.
  • Infrastructure— Assets include infrastructure such as data centers and telecommunications towers and properties. These have been high-growth sectors of late.
  • Timberland— There are just a handful of these REITs, which own land that grows timber. And timber grows even when the economy is down, though overall economic conditions affect end-market prices for timber and other products.
  • Diversified— Like the name implies, these REITs own a mix of assets that cross the standard lines, such as office properties mixed with industrial properties.
  • Specialty— This is a bit of an omnibus category and includes whatever doesn’t fit in the other subsectors, including outdoor advertising, movie theaters, and fitness centers.

Source fool.com

In my next post I will give you my TOP 10 REITs. Remember to subscribe to my page, www.stockles.com if you want to read posts like this. And if you really want to make me happy, share this post! =)

5 comments

    1. Thanks! Wow. Hard question. I´m actually going to write a top10 or maybe top15 REITs blogpost pretty soon (there are so many great REITs haha) , so I think I will give you an answer to your question then 🙂

    2. But I can give you some short insight on VEREIT which I just discussed with a friend:

      VEREIT cons: Massive turnaround case with around 4378 properties, while W.P.Carey has around 860. Has limited possibility to increase it´s occupancy rate, so the most likely way to get better margins (it´s pretty poor now compared to the industry average) is by accusations. However, that might lead to account problems, which again is why VERIET had to change it´s name and start all over again. High leverage, but that could be handled with the “laddered debt” as I have written on my blog about. Speculative undervalued long-term holding. Less quality then WPV.

      VEREIT pros:Again, Massive turnaround case with 4378 properties, great management, and if VEREIT fixes it´s Cole operations, it could account for as much as 10 % of funds from operations. Speculative undervalued long-term holding. W.P.Carrey has about 40 % assets in EU, 15 % of their operation from UK. That could turn bad, because of Brexit -> Lower GBP – Lower Income. 11% in Spain and then more countries in EURO > income might get lower. Potential to become something like O or NNN.

      Short story told is that VER is a speculative bet on a lonterm turnover. ATM it´s a over-leveraged REIT with some questionable properties to a high quality REIT with reasonable leverage. Once it reaches a steady state and begins to grow again, will VER’s lower valuation rise to industry averages? If so, how big a gain will we see in the VER’s stock price? I don´t know, but I´m keen on finding out.

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