REITs: What They Are & How to InvestFeb 08, 2021
Real estate investment trusts (REITs) offer investors a way to invest in commercial real estate property by buying a stock in the management / holding company - without having to actually own, manage or maintain the physical property.
REITs are companies that own and operate income-producing real estate, such as apartments, data centers, factories warehouses, self-storage facilities, malls, hotels. Any property type you can think of - there is probably a REIT for it.
How do you make money in REITs?
When investing in a REIT, there are two ways to make money: dividend income and capital appreciation of the share price of the REIT.
We’ll start with income. Much like owning a physical property, investing in a REIT typically provides (relatively) high income in the form of a dividend. REIT owners collect dividends similar to how real estate owners collect rent payments. In fact, REIT companies are required by law to return at least 90% of their annual taxable income in the form of dividends to shareholders. REITs typically pay dividends somewhere between 3-8%, which is far greater than most non-REIT stocks.
Next, capital appreciation. Share prices of REITs can fluctuate just like any other stocks, based on factors like earnings, market sentiment, EBITDA, management changes, etc. As a general rule of thumb, changes to REIT prices are closely tied to changes in demand for the underlying properties it owns. For example, this past year, REITs with large exposure to commercial office space vastly underperformed the market as corporations moved toward a work from home environment. On the other hand, REITs with large exposure to data center facilities and properties did well, as demand for property to host cloud computing servers increased dramatically.
We believe that REITs will outperform the broader market over the coming 1-3 years, primarily because of their attractive dividend yields. Currently we are in one of the lowest interest rate environments of all-time. This has caused conservative investors seeking income to leave more traditional income producing assets like treasuries, and municipal bonds, and seek higher yields in vehicles like REITs. We believe this trend will continue, and think that allocating a portion of a diversified portfolio to REITs is prudent.
Historically speaking, REITs have offered strong returns relative to the broader market.
- Some data to back that up: Nareit found that from 2000-2019, the FTSE NAREIT All Equity REITs index (tracks all publicly traded REITs) outperformed the Russell 1000, a stock market index of large-cap stocks. The REIT indexed investments saw a total return of 11.6% annually (including dividends) versus the Russell 1000’s 6.29%.
Different types of REITs
As we mentioned above, you can find a REIT to invest in almost any type of property. Currently, we like REITs whose tenants are in growing sectors - namely technology. We are currently avoiding REITs that have heavy exposure to traditional retail outlets (like malls or storefronts), and heavy exposure to residential urban apartment properties - as individuals have begun to leave cities in the work-from home world.
Here are a few REITs that we like (stay tuned - we may do an additional post on one or all of these as a deeper dive):
Equinix (EQIX): Equinix is a data center REIT. It’s dividend yield (1.41%) is significantly less than that of other REITs, but this is more of a capital appreciation play based on the demand for the underlying property.
The number of companies looking for ways to store and secure their data has increased massively in recent years. In fact, Cisco expects data center traffic to grow by 25% per year.EQIX is essentially the blue-chip data center REIT with the largest market cap of any of the group (~67 billion).
Digital Realty Trust (DLR): Similar to EQIX, DLR is also a play on increased demand for cloud computing and data center real estate. However, DLR is trading at a discount to EQIX - which is likely a result of investor uncertainty over a recent costly acquisition of Interxion. We believe the Interxion acquisition will be fruitful for the company over the long term despite some recent headwinds for the stock price. DLR also offers a slightly higher dividend of ~3%.
Similar to the thesis for EQIX, we believe DLR will benefit from greater data center needs of large corporations that now have workforces that largely work from home and communicate electronically.
Data centers' biggest customers tend to be cloud providers, and network providers, which will likely increase spending with data centers as demand for cloud storage and network connectivity increases.
CoreSite (COR): CoreSite is the smallest of the group, with a market cap of just over $5Billion. Being that it is the smallest, it is a bit more speculative in nature and will likely be more prone to short term share price volatility.
However, we see CoreSite as being interesting, as it generates about 70% of its annualized rent from Silicon Valley, Los Angeles, and Northern Virginia, three of the most critical cities in the world powering the Internet. COR management has emphasized that it will look to get deeper in its current market to grow revenues, as opposed to enter into new markets. We think this is smart as their revenue streams are currently tied to the fastest growing industry in the world.
In sum, we believe that REITs are an attractive opportunity. There are many different types of REITs to invest in, but we believe data center REITs are a great way to play a real estate trend of the future. Stay tuned for additional posts on some of the above listed stocks, as well as different types of REITs!