Sure, the sector suffered last year, but it’s overcome troubles before and will do so again.
Real estate investment trusts, or REITs, were misunderstood for years after they debuted in 1960 – even for decades. When they were first written into law, they were little known and little appreciated. Institutional investors simply did not trust them, seeing their very existence as too unestablished to be worthy of the risk. And to be fair, they had a point.
When REITs were signed into law in the middle of last century, there were a lot of kinks to work out. On the one hand, they did exactly what they promised in making the profits involved in owning commercial real estate accessible to the ‘little guy’ investor. What was once a rich man’s game suddenly became something in which everyone could participate, which was wonderful. But…
REITs weren’t a perfect investment back then, to say the least. Not that there ever is such a thing, but they did have a few more flaws at inception than they do today. And those flaws were fairly significant, allowing them to be taken advantage of by unscrupulous or incompetent third-party management and financial institutions more interested in their own profits than in mutual gains with investors.
“As we round out the first quarter of 2021, people are wondering if REITs really have what it takes any more. Has the ‘new normal’ changed everything?”
‘Little guy’ investors themselves, admittedly, didn’t always help out either. There were too many times they got overexcited or fearful, causing unsustainable bubbles and inevitable crashes every decade or so. Though that’s true of absolutely every single stock category, not just REITs.
Here’s another clarification I need to add. Despite their obvious flaws at first, REITs still produced positive total returns every year between 1960 and 1989, with the single exception of 1987. I think it’s safe to say that’s pretty exceptional.
Now, that track record did change for the worse in 1991. As I write in my upcoming book, The Intelligent REIT Investor (due out in May): “In the second half of the 1980s, REITs’ dividends had been rising faster than their earnings. Their stocks didn’t suffer for it at the time, outperforming the S&P 500 in 1986 and 1987, and only slightly underperforming in 1985 and 1988-89. But that changed the very next year as REIT share prices fell and fell hard…
“The past overbuilding craze in office buildings and apartment communities finally caught up to them, no matter if they themselves hadn’t participated in it. At the same time, the rise of Walmart and other discounters was beginning to encroach on traditional retailers and their landlords. Add to that their high payout ratios they themselves had encouraged and could no longer sustain, and a resulting round of dividend cuts. Combined, it was enough for investors to ditch greed as a motivator and let fear drive them instead.”
It might seem rather odd, then, that the 1990s were the start of the modern REIT era, when they began to gain favour on a much larger scale. As I also write: “At the end of 1990, their market cap was estimated at $5.6bn. By the close of 1994, it had risen to $38.8bn. A year later, it was up to $60bn – still a micro industry but a growing one nonetheless, with new sub-sectors such as malls, outlet centres, industrial properties, manufactured home communities, self-storage properties, and hotels.”
Why bring up all that history? There’s an easy and ready answer to that question, since opinions about REITs seem to have taken a few steps back in the past year. The sector is still underperforming the market; and as we round out the first quarter of 2021, people are wondering if REITs really have what it takes any more. Has the ‘new normal’ changed everything?
To me, that mindset is exceptionally unfortunate. And this is coming from someone who recently wrote about Washington Prime Group. I fully recognise that there are REITs out there that suffered enormously last year and am in no way surprised that certain mall landlords are now filing for bankruptcy.
But what investors need to realise is that this isn’t the result of the shutdowns. It’s the result of a brick-and-mortar retail mania that was never sustainable long term. The rise of the internet was a secular trend playing havoc on malls well before the shutdowns. The shutdowns only speeded up that trend.
The exact fate of office buildings is still up in the air – something that nobody saw coming so fast
And yes, the exact fate of office buildings is still up in the air – something that nobody saw coming so fast, as far as I’m aware. Personally, though, I think they’re going to pull through. And I have good reason to believe so, which I’ve detailed in more than one article in the past year. One of my arguments boils down to two points: (i) big tech companies are still scooping up property in New York City; (ii) those fleeing from California are still renting out office space in the states they’re moving to.
Plus, collaboration is much easier to do when you’re working face to face. Zoom and other online meeting tools just can’t cut it in many ways.
Next consider apartment REITs. A new report recently showed that millennials are apparently giving up on their brief hopes for homeownership after the high prices and intense demand of last year shut them out. They have to live somewhere – and preferably not in their parents’ basements.
Industrial, cell tower and data centre REITs all have intensely increased their business prospects. Rampant home-building is hardly a bad thing for timber REITs. And there are even plenty of retail REITs worth considering right now. For proof of that, look no further than the net-lease space. Those stocks fell and fell hard last March. People still have their misgivings about them today. Yet, as I recently wrote about Store Capital, many of their rent collection figures are steadily rising. And I expect them to continue up that profitable path from here.
Speaking of Store, its valuation is no longer conducive to buying in with any real safety of margin. In fact, many of the REITs that investors left for dead last year have since regained all of what they lost and then some. Then again, there are still plenty of others worth looking into – and even more that deserve to be put on your watchlist.
The bottom line is that REITs have faced trouble before, and they’ve only emerged stronger each time. So don’t give up on this sector. It still has a lot of pleasant surprises up ahead, right along with the same old boring, reliable dividend payments that make men and women rich over time.
