Brad’s Note: As readers know, I just got back from Las Vegas where I presented at the annual Stansberry Conference & Alliance Meeting. After my presentation, I sat down for an interview with Dan Ferris. If readers don’t know Dan, he’s the editor of Stansberry Research’s Extreme Value and host of the Stansberry Investor Hour podcast. A phenomenal analyst in his own right, Dan is also a great interviewer. And I was happy to sit down with him to discuss the opportunities I see in real estate investment trusts (REITs). Read on for that conversation, edited lightly for clarity.
Dan Ferris: Brad, you are an expert’s expert in real estate investment trusts. Do you have a set of bullet points or some key items that you can tell investors who are maybe investing in REITs for the first time?
Brad Thomas: Sure. Well, of course, you know the primary law in 1960 by Congress that laid out that REITs must pay out at least 90% of their taxable income to investors. And keep in mind, when I say investors, I’m not talking about institutional investors. I’m talking about ordinary investors. Average Joe and average Jane who get access to institutionally owned commercial real estate.
That’s how the law was formed, and that primary attribute, again, is 90% of taxable income. Many REITs pay out 100% of their taxable income. And because of that law, this asset class has higher yields – almost two times the yield – than you would find for traditional C corporations or other dividend-paying companies. So, that’s probably the biggest reason that you would own those.
And then there’s diversification. You can now own a variety of different types of REITs in all different types of sectors. We’re here in Vegas. So you can think of the gaming industry. Or perhaps healthcare, cell towers, data centers, fast food, and casual dining. It’s almost an endless list of anything that is considered real estate that can be securitized and owned by investors in that format. So I think diversification and certainly those high dividends are probably the primary attributes.
Dan: So, if you’re paying out 90% of your taxable income, how do you grow?
Brad: Well, that’s a great question. Again, looking at the different property sectors, certain sectors have better pricing power. If you think about a hotel, it’s a one-day contract. So they can increase rates every day. Self-storage is a couple of months contract. Industrial is generally a five-year contract. Net lease is a 10-year contract. So you look at the pricing power and the companies that have generated the best rent growth, they are going to be able to grow faster.
So just rent growth is one way to grow. The other way to grow is by issuing new shares and having new investors come into these REITs so that they can go out and acquire property.
When you think about real estate investing, it’s really a spread investing business. The company has a cost of capital. And they take their equity component, their debt component, whatever that blended cost of capital is, and they acquire properties. Hopefully, they want to have a higher cost of capital, which is an accretive investment, and they’re just going to continue to grow and grow and grow. As a result, these companies are going to be able to generate more dividend growth.
So again, it’s not just the high dividend yield. It’s the predictability of those dividend payments and the dividend growth.
Here’s a simple analogy: You can either own shares in Starbucks, which is a C corporation, and the company could pay out a dividend or they could not pay out a dividend. It’s up to the board whether or not they pay the dividend.
But if you hold a REIT that owns Starbucks buildings, you’re going to get that predictable income generated by Starbucks. You’re going to get that predictable rent growth. As an analyst, you can predict, to a high degree, the rent growth over the next five, 10, and 15 years.
That’s one advantage for a REIT analyst. We can predict those earnings a lot better than a traditional stock like a Starbucks.
Dan: Have higher interest rates made life difficult for REITs?
Brad: Well, Mr. Market thinks so. But that’s the misconception. That’s the opportunity.
Right now, we’re seeing some pretty wide discounts. REITs have come up and rallied a little bit with this first rate cut. But again, this slowdown is sentiment driven. Just look at fundamentals.
Dan, you’re the master of fundamentals. And if you look at the fundamentals of some of these companies, their cost of capital, what they’re buying, the rent growth; it’s allowed them to continue to grow their earnings. When the company grows earnings, it’s going to grow returns eventually. Mr. Market will eventually find out the earnings are continuing to grow. So the share price is going to grow.
We’re in this market where REITs have been beaten down just because of a misconception. Now, I’m not going to paint all the REITs by the same brush. There are certainly levered REITs that are riskier. They’re riskier because of leverage and because of their cost of capital.
But for the companies that we recommended, which are high quality, that have A-rated or BBB-rated balance sheets, they’re able to continue to deliver.
Dan: I love the sound of all that. Growth dividends and high yields are the stuff that make value investors salivate. And it’s funny because I’m not hearing about it from anybody but you. Thanks for talking with us, Brad. Really exciting stuff, and I hope to hear a lot more about it in the future.
Brad: Thanks very much, Dan.
Regards,
Brad Thomas
Editor, Wide Moat Daily