REIT Investor Vs. Private Landlord


In past articles, we have often argued that REITs (VNQ, IYR) are better investments than private real estate:

  • Lower risk: They are much safer because they are well diversified, professionally managed, liquid and protect you from liability risks.
  • Higher returns: Despite the lower risk, they are able to generate higher returns thanks to significant economies of scale, better access to capital, and faster cash flow growth.

This is not just our opinion. It’s proven by extensive studies that show REITs have historically managed to generate up to 400 basis point higher annual returns than private real estate:

source

source

Therefore, most investors are much better off investing in REITs rather than in private real estate. It saves you all the hassle of having with the ugly three Ts (Tenants, Toilets, and Trash) and allows you to compound your returns at a faster rate in the long run.

At least, that’s what the theory would tell you.

However, in practice, we find that the results are often very different and private landlords still end up outperforming individual REIT investors. And there’s one main reason to that: Liquidity.

Liquidity Often Fails REIT Investors

REITs allow investors to invest in real estate, just like how you would invest in any other industry – through the purchase of stock.

The shares of REITs are traded on the stock market. They are liquid. You can buy or sell them any minute in a few clicks of mouse. And it costs you close to nothing to transact.

The idea comes from a great place and it clearly provides a lot of benefits if you know how to use it. Unfortunately, in practice, this liquidity often ends up causing more harm than good to investors:

  • You start fixating at daily quotes.
  • You become more short-term oriented.
  • You lose track of the bigger picture.
  • You trade way too much just because you can.
  • And you lose in compounding effect in the process.

You see… private landlords do so well in the long run because the lack of liquidity forces them to think long term.

They do not worry about the daily market value of their properties. They ignore volatility. And they remain invested for the long run.

As a result, they end up earning a lot of income and they reap the benefits of long-term appreciation and capital compounding.

If REIT investors had the same landlord mindset, they would be earning very attractive returns (15% annual average over past 20 years):

But because they think like traders, most of them fail to earn these lucrative returns.

Therefore, the one big lesson here is to only invest in REITs if you have the emotional discipline to ignore volatility and remain invested for the long run.

If you cannot do that, then you might be better off just investing in private real estate. You won’t enjoy the same scale advantages and professional management, but at least, it will force you to remain invested for the long run.

Invest in REITs, But Think Like a Landlord

It’s easier said than done. But if you want the best of both world you should invest in REITs with a landlord mentality.

This means that you should assess a REIT investment in a similar way as you would buy a rental property.

Then once you have made your investment, you should forget about its share price for at least a few years. Don’t even look at it. Your goal is not to sell anytime soon so the price is irrelevant to you. Checking the price can only cause an emotional overreaction so don’t do it.

Instead of starring at the price, stare at the income that is coming in. REITs are very steady investment vehicles because they own diversified real estate portfolios that are conservatively financed. The rental income is stable and resilient during most time periods. Focus on the income.

Then in five years as you look back at your purchase, you are very likely to be pleased with your return as long as you selected the right company at the right time. Over the long run, REITs always have generated attractive returns as long as you remain patient and do not overreact to volatility.

This brings us to today’s market crash:

COVID-19 Response: REIT Investors vs. Private Landlords

Recently, REITs have collapsed along with the rest of the market.

Individual REIT investors are panicking and selling their investments in a rush, often at deep discounts to fair value.

Private landlords, on the other hand, continue to remain patient, earn income, and wait for long-term appreciation.

Who do you think will outperform in the long run?

There’s no doubt about it: The patient landlord will outperform the emotional REIT investor.

  • The landlord is long-term oriented.
  • The REIT investor is short-term oriented.
  • The landlord is calm.
  • The REIT investor is panicking.
  • The landlord focuses on income.
  • The REIT investor is fixating at daily quotes.

They both own the same asset, but because REITs are liquid, the investor becomes stupid.

This stupidity has recently created historic opportunities to those REIT investors who are more disciplined and long-term oriented.

REITs are today priced on average at a 30% discount to net asset value (“NAV”). Many of the smaller and lesser known REITs are priced at up to 60% discounts to NAV:

source

Essentially what this means is that you are offered the opportunity to buy high-quality, conservatively-financed, and professional managed real estate at 50 cents on the dollar.

Now, we understand that the near-term prospects are uncertain and some rent payments will be missed. However, this is only a temporary crisis and as we return to normal, rent payments will resume and these properties will still be highly valuable.

If you were offered to buy a rental property at 50 cents on the dollar, you would jump on the opportunity. Yet, when offered to buy REITs at 50 cents on the dollar, you fail to act on the opportunity because the volatility scares you away.

By thinking like a landlord, you can today capitalize on deeply-discounted REITs ahead of their recovery. The last time that REITs were so cheap, they nearly tripled in the following two years:

REITs currently offer much better value than private real estate at the moment. In fact, one of the largest private landlords in the world, Brookfield (BAM), recently noted that they are loading up on shares of discounted REITs:

Our private funds had been investing in carve-outs of assets from companies for years, as high valuations in the public markets offered few opportunities. Today, the opposite is true. We are buying shares of companies in our private funds at a fraction of what we would have to pay to acquire those same assets directly from the companies. Our goal is the same; it is just the execution that is different.

We have recently deployed approximately $2 billion of capital into the public equity markets, including repurchasing shares of BAM and our public affiliates (BPY, BIP, BEP) at significant discounts to what we believe to be their intrinsic value, as their prices traded down with the general market sell-off. We have also built up toehold positions in the shares of several companies that we feel, like ours, are being significantly undervalued in the current market environment. (Source: First Quarter Shareholder Letter)

Now is time to think like a landlord and buy REITs while prices are cheap. Ignore short-term volatility and focus instead on the income and long-term appreciation prospects. If you can do that, you are likely to be very richly rewarded in the coming years.

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Disclosure: I am/we are long BAM; BPYU. 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.

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