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IFB173: Why to Invest in Real Estate Investment Trusts (REITs)

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Dave (00:33):

All right, folks, we’ll welcome to investing for beginners podcast. This is episode 173 tonight. Andrew and I are going to talk about REITs stand for real of a real estate investment trust. And we’re going to talk a little bit about them and how you can invest in real estate using these kinds of vehicles. So without any further ado, I’m going to turn it over to Andrew. We’re going to go ahead and start, and then we’ll go ahead and do our little give and take. So Andrew wants you to tell us your thoughts about REITs.

Andrew (01:00):

I’m excited to talk about rates and just to have you talk about REITs because you’ve been, you dove super deep into this, this topic and have, based on our conversations, you’ve achieved a decent circle of competence on it. And I think it would be very helpful for investors to share some of that knowledge, particularly when you look at the landscape we have today. Some of the opportunities out there mentioned the words real estate, and I’m sure that that probably triggers alarm bells with many people.

Andrew (01:36):

You know, how could you, how could you say you feel positive about real estate amid a pandemic and global depression, but I’ve talked about on the Eli there. I occasionally think on the show, I know we’ve had discussions about Dave, how the economic recovery has been different. And I mentioned months ago, how higher-income workers, where we’re not only doing just fine from an employment standpoint income standpoint, but they’re doing quite well. And then you had the lower-income disproportionately affected by the pandemic job, losses, income loss, and all sorts of things. You know, we have the presidential debates going on and, and, you know, there’s, there are talks of the K shaped recovery. So, you know, it’s not a foreign concept, and I think when you think about real estate today and where the opportunities are, it’s very dependent on you. You can’t pay it in a broad brush as you would, the economy, you don’t want to paint that in a broad brush either. There’s going to be K parts that maybe parts of real estate will do well in the coming months. And parts will continue to struggle regardless of what

Andrew (03:00):

Happens with the vaccine or not. And so maybe you can start by introducing certain types of rates because I think that’s interesting how there can be specializations within the rates. Maybe, maybe, why you personally, maybe start there, why you are excited about rates in general right now.

Dave (03:21):

Sure. So I think let’s start, I guess, with some of the basics, and then we’ll talk a little bit about the types of companies. As I mentioned in the intro, Rita stands for it’s an acronym for real estate investment trust, and really what those are, are those are businesses that own different types of real estate. They can range from healthcare owning retirement homes to skilled nursing facilities, apartment complexes, malls to storage spaces, even data warehouses you name it, there’s a reach to that that allows you to invest in it.

Dave (04:05):

And the cool thing about REITs is it allows you to invest in an asset class of real estate without actually having to go through a lot of the drama and headache and stress of actually buying real estate. For example, if you want it to, I don’t know, buy a building, or buy some land. You have to go through the process of finding the place or space that you want to purchase. You have to negotiate a price, and then you have to go through the fun of going through the approval process to qualify and buy the land. So you have to borrow the money if you don’t have the cash to do it. So those are all kinds of fun obstacles that you can go through to invest in real estate. Now, for me, that’s not something I care to put myself through.

Dave (04:57):

There are gazillions of people that do and more power to them. And I’m not here to bash those people by any stretch of the imagination. It’s just not for me. So in, along with that, then you have the aspect of liquidity. For example, when you’re buying a property, it’s generally a drawn-out process and wants to sell it. It’s an even more drawn-out process, especially depending on the location and what’s going on with the economy at the time, as you mentioned at the beginning. So there are all those aspects. When you’re investing in a REIT, you’re, in essence, you’re buying a stock, just like you buy a Microsoft and Apple or a Facebook; it’s the same process. You go online, find a company you’re interested in, do your research, and then pull the trigger and buy a company.

Dave (05:49):

Now you own a stock, but you also own real estate. Those are the, I guess, the overarching basics of how the reworks and, and I guess how you would start investing in it. As I mentioned, when I started talking about this, there are many different kinds of companies out there, which is exciting. And it also gives you lots of opportunities to not only diversify into different types of real estate. It also allows you to find gems if you will. There are companies out there that, overall, the REIT industry since the pandemic was beaten down pretty hard. And in large part, a lot of it had to do with the fact that these businesses that people were investing in were having to shutter their businesses. For several months, in some cases permanently, it just Kind of depending on what kind of business you are investing in.

Dave (06:52):

So if you were buying something that was investing in malls, for example, depending on where you were in a country, some of those businesses may have been shut down for a few months or may still be shut down. Suppose you were investing in companies that invested in, for example, movie theaters. In that case, you’re going to be hit hard because even though the movie theaters have reopened, their capacity is greatly reduced. Some of them just announced the other day that they’re going to shut down because there are not enough movies out there, and people are coming up to see movies, understandably with everything going on. So there’s a wide range of things, but among those opportunities, there are also other businesses that have done quite well during the whole pandemic and have been able to thrive through this whole period.

Dave (07:42):

But the prices are still depressed too because the overall market sees real estate as a possible bad investment. Now, without getting into all the ins and outs of actually buying real estate versus a REIT, if you think about how rates work and how they function, the majority of their income they gather through collecting rents from the businesses that they rent to that come to them and want to have space. So when you look at, for example, a mall, it’s probably the easiest thing for people to kind of visualize when you think of your local mall, wherever that maybe, all of those different businesses are renting that space from the landlord. Well, the landlord is the company that owns the building, which is the REIT. When Dillard’s or Macy’s or any of those huge anchor tenants are renting spaces, they’re renting it from the REIT and paying the rent to rent that space to use it for their general purposes, whatever that may be.

Dave (08:47):

In particular, when the malls are another good example; when they went through the pandemic’s beginnings and everything shutting down, the malls were very large spaces where lots of people would congregate. And that became one of the first places that we decided to close because it would be bad for the spread of the disease, which is a very logical thing to do well when that happened, then all of a sudden, the REITs now they can’t collect their revenue because they can’t collect their rents. And so wall street, coinciding, glee, also the proceeds to selling off anything remotely connected to REITs. But the flip side of that is that you had reached that also own healthcare facilities. And those were all full. Those people were sick, and people were going to the doctor, people still go to the doctor, and they could collect all the rents.

Dave (09:45):

And so they’re humming along just fine, but their prices all got smashed down along with everything else. And so that is, I guess, the beginnings of why I started getting interested in this, because as I’ve been working on the project that you and I have been working on with the newsletter that I’ve been starting to put out one of the things I wanted to do was look at different asset classes, try to start to expand not only the portfolio but also my knowledge about these and real estate is something that I’ve always sort of had an interested in but was never really interested in actually going the full nine yards and buying a property and going through that the whole, you know, buying a house and flipping it. That whole business was something I was never interested in, but REITs have always been something that I thought might be a way to get my foot in real estate, without going through the other stress and trouble.

Dave (10:41):

And so, I started doing all this research for me and helping the people who follow along with what I’m trying to do. So that’s kind of where this all started, and that’s why I’m excited about it because I think this is an opportunity to get into an asset class that is going to recover. The thing about REITs that I’ve learned is that they generally lag the recovery of the economy. Generally, it could be anywhere from a couple of months to a year or so, but at that time, there will be opportunities for companies that have been beaten down that will recover over time. And that allows us to find undervalued things, which is as a value investor has always like E Yahoo. So anyway, that’s my thought.

Andrew (11:30):

I love that. It’s like, that’s a great breakdown. I think it paints a picture of where we’re at today and where the opportunity is. So from a basic level, you know, when I look at where the REITs are standing right now, if you take them through a screener or some other tool online, you’ll see their yields are very, very high. So maybe talk about the dividends and why that’s critical for REITs and why those yields?

Dave (11:54):

Yeah, that’s a great question. So one of the things that attract most investors to reads right away besides investing in real estate is the dividends. So the way rates work is they have to pay at least 90% of their earnings as a dividend. It’s part of the structure that allows them not to pay income taxes on the money they earn. And it’s a legal way that the entity is set up, that the government established a while ago. And it allows the reach to in, I guess in exchange for not paying taxes, they have to give the majority of their money back to the shareholders, and the way they do that is via a dividend. And it has to be at least 90% of their earnings. Generally, the yields that you’re going to see on dividends, depending on what’s going on with the prices, you’re going to see your range between four and a half to 10%.

Dave (12:52):

It’s not unusual to see, see it in double digits at all. Some of the ones that I’ve been looking at have been in the high sevens to mid eights as far as yields go. So there, it’s, they’re quite attractive in that regard. They’re also the also have the tax advantage in that they don’t have to be; you can buy a REIT in a normal taxable brokerage account and not pay taxes on the dividends because of how they’re structured, which is rather nice. So they have some tax benefits as well. And that’s kind of; I guess the main attractor to most people is the dividend yields. And they’re great for you to either use them as a drip like Andrew, and I like to do so you reinvest those back into the company or for people looking for income. They’re high income because, because the yields are so high, it’s a great way to generate income for income investors that are, they’re looking for that kind of income. And generally, there are a lot higher than bonds that yes, they’re riskier than bonds, but the returns are, are much, much higher than, than bonds are. So that’s another attractor, I guess, to a REIT.

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Andrew (14:19):

As an example for the stock market, the S and P 500, they say the average over a hundred plus years is 10% returns, 7% or so comes from share price appreciation 3% comes from dividend yield. And that reinvestment generally over time, very long period, right. Rates are a lot newer. So maybe talk about the short history of rates and any data at all that you’ve come across, as far as how they performed, or, you know, you mentioned how they, they kind of lag economic recoveries. Can you add any more color to those parts?

Dave (14:58):

Yeah, so The returns on REITs over, I guess the last 20 years, has been 10.92%. And I got that number from a website called not it’s a NASA national association of real estate and investment trusts. It’s a website that is, was created when REITs were created, and it tracks all kinds of data about rates. And so you can see the returns overall of the sector and different ETFs that were set up to track the whole sector as a whole. And you can also see individual information about particular individual rates as well. And so it is, it is since the formation of reach, I believe it was in 1992, but don’t hold me to that. Though REITs were established, the return has been 10.92% since REITs were established, which I think I believe the S and P was a little over 10%. So overall, the sector has done better than the P over that same period. What percentage is share appreciation versus dividends? I, I honestly don’t know the answer to that. I could find out if somebody wants to know, but that I do know that that’s what the return has been.

Andrew (16:19):

Yeah. I mean, it’s such a short period. I’m sure that components will change as we are going through different bearable markets. The big takeaway for me is such a new investment vehicle, part of the freeze, and why it could be so undervalued because it’s just not been around that long. So people aren’t thinking of it, but you know, there’s some of these in the S and P two, right?

Dave (16:43):

Oh yes, There’s, I believe, there’s about 50 of them in the SMP. There are 243 total REITs available on the market for you to invest in. And like I said, there, there’s, there’s a myriad of different kinds of businesses. There are different types of reach that you can invest in from diversified REITs, which means that they will have multiple businesses under their umbrella. They may have apartment complexes, and they may have malls, and they may have warehouses there. There are that kinds of stuff there’s even recent invest in timber that by Timberland, and they process the wood and sell it to the lumber wholesalers. So, you know, there’s, there’s just so many different kinds of opportunities. As I mentioned, there’s healthcare; there are warehouses; there are data REITs. There are public storage, REITs. There are just so many different kinds of sectors.

Dave (17:47):

And generally, and large when you’re looking at we mentioned this, the screening process, when you’re looking at, at rates, a lot of the same metrics that you would want to look at are, are going to apply, but some other things are not going to apply. Some of the scariness I think of REITs is people look at reeds and think about how leveraged they are. And by and large, they are more leveraged than you’re going to see on the average S and P 500 company. So when you look at a REIT, let’s say I’ll pick a really popular one, a big name, a Federal Realty, which is a dividend king. They’ve been paying a dividend for 51 years now, and it’s a pretty good size REIT. And they carry a fair amount of debt now because dividends are, I’m sorry, because of reeds pay the majority of their cash flow or their earnings as a dividend.

Dave (18:45):

They don’t generally have a lot of money laying around to do a lot of growth. And so the way that REITs grow is by acquiring new spaces. Depending on what their business is, what they do is, they find different opportunities and either build them out themselves or them, or they buy them. And they have two main ways of going through that process. One is to issue equity. In other words, they sell shares of their company on the open market, and they generate income. They raise money by doing that. The other way they do that is they give out debt or issue bond offerings to raise money. And that’s how they raise money. Now, the thing about the debt with REITs is if you look at debt, debt-equity, have a read and compare that too; I don’t know, Apple, you’re going to, you’re going to pass out.

Dave (19:45):

But the bigger issue when you’re looking at debt for reads is to look at how it’s structured and when it is due; generally, a lot of the REITs will try to stagger their debt based on the length of the leases that they have on their properties. And every read that you come across is going to have different links of leases. So, for example, was, think about an apartment read. Most of us who live in apartments know that we can rent for depending on where you are and what you’re trying to do. You can; a standard lease is six months to 12 months. And so if you’re looking at debt for those kinds of businesses, it would be shorter-term debt. And it was, if you’re looking at something like a healthcare REIT, those have longer leases, generally are anywhere from 10 to 15 years, they’re going to structure their debt to be long periods like that.

Dave (20:40):

And so when you’re looking at a debt of a REIT, for example, when you’re analyzing a company you’re trying to decide, is this something I want to buy, or, and you’re worried about the debt that they have what you want to look at is not necessarily just the overall number, which is important to look at. Still, it’s also important to look at when this money is coming due. And so, for example, there was a REIT that I was looking at the other day that the debt they had, they had debt, but it wasn’t exorbitant. But the other cool thing about it was that none of it was going to be coming due until 2023. There were looking at three years of the cashflow of the ability to use money, pay down debt, invest in other properties, and go out and borrow more money to buy more properties. And so all those things were kind of exciting because you see that the way they’re structuring it gives them more flexibility. And other retailers were looking at, for example, that they had a ton of debt coming due in a very short period. And they were struggling to generate revenues from the rents they’re collecting because the businesses were struggling to recover from the pandemic. And so that was a bigger burden for them. As we’re looking at REITs, those are some things that I guess are things to think about.

Andrew (22:04):

Yeah, those are two great examples of the contrasting differences that you can have. And then it sounds like two takeaways. I have one; this any sort of re could be a fantastic opportunity to try to invest based on the theme of low-interest rates. If you think low-interest rates will continue, it’s very bullish for REITs dependent on this debt. And to, you know, it seems, especially based on that example, if you’re talking about one company with no debt due for the next three years and another company with not only a lot of debt due but revenue issues now is it seems like you need to be very fluent and how the debt obligations work and how they affected any rate you’re looking at. Now, you know, you mentioned the debt, we mentioned the dividend, as you were looking through this, is there anything that you can look back on now and say for somebody who’s maybe more green or looking at these for the first time, have you come across something where you’re like, Ooh, that could be a potential value trap. You know, maybe now that you have more knowledge about the industry, you would be able to parlay some of that knowledge to somebody else to avoid a situation like that. Yeah. I think that’s

Dave (23:23):

Yeah, I think that’s a great thing to look at. And I think Biggest the two biggest issues investors are looking at how the data structure like we talked about. That’s a big one to look at the leverage basically that the company has. And the other thing to look at is how the leases are structured and tied in with the particular REIT and thinking about the long-term prospects for those types of businesses. And I’ll use an example. So when you’re thinking about malls, and you think about retail, one of the things that retail has struggled with is Amazon’s online presence and now Walmart and target. And some of the other big names have stepped up their internet game and have put a real big crimp in foot traffic of malls in particular. And when we hear about these bankruptcies that have been going on for the last six to eight months, a fair amount of them have been in bigger; I guess the bigger anchors of the malls and the thing about malls that I didn’t think about.

Dave (24:42):

The importance of those anchors in a mall, for example, was it brought foot traffic. It wasn’t necessarily that Macy’s was selling that much more than some of the other smaller stores in the mall. The bigger issue is that it brought in foot traffic to the mall. And as a general rule, because I don’t know if kids had changed since I was a kid when I was a kid, we would go to the mall and be there all day. And you shop, and you do all this stuff, but what drove a lot of us, there were things like movie theaters and food court and the big stores that we maybe, you know, I grew up in Des Moines, Iowa. Growing up in a place like de Moines, we didn’t have a lot of the big fancy stores that somebody like lives in Los Angeles, hint, a hint would have had.

Dave (25:35):

And so you know, we had different opportunities. So anyway, when a place like Macy’s or Nordstrom’s, or Dillard’s, or, or JC penny, when those big anchors start to struggle in the malls, that’s going to affect the overall foot traffic of the mall, which is going to filter down into the smaller stores that are in the malls. And so when we read about some of these, some of these other retailers, like a warden Taylor and JGL, and I’m just blanking on all of them, but there’s been a lot of them respects brothers Brooks brothers now are a great example with some of those that are big names, but maybe not as big as a Macy’s or JC penny, when, when the big ones start to suffer, the little ones are going to suffer because the foot traffic’s not going to be there. And when the foot traffic is not there, that means that those people are coming to those balls to buy those products from those other retailers as much. And it all kind of goes hand in hand. So when you’re looking at the possibility of investing in something like that, you have to think beyond just the company’s financials. You also have to think about what the entities are in that particular business and how they’re being impacted By all the different, various things and situations that that may be happening in the world. That’s why looking up malls, for example, their prices are very depressed, but they’re also struggling to collect rents.

Dave (27:12):

And there’s also a lot of worry about what’s going to happen with the malls and the anchors and some of the things that are happening. And there was lots of discussion with JC Penney recently about Amazon buying some of those properties to use as warehousing opportunities for Amazon, whether or not that’s going to come to pass. I, who knows, but would that necessarily save the malls? I don’t know that it will. And so that’s where some of this, I guess, intuition and guesswork come into just like anything else when you’re trying to invest, you have to try to think about all the different possibilities and how it could impact things. Sometimes, it doesn’t have to be about numbers and getting into the nitty-gritty of things. It’s also looking at some of the other economic impacts of some of the other things in a particular industry or a sector that can have an impact.

Andrew (28:10):

That’s yeah, that’s such a perfect answer. And I think that that equips us with, you know, the kinds of thoughts that we need to be thinking about and the things we need to focus on as we analyze REITs and look for good investments. Now, I know you recommended a re in your upcoming newsletter, which is going to be released next week should be live by the time our podcast episode goes live, I think, but, you know, without giving away the stock pick, can you talk about, so I got, I got the early access, right? So I got to read what you wrote about this particular REIT. And I was impressed with how you talked about their competitive advantage and how it was inherent with the way their business model was in how they brought revenues. So maybe without saying what the stock is outright or giving away the stock pick, can you talk about how this particular stock has such a great competitive advantage, and maybe that can serve as a model,

Dave (29:13):

For example, for other types of rates that could have competitive advantages?

New Speaker (29:17):

Well, yeah, yeah, that’s, That’s a great point. So I think the, A couple of things, when I think about the particular reef that I’m recommending, is the biggest issue that I guess they have as an advantage is they operate in, in a healthcare sector and their particular niche. The healthcare sector is one that is growing by leaps and bounds, and they shared information and their financials, as well as their earnings calls and things of that nature about the opportunity they have to grow, not only now and next year, but for the next 30 or 40 years. And because our population is aging, and there are, we’re living longer, and we’re also more of us are getting older. That means that there will be more opportunities for this particular type of reading because it’s kind of an area they cater to. And when they show Map is one of those Financials that showed all the different areas where they’re located, that are in vast group need of their services. And it’s not just for now; it’s for the next 20 or 30 years based on the population growth and the aging potential of that population.

Dave (30:43):

And so The opportunity Going to have will be huge over the next 20 or 30 years, which for me as a value investor is something I was just like, wow, I just never even thought of that. When I came across these charts, I thought, wow, that’s an amazing opportunity because it doesn’t just mean that this company will do well for the next couple of years. It means it’s got the potential to do great for a long time and be around and have a security, I guess, because it’s a needed business. It’s, it’s a, you know, a necessary business and it’s something that we’re going to need. To me, that is a great place to be as an investor because you know that when you buy this particular company, there’s going to be a need for it. And it’s going to have the opportunity to thrive if it’s managed well.

Dave (31:36):

And this particular company is managed extremely well. And the CEO, the CFO, and the CEO have all been with the company for 19 years. And all three of them have also been in the business for 35 years. So they know what they’re doing, and they’ve been doing it for a long time and that, and they’re young enough that they will, we’ll be doing it for at least, or 10 or 15 years, probably. So all those things bode well for the company. And that was those were a couple of the reasons why I was excited about them.

Andrew (32:08):

Yeah. I got excited just reading it, you know, it has all the right numbers. It has a lot of things going for it, not just on the revenue side, but also, you know, on the balance sheet side. You have that great secular trend, which I think is very important to consider as you look at investments, potentially if you’re thinking about looking long-term. So I think it’s a, it’s a, it’s a great thing to think about. I like where your head’s at. I liked the explanation today, and I think it’s, it’s worth it for investors. You know, I think the S and P is something around 2% expose right now and into real estate. And so, you know, if, if, if an investor doesn’t have any exposure whatsoever or is just interested in a beaten-up sector, I think Reese can fulfill that in both of those circumstances.

Dave (33:08):

I would agree.

Andrew (33:10):

Your newsletter against fat pitch fundamentals, and how can people go in and check that out?

Dave (33:19):

We go to Einvestingforbeginners.com, and you’ll find the links on there under our products page for the newsletter. It’s all right there. Easy, easy peasy. L Paul, we’ll put a link in it here in the show notes as well. That’s awesome.

Andrew (33:37):

Yeah. I recommend people check it out.

Dave (33:39):

All right, folks. Well, that is going to wrap up our conversation for this DVD. Thank you, guys, for taking the time to listen. I hope you enjoyed our conversation about REITs and that you are under thinker, too, cause there’s a great opportunity out there. If you want to branch out and learn something new about the asset class, you may not be familiar. So without any further ado, I’m going to go ahead and sign this off. You guys go out there and invest with a margin of safety emphasis on safety. Have a great week. We’ll talk to you all next week.

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