To begin with, I wish everyone a Happy New Year. 🎊🥳This year should be a time of restructuring your investment decisions to exploit the alpha-rich opportunities available in the market.
Before I talk about the best REIT investment strategy for investors out there. I would like us to note the strategies available for REIT investors. Investment strategies are generally divided into two main groups.
Active strategies - This involves buying and selling individual stocks in an attempt to invest only in the best opportunities and earn superior returns.
Passive strategies - This, on the other hand, involves buying an ETF or CEF that provides diversified exposure and then holding this fund for a long time with minimal trading. This is normally called index investing.
Take note, active strategies may not always be individually picking out stocks you have due diligence in, however, mutual funds which invest in a basket of stocks can also be active investing. The difference is that the work is done by a fund manager and analysts who actively research the market to pick out the best stocks to outperform the market. Individual investors wouldn’t be doing basically anything, so they are typically charged a higher management fee than you would’ve in index funds.
Anyways, for most market sectors, I believe that investors would be better off to stick to low-cost ETFs and index funds, avoid trading and follow a very passive strategy. There is evidence that active investing has failed to outperform the market in the long run.
Let’s think for a moment, most professional fund managers fail to outperform their benchmark, if professionals cannot do it, what are the chances of us beating the market? That is why Warren Buffet vouches for passive approaches of investing over active approaches. But let’s leave it here.
Regardless, my stance is active approach over passive approach.
So Why Aren’t I Following a Passive Strategy?
The reason I choose active strategies over passive ones in the REIT sector is that alpha remains real and abundant there. Active investors have historically been able to consistently identify and exploit alpha-rich opportunities. The annual outperformance after fees has been 100-200 basis points per year, with the best investors reaching up to 22% per year compared to just 10% for indexes.
In Module #4: “REITs vs. REIT ETFs/CEFs”, we explained the flaws of REIT ETFs and CEFs over picking out individual REIT stocks. I will list them here.
REIT Exchange Traded Funds (“ETFs”) suffer from 4 big flaws:
ETFs are market-weighted and invest most of their capital in overpriced large and mega-cap REITs.
They invest in all companies, including the good, the bad, and the average.
They are missing out on the lucrative returns of smaller and lesser-known REITs that are often discounted.
Finally, they pay very little income, which is the main reason why we invest in REITs in the first place.
REIT Closed-End Funds (“ETFs”) are arguably even worse:
They charge higher fees.
They are overleveraged.
And most often they are just closet indexing and greatly restricted in their investment approach.
These vehicles offer instant diversification, convenience and passive management but if you’re looking to generate higher income and greater returns, you should opt for an active strategy that targets undervalued individual REITs.
Value💎 & Growth📈
Active investors share one common motive; to beat the market.
I want to talk about the active approach which will enable investors to reduce underperformance of the market over index or passive investing. Author
on his newsletter Equity 101, Part 2💹talked about why passive investing was the best approach for investors. Active investing has failed to beat passive investing. That’s absolutely true. I recommend this blog on evidence that proves finance professionals couldn’t beat the market with active investing over the long run. I prefer active investors build an index portfolio for the long term. But I’m also here to make out my point on what active investors should build on to stand a chance to outperform passive approaches.
In active REIT investing, there are two schools of thought here. We have growth investors and value investors.
Growth investors buy REITs with large investment pipeline and superior growth prospects. They are less worried about valuation (e.g. P/E ratio) and dividend yields. As long as growth and earnings are robust, total returns will follow.
Value investors are much more worried about valuation. Due diligence is always done before they buy a REIT or stock that is trading at discounted valuations and typically having a higher dividend yield. Growth is more of a secondary concern.
When it comes to active strategies, investors identify themselves as one of the two. My opinion is to not fall victim to active approaches’ inability to outperform indexes is by mostly avoiding only building your portfolio with a growth mindset, that is to focus only on blue-chip companies, be short-term, and an attempt to beat the market. These are typically why investors find their portfolios crushed in the long run.
Building a portfolio, in my opinion, with more of a value-mindset is the best. Buy undervalued companies and earn high income as you wait patiently for long term capital appreciation and repricing. I believe this is the best strategy for investors because:
Value beats Growth: Value investors enjoy 3-return components, namely dividend yield, growth and repricing. Growth investors enjoy only 2, namely dividend yield and growth.
High Quality Value beat Deep Value: It means you are not to just invest in any discounted company you find your hands on, you pick out those selling below fair values but with robust fundamentals, those that are going through temporal challenges that are solvable over time. Deep value ones are indeed discounted but probably have bad fundamentals which sent the stock price down, holding unto these can lead you nowhere.
💎Value Beats Growth📈
Value has consistently beaten growth over the long term. The fact about it is that value enjoys repricing return potential as things improve over time whiles growth stocks although has high earnings and are poised for capital appreciation, has no margin of safety if it makes a simple misstep, especially for those with higher-than-normal valuations.
This is the advantage value enjoys over growth. If things don’t come out as expected for value stocks, you don’t lose much since it’s already undervalued. However, for growth stocks trading at a higher-than-normal valuation is at a risk of losing much if things don’t happen as expected. So, to conclude, having a margin of safety by choosing valued REITs or stocks can reduce long-term underperformance.
💎Quality Value Beats Deep Value🧱
“Price is what you pay, value is what you get” Warren Buffett
In this sense, investing in a great company which is currently overpriced will not make a good investment over time. It limits performance. From this we know that taking the valued approach can enable us to avoid the current hypes of the market.
But anyways, there is a difference between value and just being too cheap. Many investors fall for this trap and invest in any company because it has lower valuations. Yes, we never want to overpay but we also shouldn’t think that diamonds can be found everywhere like stones. That’s where quality value and deep value comes into play. Quality value is simply investing in discounted companies but with robust balance sheets, good fundamentals and is poised for price restructuring over time. However, deep value appears discounted but it’s relatively cheap because the company might be undergoing significant challenges like cash burn, high operating cost, negative cashflow, and others. Such companies may have lower valuations but one thing to keep in mind is that cheap can very quickly get even cheaper. There are such REITs on the exchange that have high yields with lower valuations but their total returns have been disappointing.
Medical Properties Trust (MPW) is a great example to value REITs being too cheap. It had a high dividend yield with a lower valuation a year ago which made it attractive to invest in. But within that year, cheap turned into cheaper and everything went from bad to worse which led to dividend cuts. This is a company currently going through headwinds as some of their large tenants haven’t been able to pay their rents and all. It’s currently down like -70% YTD, pretty disappointing for a value REIT, right? It would’ve been better for investors to have invested in an index like the S&P 500.
So now you can see we don’t want to pay full price, but we should not be too cheap either. My only advise to not fall for these traps is to never stop learning. In the end, you will find the big winners poised to outperform passive approaches and not get distracted by deep value companies.
🗝 Bottom Line
My advise is to focus on generating about half of your income from total returns and the other half from a mixture of repricing and growth. Concentrate your efforts to find quality value companies and not deep value ones even if the price is so compelling. Be long-term focused and don’t let the current market news dictate your thinking. My investment strategy is not rocket science. Put simply, I aim to buy properties at less than what they are worth in order to achieve high income and capital appreciation. This strategy if implemented correctly can lead to attractive investment results. This is what I call the best investment strategy.
I personally use Interactive Brokers for all my REIT investments. They provide access to all REIT common shares and preferred shares as well as international REIT investments with low transaction costs. I have been with them for many years and can definitely recommend them. Other people use Fidelity, E*TRADE, Charles Schwab, Robinhood and others.
If you want to open an Interactive Brokers account, you can use my referral link to get up to $1000 of free stocks. Click here
I wish you good luck on your real estate journey :)
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Hi Joshua. This is an excellent update. I like how you have touched upon the concept of value trap. Quality > value any day. I also feel that for a young active investor with decent risk appetite and knowledge of the market, a mix of growth and value stocks can be considered.
Hi Joshua. This is an excellent update. I like how you have touched upon the concept of value trap. Quality > value any day. I also feel that for a young active investor with decent risk appetite and knowledge of the market, a mix of growth and value stocks can be considered.