Mostly Voices [0:00]

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.

Mostly Mary [0:15]

If a man does not keep pace with his companions, perhaps it is because he hears a different drummer. A different drummer. And now, coming to you from dead center on your dial, welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor. Broadcasting to you now from the comfort of his easy chair, here is your host, Frank Vasquez.

Mostly Uncle Frank [0:38]

Thank you, Mary, and welcome to episode 19 of Risk Parity Radio. On today's episode, we are going to begin our discussion of REITs. And this will be a two-part discussion, analyzing REITs and whether they will be appropriate for your risk parity style portfolio. And to do that, we are going to use the 10 questions to master successful investing from David Stein's Money for the Rest of Us, which we will link to in the show notes. We will be doing the first five questions today and the next five questions next week. First question. Question one is what is it? What is a REIT? Well REIT is spelled R-E-I-T and it stands for Real Estate Investment Trust. Now according to a basic definition, a real estate investment trust is a company that owns, operates, or finances income generating real estate. REITs are modeled after mutual funds, and they pool the capital of numerous investors. This makes it possible for individual investors to earn dividends from real estate investments without having to buy, manage, or finance any properties themselves. So what a REIT is, is a specific kind of company that is designed to hold real estate investments. Now, REITs have been around since 1960, and they came into being as an amendment to the Cigar Excise Tax Extension. Now, I do not know what that is, but I do know that REITs have become more popular in the past 30 or 40 years and now are a standard and accepted part of the overall stock market. The kinds of REITs we are going to discuss in these episodes are publicly traded REITs, and I should distinguish those from private REITs. Public REITs are traded on the stock exchanges, and they are also bundled and contained in mutual funds and exchange traded funds, so you can buy them that way as well. Now what qualifies an entity to be a REIT. To qualify as a REIT, a company must comply with certain provisions of the Internal Revenue Code. These requirements include to primarily own income-generating real estate for the long term and distribute income to shareholders. Specifically, a company must meet these requirements to qualify as a REIT. It must invest at least 75% of its total assets in real estate cash or U.S. Treasuries. It must derive at least 75% of its gross income from rents, interest on mortgages that finance real property or real estate sales. It must distribute 90% of its income annually to its shareholders and it must have no more than 50% of its shares held by five or fewer individuals. Now currently there are about $2 trillion worth of publicly traded REITs in the United States. There is another $1 trillion worth of private REITs, which can only be accessed by accredited and institutional investors. But focusing on those public REITs, the $2 trillion that are in the US are out of about $5 trillion worldwide, about 40 different countries will allow the formation of a REIT that can be traded. And so the US market is about 40% of the world market. Now, $2 trillion sounds like a lot of money, but that is actually only a very small portion of the total US stock market. It's only 2 or 3%, really. I should say 3 or 4%. If you compare the entire market of REITs to a couple of the largest big tech companies like Microsoft or Amazon, Microsoft or Amazon together have a capitalization that is larger than the entire REIT sector. Now, the REIT sector is comprised of about 225 different individual REITs. in the US. And those are categorized in 12 different categories and then a catch-all category. And we'll just go through each one of those so you can get a feel for what is actually in these businesses because a lot of them are not actually traditional real estate businesses where we think of renting a building to some people that are going to occupy it. Some of them are that way and some of them are not and we'll go through each one of them. So now the first category is office REITs and these are REITs that own and manage office real estate and rent space to prospective tenants. These properties can be skyscrapers, office parks and similar things like that. A couple of examples of office REITs are BXP, Boston Properties or NYC which is a New York realty company. As you can imagine, these have not done very well during the COVID pandemic, but they are a standard kind of stalwart of the REIT world. The next category is industrial REITs. Now, industrial REITs own and manage industrial facilities and rent space in those properties to tenants. Some of them focus on warehouses, some of them focus on distribution centers. they have become very important in the e-commerce world. And so one of the largest REITs overall is a recalled Prologis, which rents warehouse space, and the ticker symbol for that is PLD. The next category of REITs is the retail REITs. Now these include companies that run Shopping malls, for example, but they also include companies that rent smaller retail space to entities like 7-Eleven's and Walgreens and those sorts of retail entities. And a couple of examples of those are SPG Simon Property Group is one of the largest REITs and it mainly owns and rents out shopping malls. And then one of the most popular REITs is ticker symbol O, and that is Realty Income, Inc. And it does rent a lot of space to individual stores like 7-Eleven's and pharmacies. Now the next category is lodging or hotel REITs. There are not as many of these and they are not as large. One example of that would be MGM Growth Properties, MGP. but they rent property to hotels and the like. The next category is residential REITs and as you can imagine that is a traditional real estate business where you are renting apartment buildings, student houses, manufactured homes, and also single family homes or developments. A large REIT in this sector is Avalon Bay Properties, which is ticker symbol AVB. And now we're getting to some more specialized REITs that you wouldn't think of when you think of real estate. And one of those is Timberland REITs, those that invest in forests for the purpose of harvesting trees. The largest REIT in that sector is Weyerhaeuser, WY, and it owns lots of property where it grows trees. which are harvested and then used for lumber. Another specialized area for REITs is healthcare REITs. Now, healthcare REITs own and manage a variety of healthcare facilities, including hospitals and nursing homes and medical office buildings. A couple examples of those type of REITs are Ventas, VTR, and Welltower, WHT. E L L and both of those own those types of buildings and rent them. The next type of REIT is self-storage REITs. Now, this has become much more popular and has been a growing area over the past couple of decades. The largest REIT in this area is public storage, and you probably have driven by public storages where individuals can rent little garage or smaller spaces to just store their stuff in. And so public storage has the ticker symbol of PSA. Now the area with the largest REITs in the world is actually an infrastructure, which is not renting to people or humans for human occupation. What these REITs cover are largely things like cell towers and some of them cover energy storage facilities or pipelines and other telecommunications. And so two of the largest REITs in the world are American Tower ticker symbol AMT and Crown Castle ticker symbol CCI. Now if you look inside of a REIT fund like VNQ, which is the Vanguard REIT fund, you will see that the largest holdings in that REIT fund are actually in these infrastructure REITs. They are not in residential REITs like you might think of when you are thinking about real estate. And these have been some of the fastest growing REITs with the internet. Another fast growing area that does not have to do with human occupation is the next category of REITs, which is the data center REITs. Now these data center REITs of managed facilities that house computers that safely store electronic data. Data center REITs offer a range of products and services to keep servers and data safe, including providing power, air-cooled chillers, and physical security. Two examples of these are Digital Realty Trust, which is ticker symbol DLR, and Equinix, which is ticker symbol EQIX. And again, these REITs have grown considerably in the past couple of decades due to the internet. Now, there also are some REITs that are just called diversified REITs. And these type of REITs are companies that both own and manage real estate and loan money for real estate. So they cover several of these different sectors, typically involving office buildings, warehouses, and sometimes residential, a couple of Examples of that are the WP Carey Company, which is ticker symbol WPC and Vornado, which is ticker symbol VNO. And if you're in a large city, you may have seen properties managed by either one or both of those companies. Now the last category before the catch all is mortgage REITs. And mortgage REITs invest in mortgages, so money lent to to others to buy property and maintain property. These are not as popular as they used to be. They are more akin to financial companies than they are to real estate companies. And an example of one of these would be Starwood Properties ticker symbol STWD. Okay, now let's get to this catch all category because it has some very interesting businesses in it. And these are the, what are known as the specialty REITs. they just put them in a separate category. Now these can cover everything from casino properties to land to raw physical storage to billboard advertising. And I'll give you some tickers for those kinds of companies. So there is a company called Gaming and Leisure ticker symbol GLPI which invests in casino properties. There is a company called Gladstone Land Corporation, ticker symbol L-A-N-D, which invests in raw land. There is a company called Iron Mountain, ticker symbol IRM, that invests in places to store physical paper, like in salt mines and other very secure remote places. It also does some digital, but It is known mostly for that hard storage. And then the billboard company I was mentioning is called Lamar Advertising, Ticker Symbol LAMR, and they rent and operate billboard space all across the country. So as you can see from these descriptions, REITs cover a wide variety of types of businesses. And so it's best to think of these publicly traded REITs as income generating businesses because they are, while they're all related to real estate, that is not necessarily how they get their main income as you might if you actually owned property and were renting it out. Now let's move to question two, which is, is it an investment, a speculation, or a gamble? and this is an easy answer for this one. REITs are investments because they are businesses that generate income and 90% of that income is paid out to its shareholders. And so if you buy a REIT, you can expect to get an income from it. REITs are very well known as good income generators and REITs may pay anywhere from 1% from those fast growing internet related data storage rates to 9 or 10% for the more speculative and smaller rates, particularly if they involve some leverage. Most of the rates are somewhere in between these days in the 4 to 6% range for annual income. All right, question three. What is the upside for REITs? Well, the upside is you are going to get a steady income. Most of the REITs pay quarterly. Some of them actually pay monthly. And that would include that ticker symbol O, Realty Income, Inc., which is a very popular REIT for people who are just looking for a REIT to generate some income. Now REITs also have a capital appreciation or depreciation component and they can be fairly volatile in that respect. Their prices go up and down. So during this last crisis we saw a number of REITs go down considerably. Now as you can imagine a lot of those REITs have recovered and some of them haven't. so the REITs that are investing in malls have not recovered very well or very much in terms of their price. They do have a very high income right now because the price has been depressed. Other REITs have recovered fully or gone on such as the Digital Realty Trust DLR REIT is flying high along with many of the other internet companies that have done well during COVID But that is something to be mindful of that REITs are stocks in a way and they can be just as volatile or more volatile than other stocks in the stock market. Historically over long periods of time REITs have performed just as well or better than the stock market if you include all the dividends and you would have reinvested them. Now question four：what is the downside to REITs? Well, there are a couple of downsides to REITs. They are concentrated in whatever area they're in. So a REIT that owns shopping malls, if the world is bad for shopping malls, it's going to affect all their properties. On the other hand, they are diversified generally over many, many properties all over the country. individual areas, suffering usually doesn't affect them too much on the downside. The other downside to REITs is typically on the tax side of things. REITs do not typically generate what are known as qualified dividends or capital appreciation, although they can. And so their taxation is at ordinary income. as if it was just another part of your income for that year. There is, however, a little bit of a clawback on that. These days, most REIT income qualifies for what is known as Section 199A as a qualified business investment under the new tax law that came into being in 2017. and the upshot of that is that the taxes on the REIT income have been reduced by about 20% in most circumstances. This will vary actually depending on your other income and it's a little bit of a complicated calculation, but there is a form for it and you are getting a benefit from REIT income as opposed to wages and other income that you might get. So it's not as bad as it used to be in terms of taxation, although it's not as good as, say, a qualified dividend from another company. The income from REITs is fairly steady as income from the largest REITs, or if you buy the REITs in a fund like VNQ, then you're getting all of the REITs together. And so it can be a useful source of income for somebody who is drawing down their portfolio. Therefore, taking this income they don't have to sell to generate that income out of these REITs. And that is often a convenient and useful feature to have for somebody who is living off their portfolio. Now we get to question five, which is the last question we'll do today. And that question is who is on the other side of the trade? Now for well-established public REITs, They are traded on the stock markets. They're usually fairly liquid, and so you are just trading with other people that want to own REITs, which include individuals, which include a lot of institutions that like to have that income as part of their portfolio. And so it is really not too much different than any other stock you might buy or fund you might buy. on the stock exchanges. Now the answer to that question is going to be different if you are investing in private REITs. In private REITs you are going to be dealing with some kind of manager or promoter and that could be structured as some kind of partnership. That is beyond the scope of this presentation, but just be aware that investing in a private REIT is a different kettle of fish from the public REITs because you can't necessarily sell them or get out of them when you want to. The private REITs are not liquid. Public REITs are very liquid. And with that, I see our signal is beginning to fade, so it is time for me to say goodbye. If you'd like to reach me, have any questions, please send them to frank@riskparadioradio.com that's frank@riskparadioradio.com or you can fill out the little contact form on the website, which is at www.riskparadioradio.com. Now our next episode will be this Sunday and it'll be our weekly portfolio review of the six sample portfolios that you will find at the website on the portfolios page. We will be reviewing all six of those and then talking about the drawdowns that we're taking out after today for the month of October and how those are going to be pulled from each of the various portfolios. We will be continuing with our discussion of REITs, publicly traded REITs, as an investment in our episode that will be coming out next Wednesday or Thursday. And in that episode, we will be going through questions six through ten of the ten questions for analyzing an investment and seeing how REITs may fit into our risk parity style portfolios. Thank you for tuning in. This is Frank Vasquez with Risk Parity Radio signing off. The Risk Parity Radio Show is hosted by Frank Vasquez.

Mostly Mary [23:01]

The content provided is for entertainment and informational purposes only and does not constitute financial, investment, tax, or legal advice. Please consult with your own advisors before taking any actions based on any information you have heard here, making sure to take into account your own personal circumstances.