What I Wish I Knew Before Investing In REITs (2024)

What I Wish I Knew Before Investing In REITs (1)

Over the long run, REITs have been some of the most rewarding investments in the entire stock market. They have generated a 14% average annual total return over the past few decades, outperforming the S&P 500 (SPY) and even growth stocks (IWM):

What I Wish I Knew Before Investing In REITs (2)

Moreover, that's just the average performance of the sector, which includes, the good, the average, and the bad REITs. If you actually knew how to sort out the good from the bad, you could have earned even better returns.

I have been a REIT investor for a long time and while I have made my fair share of mistakes and suffered occasional losses, I have still managed to beat the sector averages (VNQ) over time:

I would like to think that I have learned some valuable lessons along the way and in today's article, I am going to share with you what I wish I knew before I started investing in REITs.

Some of these lessons were learned the hard way. Don't make the same mistakes.

Mistake #1 - Chasing a high dividend yield

This is the biggest and most important mistake that REIT investors keep on making.

They see REITs as "income vehicles" and therefore, they will select their investments based on their dividend yield.

In their mind, the higher the better.

But in reality, the dividend is just a capital allocation decision. It says nothing about the underlying business or even the valuation of a company.

A REIT could offer a very high yield simply because it is overpaying and heavily leveraged. Another REIT with similar properties may offer a much lower dividend yield simply because it wants to retain some cash flow to reinvest in growth.

9 times out of 10, the more conservative dividend policy is preferable and will result in better total returns over time, but most investors will still favor the REIT with the higher dividend yield.

Let me give you an example: Global Net Lease (GNL) is a net lease REIT that has offered a ~10% dividend yield throughout its history. It has consistently overpaid and used too much leverage to pay a high dividend and this has attracted unsophisticated yield-hungry investors.

Against it, we have W. P. Carey (WPC), which is a close peer of GNL. It follows a similar strategy, but it retains a greater portion of its cash flow and uses less leverage. As a result, it has typically traded closer to a ~5% dividend yield.

Here is how they have both performed over time:

What I Wish I Knew Before Investing In REITs (4)

The lower-yielding REIT generated far higher returns.

GNL suffered large losses because it was overpaying and used too much leverage. This then pushed the management to issue a bunch of equity at dilutive prices. The dividend was cut during the pandemic and it will likely be cut again because they are still overpaying.

So never select your REITs based on their dividend yield. The dividend yield should be just an afterthought.

Much more important are the cash flow yield, the payout ratio, the leverage, the quality of the assets, the growth prospects, the management alignment, etc.

Mistake #2 - Seeking a low valuation over everything else

This is a mistake that I have made myself.

We are value investors and so we want to pay the lowest price possible, but from my experience, deep value plays rarely work out well in the REIT sector, and it is typically worthwhile to pay a premium for quality because good real estate that's conservatively financed has time on its side.

Let me again illustrate this with an example:

Back in 2019, mall REITs appeared to be extremely cheap. Some of them, including CBL (CBL), were priced at just 4x their cash flow.

Put differently, they were priced at 25% cash flow yield, out of which they paid about half in dividend income and retained the rest to reinvest in their assets to make them more desirable.

Therefore, the investment thesis was that the price is so low that even if these malls never experience any growth from here, investors should earn strong returns over time.

But a few years later, CBL filed for bankruptcy. It had to heavily reinvest in its properties to keep them desirable and this was draining its cash flow even as it also had to deleverage its balance sheet.

We have seen similar cases with other "deep value" opportunities. Those that come to my mind right now are Uniti Group (UNIT) and Industrial Logistics Properties Trust (ILPT).

What I Wish I Knew Before Investing In REITs (5)

The lesson is that a very low valuation does not equal high total returns.

More often than that, the market knows something and the valuation is so low for a good reason.

Mistake #3 - Not paying enough attention to the NAV

But at the same time, you shouldn't overpay either.

It may be the best REIT, but if you pay too much for its shares, you will still likely underperform over the long run.

Therefore, you still want to keep an eye on the price tag.

For this purpose, most investors will look at the P/FFO multiple, which is a cash flow multiple. The lower the better of course.

But the issue here is that FFO does not adjust for capex and on top of that, leverage can also have a large impact on this valuation multiple.

For this reason, I think that investors should also keep an eye on P/NAV, which measures the value of the assets, net of debt, relative to the market cap of the company.

This metric gives you a better sense of how much you are really paying for the real estate. Yet, most investors are ignoring it simply because it is more difficult to obtain and end up not really knowing how much they are paying.

Mistake #4 - Suffering from home bias

This is a particularly big mistake for US-based investors.

They will only consider American REITs and overlook anything outside of the US. That's despite the US being just one out of 30+ REIT markets:

What I Wish I Knew Before Investing In REITs (6)

REITs are all over the place these days and the best opportunities are often abroad. Simply buying American REITs due to laziness won't get you the best results.

To give you an example: Today, residential REITs like Equity Residential (EQR) are cheap in the US, but similar REITs are even cheaper in Europe. Some of them are priced at discounts of up to 70%!

#5 - Thinking like a trader, not like a landlord

I kept the best one for the last.

Most REIT investors are investing as if they were traders when they really should invest like landlords instead.

REITs are real estate investments so you need to have a long-term horizon and realize that quarterly results really aren't that important.

Yet, most investors will trade in and out of REITs based on short-term results/news and are very quick to lose patience if their thesis isn't playing out within a few quarters.

I can't count how many times I have invested in a REIT, then seen its share price drop a lot lower, before eventually earning very good returns because I was patient and had the courage to buy more.

This is why you should think like a landlord, not like a trader.

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What I Wish I Knew Before Investing In REITs (7)

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What I Wish I Knew Before Investing In REITs (2024)

FAQs

What I wish I knew before buying REITs? ›

A lot of REIT investors focus too way much on the dividend yield. They think that a high dividend yield implies that a REIT is cheap and a good investment opportunity. In reality, it is often the opposite, and the dividend does not say much, if anything, about the valuation of a REIT.

Is there a downside to investing in REITs? ›

Non-traded REITs have little liquidity, meaning it's difficult for investors to sell them. Publicly traded REITs have the risk of losing value as interest rates rise, which typically sends investment capital into bonds.

What do I need to know before investing in a REIT? ›

When you're ready to invest in a REIT, look for growth in earnings, which stems from higher revenues (higher occupancy rates and increasing rents), lower costs, and new business opportunities. It's also imperative that you research the management team that oversees the REIT's properties.

What is the 90% rule for REITs? ›

How to Qualify as a REIT? To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.

What is the best time to buy REITs? ›

REITs historically rebound when interest rates pivot and have the potential for rent growth. Realty Income, Agree Realty, VICI Properties, Essential Properties Trust, and American Tower are strong picks for long-term growth and income.

What's the average return on a REIT? ›

Which REIT subgroups have done the best at outperforming stocks?
REIT SUBGROUPAVERAGE ANNUAL TOTAL RETURN (1994-2023)
Industrial14.4%
Residential12.7%
Health Care11.6%
Retail11.2%
5 more rows
Mar 4, 2024

What happens to REITs when interest rates go down? ›

With rate cuts on the horizon, dividend yields for REITs may look more favorable than yields on fixed-income securities and money market accounts. However, REIT stocks are only as good as the properties they own — and some real estate sectors may be better positioned than others.

Do REITs go down in a recession? ›

REITs historically perform well during and after recessions | Pensions & Investments.

Are REITs a good investment in 2024? ›

April 2, 2024, at 2:50 p.m. Real estate investment trusts, or REITs, are a great way to invest in the real estate sector while diversifying your options. Real estate investments can be an excellent way to earn returns, generate cash flow, hedge against inflation and diversify an investment portfolio.

Is it hard to get out of a REIT? ›

Getting out of a non-traded real estate investment trust, or REIT, can often be rather difficult and expensive. Once a REIT is closed to new investors, the board of directors of the REIT can suspend the redemption policy.

What is the 5 50 rule for REITs? ›

A REIT will be closely held if more than 50 percent of the value of its outstanding stock is owned directly or indirectly by or for five or fewer individuals at any point during the last half of the taxable year, (this is commonly referred to as the 5/50 test).

How much should I start investing in REIT? ›

According to the National Association of Real Estate Investment Trusts (Nareit), non-traded REITs typically require a minimum investment of $1,000 to $2,500.

How long should I hold a REIT? ›

"Both public and non-public REIT investments should be considered long-term, and that could mean different things to different folks, but in general, investors who typically invest in REITs look to hold them for a minimum of three years, and some of them could hold them for 10+ years," Jhangiani explained.

How much of my portfolio should be in REITs? ›

“I recommend REITs within a managed portfolio,” Devine said, noting that most investors should limit their REIT exposure to between 2 percent and 5 percent of their overall portfolio. Here again, a financial professional can help you determine what percentage of your portfolio you should allocate toward REITs, if any.

How often do REITs pay dividends? ›

REITs and stocks can both pay dividends, usually on a monthly, quarterly, or yearly basis. Some investments will also offer special dividends, but they're unpredictable.

Is investing in REIT a good idea? ›

Are REITs Good Investments? Investing in REITs is a great way to diversify your portfolio outside of traditional stocks and bonds and can be attractive for their strong dividends and long-term capital appreciation.

Can you really make money from REITs? ›

REITs' average return

Return a minimum of 90% of taxable income in the form of shareholder dividends each year.

Is it good to buy REITs now? ›

Bottom line. Investors eyeing REITs may find a potential recovery ahead. With rate cuts on the horizon, many publicly traded REITs have rebounded, and the industry as a whole seems well-poised for a recovery in the coming year.

What is the most profitable REITs to invest in? ›

8 Best High-Yield REITs to Buy
REITForward dividend yield
Blackstone Mortgage Trust Inc. (BXMT)12.1%
KKR Real Estate Finance Trust Inc. (KREF)13.5%
Easterly Government Properties Inc. (DEA)8.3%
Realty Income Corp. (O)5.5%
4 more rows
Jan 24, 2024

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