When I talk to people about owning REITs, I find that there are two types of people: those who ask me where Amazon closed today to change the subject, and those who get it and already own a bunch of REITs.
In most cases, most of the second class of folks are either related to me, or have been associated with me for years.
Warren Buffett once said that when it comes to value investing – you either get it, or you don’t.
When it comes to owning REITs at bargain prices, most people just plainly don’t get it at all.
Do yourself a favor- take a look at the Forbes 400 and look how many of these vast fortunes were generated by real estate projects of one sort of another.
Consider the richest guys in your town. Now ask yourself, “How many of them made their cash in the real estate game?”
Do as the Millionaires Do
Most of your run-of-the-mill millionaires got there because of real estate, running a successful business, or some combination of the two.
There’s a group called TIGER 21 that is made up of about 700 people with at least $10 million in investable assets.
They share their asset allocations with the world-at-large every three months and take a guess which asset classes are the most heavily owned by these well to do guys and gals…
It’s real estate followed closely by private equity- a subject I’ve talked about before and I promise you we will do so again, soon.
Real estate builds fortunes, plain and simple. What REITs do is allow you to own real estate and also have it managed by professionals.
If they screw up, you can fire them in seconds and move on to the next opportunity.
If the markets get frothy, you don’t need to hire a broker or begin a lengthy sales process. All you have to do is click a button and get your cash quickly.
The Secret to Getting Ahead with REITs
There are two key factors that you need to focus on to make money in REITs and real estate value.
The first is Free Cash Flow (FCF).
To figure that out, start by figuring how much money is left after you collect the rents, pay the bills, and salaries of your staff. Next, subtract maintenance costs, the mortgages, interest on any other debt. Now, pay your taxes.
What’s leftover- that’s free cash flow.
If our project or REIT does not produce free cash flow- and there is not a concrete plan to do so soon- then this may not be a great purchase.
I like to see free cash flow and lots of it. You should, too.
The next is the Net Asset Value (NAV).
Figuring this out is also straight-forward.
Based on rents, locations, occupancy levels, balance sheet quality, and – yes – the amount of aforementioned free cash flow produced by the property… how much is the property worth?
Now how much is left after I pay off any debt associated with the properties?
That amount is the net asset value.
Armed with these two numbers, you then need to ask yourself, “Can I buy this collection of real estate for less than the asset value, right now?”
Buying good properties at great prices relative to their asset value are how you get rich in real estate, or make a fortune in REITs.
Building the Foundation
When I started in this game, our focus was almost entirely on asset values.
It was too easy just to sell them when they traded back above asset value because they usually did before too much time passed.
If for some reason value wasn’t restored back in the dark ages, many REITs would go into liquidation mode. They would sell the properties at fair value (or better) and return the cash to shareholders.
Those unfortunate circumstances were usually something on the order of wildly profitable.
As the industry continued to mature, free cash flows became as important as asset values, and I had to develop new ways of combining the two.
Fortunately for us, we’ve found several methods of doing just that, and these types of strategies can help you earn the kind of returns most mutual fund and hedge fund managers don’t even dare dream about making.
Today we’ll focus initially on net asset value.
We only want to look at REITs that we can buy below asset value. Then, once we have that list together, we will narrow it down to just the 10 with the lowest price to free cash flow multiple.
The result is a concentrated portfolio of REITs that we can buy below the property value with high free cash flow yields.
When I run that screen today out, ten stocks can be purchased for just 75% of the net asset value of the properties they own.
The price to free cash ratio is only eight on average, so our new real estate empire is throwing off free cash flow yields of 12.5% right now.
Even though we didn’t use it as a requirement to pick the REITs for our new empire, we will also be collecting an average dividend yield of about 7.75% at current prices. That will help keep us company on those balmy Florida nights as we enjoy some bourbon and let our empire grow.
Once our portfolio is in place, we will check it monthly.
If there any REITs we can sell above asset value, we will do so.
If one of our REITs has seen free cash flow decline and falls out of the top ten, we will fire them and hire the next REIT in line to replace them.
There won’t be a lot of turnover, usually just one or two a month, but there will be some along the way.
Over the last decade, this approach has returned just a bit over 21% annually.
That $44,000 we invested in the previous article (I’ll stick with that number to make an easier comparison for us) is now worth $300,951.
That’s $162,000 more than an index fund investor in what has been an above-average decade for US stock prices!
Not too bad.
I will mention that Colony Capital Inc. (NYSE:CLNY), a long-time Max Wealth favorite is on the list of bargain-priced REITs.
Colony just announced a transformative transaction when they bought out the digital real estate company they’d been partnering with on several deals.
They will be selling some assets out of their portfolio and investing in projects that involve cell towers, data centers, small cell networks and other real estate projects that should get a massive boost from the global rollout of 5G over the next few years.
Shares of Colony are up 20% so far this year, and I expect much more substantial gains over the next year as they transform the business to be a 5G-fueled powerhouse in the digital realty space.
Along the way, we’ll be collecting a 7.7% dividend so we will be well-paid to wait for great things to happen!
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I’ll return on Thursday with some more ideas to help put you on the path to building your real estate empire using Real Estate Investment Trusts.
To the Max,