2023-09-17 09:00:00 ET
Summary
- My portfolio is unique in that it is heavily invested in REITs.
- So heavily that they now represent half of my net worth.
- I present 6 reasons why this makes sense to me.
Today, I have about 50% of my net worth investing in REITs ( VNQ ):
High Yield Landlord
That may seem crazy to some of you.
Why invest so much in a single sector?
We have always been told to diversify and putting half of your eggs into one basket sure seems risky.
But we all have our own unique circumstances and in today's article, I am going to give you 6 reasons why I think that my REIT-heavy portfolio makes sense for me in today's environment.
Reason #1: I have a multi-year time horizon and a high-risk tolerance
Let me start with the obvious.
I really don't mind volatility.
If I was trying to minimize the volatility of my portfolio, I would take a different approach, but I just don't care much about it because I have a very long investment horizon, do not need the capital today, and recognize that volatility is nothing more than noise in most cases.
It does not say anything about the quality or even the risk of your underlying investments, and if you are patient and disciplined, it is really nothing more than a distraction. I would argue that seeking to minimize volatility is in most cases counter-productive if you are long-term oriented because it will lead you to invest in less desirable assets that you are less familiar with just for the sake of diversification.
While I don't care about volatility, I care a lot more about my expected returns and passive income. This brings me to my next point:
Reason #2: I am seeking maximum total return, but I also want to earn a good amount of dividend income
There are few sectors that offer both: high total returns and high dividend income. Typically, you either get growth or you get income, but it is tough to get a good combination of the two.
REITs are an exception. They pay a large portion of their cash flow in the form of dividends, often resulting in >6% dividend yields, but they are also able to grow at a good pace. That's how REITs have managed to generate 12-15% average annual total returns over the long run:
NAREIT
You will note from the above chart that REITs have even outperformed the S&P 500 ( SPY ) and Growth stocks ( IWM ) despite paying so much more income.
This makes REITs very attractive to me.
Their returns are far more consistent because you get about half of it in the form of cold hard cash. You are less reliant on the market for appreciation, which is far less predictable. It helps me to stay patient about the long-term prospects even during times of intense volatility.
Reason #3: REITs are far safer than your typical stock
Businesses come and go, but good real estate is here to stay.
It is a far safer asset class because it is absolutely essential to the survival and prosperity of the human race.
Think about your odds of success if you buy a rental property vs. start a new business. The rental property is of course far safer.
Most businesses eventually fail, but most rental properties are far more durable. Everyone needs a roof over their head, the supply is limited, the demand in good locations is ever-growing, the location is your moat, and the replacement cost keeps on rising.
Now let's take this concept to the REIT level.
REITs will commonly own 100s, if not 1000s, of properties. They are widely diversified and enjoy huge economies of scale and synergies. They are also typically conservatively financed and professionally managed by some of the best talent in the real estate sector.
It is a far safer business to collect rental income from long-term leases than to operate a regular business - 9 times of out 10.
For this reason, I think that a higher allocation in a portfolio is more reasonable than it may seem.
Reason #4: My specialty is real estate and I like to invest in what I know
This reason is specific to me.
I come from a private equity real estate background and I want to stick to my circle of competence because it maximizes my chances of success.
I could of course buy tech stocks or whatever else to better diversify my portfolio, but I would be shooting darts in the dark. I would likely end up overpaying for something that I don't fully understand and that probably wouldn't help improve my long-term performance.
I would much rather operate in a small niche in which I become an expert.
That niche is listed real estate for me. It can be something else for you.
I am especially interested in listed real estate, including REITs, because they are a bit of an odd category, fitting right in between stocks and real estate, and this often causes them to become mispriced.
I really like the idea of buying good real estate at a large discount and then getting the added benefits of liquidity, diversification, and professional management on top of it.
Reason #5: REITs are a vast and versatile sector with enough opportunities to diversify
It is also important to remember that the REIT sector is big.
There are over 200 companies in the US alone and they invest across 20 different property sectors:
- Office
- Industrial
- Apartment
- Retail
- Hotel
- Net Lease
- Senior housing
- Skilled nursing
- Hospital
- Medical Office
- Manufactured Housing
- Single-Family Rental
- Student Housing
- Self Storage
- Timberland
- Farmland
- Billboard
- Data Centers
- Infrastructure
- Ground Lease
Prologis
Moreover, there are also REITs in 30 other countries:
NAREIT
Therefore, just because two companies share the "REIT" corporate structure does not mean that they have anything else in common.
To give you an example: A self-storage REIT in the UK ( BYLOF ) has nothing in common with the fundamentals of a hotel REIT in the USA or an industrial REIT in Japan. You can diversify within the REIT sector.
Reason #6: There's a big opportunity today in the REIT sector
Finally and perhaps most importantly, I think that especially today, it makes a lot of sense to invest heavily in the REIT sector because they are priced at exceptionally low valuations at the moment.
REITs have crashed over the past year even as their cash flows kept on rising.
The market appears to have overreacted to the rising interest rates, thinking that it would lead to significant pain, but in reality, REIT balance sheets are today the strongest they have ever been with low debt and long maturities, and then top of that, rents are growing rapidly as a result of the high inflation.
As a result, it is not uncommon today to find REITs that are priced at 30-50% discounts relative to the fair value of their assets.
An easy example that I like to use is BSR REIT ( BSRTF , HOM.U).
It owns apartment communities in rapidly growing Texan markets and yet it is today priced at a 40% discount relative to the fair value of its properties.
BSR REIT
If I offered you the chance in the private market to buy these assets at 60 cents on the dollar, you would probably jump on the opportunity.
This is one of the main reasons why I think that it is worth holding a larger allocation in REITs. The opportunity is just so compelling today.
Closing Note
By traditional standards, I may be following a risky approach, but when you take these circumstances into account, I believe that my unique approach actually makes sense.
Why would I go invest in some tech stocks just for the sake of diversification when I have no edge in this sector?
I think that focusing on my circle of competence, especially today, makes a lot more sense.
For further details see:
My Portfolio Strategy For Today's Environment