Investing in REITs has always been very profitable. In fact according to the charts they have outperformed the SP500 by 300% during the last 20 years. Does this sound totally outrageous? Right? There are a few reasons for this. First of all, real estate as an investment is not really enticing when bought in cash but is very enticing when bought with leverage. What is leverage? It’s mortgage. You basically leverage your money usually at ~4:1 and the best thing of all compared to traditional margin investing is that you don’t get margin called unless you miss your payment. Even when missing your payment a ton of other measures are usually done, individual bailouts and mass forgiveness in times of hardship. When compounding leverage for 30 years the returns are much better than stocks.
Real Estate Investment Trusts are professional managers that hand pick investments and offer the benefits of diversification and knowledge. After all either you are a professional real estate investor or you got your own apartment and maybe a vacation apartment. Hardly investment grade behavior. So with REITs one can invest in real estate with leverage. REITs also have a much better sharpe ratio than stocks unless special conditions arise (see below). In that case it’s a very prudent addition to every portfolio for that middle range of dividend producing and not very risky investments.
Which ones to choose?
According to each investing environment one can pick winners and losers. Unlike the massive mortgage crisis of 2008 other times are a bit more predictive.Let’s talk about some categories.
Retail and mall REITs are being phased out for years now because of the rise of e-commerce. That has accelerated massively during the pandemic and I don’t personally think it’s ever coming back. Maybe some malls survive because they are cool places to hang out and host bars and restaurants but most people will only look and maybe try on and then go and shop online with reduced prices. So these are OUT.
Residential REITs can be interesting. Although a recession is predicted worldwide and heightened unemployment there are other forces that are working against them. The main one is that interest rates are at all-time lows. That not only means that it’s free money to get a mortgage but also that because bonds and fixed income pay almost nothing there are not many income producing places that investors put their money to preserve purchasing power. That is also a bit of a conundrum because along with low interest rates, inflation is also predicted because of the massive money printing that took place to boost the economies. In other words, either you buy stocks or put your money in a house. Another interesting force here is that people seem to be leaving big cities for the suburbs because suddenly when you are working remotely you would prefer to have a garden a bigger apartment for a fraction of a price. This will probably especially be true for mega cities with lots of tech workers (San Francisco, NY, Amsterdam, London). So YES to residential REITs but NO to ones that predominantly have portfolios in risky cities.
Healthcare REITs are an interesting play. These include mostly nursing houses, hospitals and maybe senior housing. These seem to be good but some selection is necessary. I don’t think one can know the inside outs of a REIT that owns hospitals. It’s usually too political. Nursing homes will probably fair quite well in the future because of increased aging population.
Industrial & e-commerce REITs are in the business of renting out big storage spaces to e-commerce giants such as Amazon or host car factories and freight cargos. These in my opinion are totally recession proof not only because there will be more need of them but also because the industry is back at almost pre-pandemic production levels. Especially industrial REITs in Japan have boomed even higher. We say YES.
Special purpose REITs need to be studied case-by-case:
- Public storage is a nice niche that is not going away during a recession but may even climb higher.
- Cell towers are very trending with all the 5G narrative and an interesting segment that can fair well.
- Gas stations are not my favorite ones because Electric Vehicles in the future can render them obsolete. Maybe they are converted to just stop and go cafes on the road.
- Student housing is also very interesting but one needs to think about the future. How much will e-learning change the landscape? In case of Brexit for example, where will students from the European Union go?
All in all, REITs are a good investment but given the current landscape much thought needs to be put in them. Some promiment investors I have privately discussed with are of the opinion that is even more profitable to be renting an apartment and investing in REITs rather than buying your own but usually that is more of an emotional decision because we humans want to have a safe shelter that we own.
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