These Left-for-Dead “Income Machines” Have Never Been More Promising
Faced with the prospect of an imminent rate hike, many investors have given up on real estate investment trusts (REITs), mistakenly assuming that they’ll underperform as the cost of money goes up.
I can’t think of a more expensive mistake.
Contrary to what a lot of people believe, REITs have historically done well when the cost of money is increasing. Between 1994 and 2013, for example, there were nine time periods when interest rates rose by more than 1% (or 100 basis points in trader speak) as measured by the 10-Year U.S. Treasury note. Six out of nine of those times, REITs provided positive returns.
Put another way, REITs made money when the markets experienced rate increases that were four times larger than the 0.25% boost the Fed is reportedly contemplating. Of course, positive isn’t good enough when it comes to Total Wealth.
I want you to have the opportunity to really put some numbers on the board.
Here’s your path to profit while everyone else disregards history.
Commonly held wisdom is that REITs are going to get pounded when rates rise. That’s logical given that the cost of money is an integral part of real estate investing.
What most people are missing, though, is that there’s a big difference between a sharp rate spike in the mold of Chairman Paul Volker’s 1970s “torpedo” and the slowest interest rate normalization in history that’s likely Yellen’s legacy.
The former is a mechanism designed to shut down inflation and rein in speculation, while the latter is intended to maintain all the things policy makers believe it makes possible – improving employment, consumer spending, and overall demand.
Since 1994, there have been nine instances when rates rose by 1% or more and real estate did just fine.
And if it’s different this time?
I get that question a lot – usually more as it relates to traditional dividends and income than real estate – but either way, it really doesn’t matter much. The principle is the same – there is a strong correlation between high total returns and the management approach taken to dividend policy.
Let me prove it to you.
Imagine investing $200 in 1940, $100 of which you put in dividend stocks and reinvested over time and the other $100 of which you put in non-dividend payers. By the end of 2011 the former would be worth approximately $174,000 while the latter would be worth only $12,000, or $162,000 less, according to a study by Dr. Ian Mortimer and Matthew Page of Guinness Atkinson.
To be clear: I’m not saying that growth investing is worthless. My point is that simple mathematics can give you a tremendous advantage in widely varied market conditions that, in this case, include a World War, multiple regional conflicts, expansion, contraction, recessions, and more.
Back to REITs…
What Almost No One Gets About REITs
Most REITs are publicly traded entities that make money through their investments in real estate that are usually a combination of income-producing properties. Think shopping centers, retail strip malls, offices, warehouses… all the usual stuff. They can be private or non-listed, too.
Originally created by Congress in 1960, REITs are intended to provide a structure that, for all intents and purposes, is similar to a mutual fund. They’re typically broken up into two groups – so-called equity REITS and mortgage REITs. As of June 2014, there were more than 456 listed real estate companies in 37 countries with an aggregate value of more than $2 trillion, according to NAREIT.
What makes them special for our purposes is that REITs have to return 90% of their profits back to shareholders in the form of dividend income. Many offer high yields that make them appealing to income-starved investors.
Unfortunately, too many people view this same strength as a weakness right now.
We’re already seeing this misguided theory play out in the media. As it’s become increasingly obvious that the Fed will raise rates, however gradually later this year or in 2016, analysts on CNBC and elsewhere speculate that now is the time to dump REITs from your portfolio. It’s no wonder that the Vanguard REIT ETF (NYSEArca:VNQ) is down almost 10% over the last six months even as the S&P 500 has returned 5.3% over the same time period.
But again, this is an expensive mistake and, as usual, their knee-jerk reaction is your opportunity.
Not All REITs Are Created Equal
Mortgage-based REITs – that is those investing mainly in agency-backed securities – are going to come under the most pressure when rates rise. That’s because the value of the fixed income investments they hold will decrease as rates go up. The reason is that yields of existing holdings will match or be inferior to newly issued alternatives with higher coupon rates.
Equity-based REITs – those investing in income-producing properties – are less sensitive to increasing rates. That’s because there’s usually plenty of cash flow AND appreciation to offset any price drop associated with higher rates. Not always, mind you, but enough that it’s a good rule of thumb.
Tap into one of more of our Unstoppable Trends and this takes on an entirely new dimension.
Take Alexandria Real Estate Equities Inc. (NYSE:ARE), for example.
The company deals heavily in tech real estate in New York and San Francisco among other places, and I recommended it to Money Map Report subscribers months ago as a way to play the Silicon Valley boom while avoiding the risk of flashy startups.
It taps into the explosive Unstoppable Trend we call Technology using a very innovative “cluster model” that groups investments immediately adjacent to world class academic, medical, and technology institutions. The model exploits the logical strength associated with the world’s most sophisticated biotech companies, medical researchers, product development and even biofuels – all of which are highly secure lessees, not the fly-by-night, perennially unprofitable tenants you get in lesser REITs.
ARE has returned 2.01% since we recommended it to Money Map Report subscribers at a time when REITs have largely been on the decline. More importantly, though, it’s hiked its dividend payout by 4.05% since we recommended it and increased dividend payouts by more than 12% during the last round of fiscal tightening.
Or, consider Omega Healthcare Investors Inc. (NYSE:OHI).
The Maryland-based company invests heavily in hospital properties and health care facilities, with a special emphasis on nursing facilities. In fact, it recently acquired Aviv REIT, another significant player in assisted-living.
OHI’s nursing home concentration plays nicely with not one but two Unstoppable Trends, Medicine and Demographics, at a time when an estimated 10,000 baby boomers retire each day in America.
Like ARE, OHI has high-quality tenants representing a fraction of the risk associated with traditional office or residential tenants. And like ARE, OHI recently raised its dividend, increasing it by 8% year-over-year and resulting in a current yield of 6.1% according to Yahoo!Finance.
OHI is cheap after the haircut so many REITs have seen in 2015, and it currently trades at a PE ratio of just 22, which strikes me as great value for a company that’s expanding its holdings at a time when Obamacare means more money flowing into all manner of health care facilities.
In closing, we’ve covered a lot of ground today and I hope I’ve made my point – REITs are not the investing zombies many investors think when it comes to rising rates.
More specifically, though, some are destined to be superstars. As always, that’s a search that begins and ends with our Unstoppable Trends.
Until next time,