But it is not big enough to typically change your life.
It certainly isn’t enough to retire these days.
But I am going to make the case that putting $100,000 into real estate investment trusts, or REITs (VNQ), today could be a life-changing investment for long-term-oriented investors. Their valuations are at their lowest in 10 years right now, and I expect their returns over the next decade to be exceptional.
But let’s back up a bit and first review their historical results.
Historically, REITs have been some of the most rewarding investments in the entire capital market, outperforming even the S&P 500 (SP500) and Growth stocks (SPYG).
On average, they earned 15% average annual total returns for the past 20-year period ending with the crash of the pandemic:
But why were REITs even so rewarding?
REITs often get mischaracterized as boring retirement stocks and so investors are always surprised to hear about their past performance.
But in reality, REITs are total return vehicles and they were so rewarding because they enjoyed three return components:
For one, they earn significant cash flow from their properties. Investors often look at the relatively low dividend yields and get misled into thinking that REITs aren’t yielding much, but that’s because they retain a lot of cash flow for growth. As such, the dividend yield maybe 5%, but the REIT could be earning an 8% cash flow yield from its properties.
For two, the cash flows of these properties grew significantly and this also led to some asset price appreciation. If the same property NOI of a property rises by 4% annually and you are earning an 8% cash flow yield, that gets you to 12% average annual total returns.
And finally, some REITs also still benefited from external growth as they raised more capital and reinvested it at a positive spread. Realty Income (O) is a master of that:
And some other REITs also enjoyed some multiple expansion as they gradually improved the quality of their portfolio and/or balance sheets, and that’s how they generated these exceptional returns.
I would add that these were just the average returns of the sector.
It includes the good, the average, and the bad REITs.
This means that if you were able to sort out the good from the bad, you could have materially improved your results, and it does not have to be very complicated. By simply skipping struggling property sectors like offices and avoiding externally managed REITs that suffer significant conflicts of interest, you would have already gotten ahead of the averages.
Just to prove this point, consider that self-storage REITs as a group earned 18.8% average annual total returns over the past 28 years:
National Storage Affiliates
This means that $100,000 invested 28 years ago would have turned into $12,441,144.61.
That’s life-changing money.
But now let’s take this a step further.
REITs have historically been particularly rewarding in the periods following market crashes when they were heavily discounted relative to their net asset values.
A study from the investment firm Janus & Henderson found that REITs have historically earned a 130.6% total return in the 3-year period after they had been priced at a 24% discount:
Today, they are priced at closer to a 30% discount by our estimate, which means that all else held equal, the future returns should be even greater than that.
This may seem unlikely to some of you, but consider that REITs were actually far more rewarding following the two last crashes.
Following the crash of the great financial crisis, REITs nearly tripled investors’ money in the following two years:
And following the pandemic crash of 2020, REITs more than doubled investors’ money in just over one year:
Today, REIT valuations are back to the 2020 crash levels.
Share prices have crashed by 36% even as their cash flows grew by 5-10%:
Data by YCharts
Moreover, their performance leading up to their recent peak had been below average, and their valuations were in line with historic averages when adjusting for their now lower leverage and exposure to faster-growing property sectors. Therefore, this wasn’t just a reversion to the mean or the correction of bubbly valuations.
REIT balance sheets were actually the strongest they have ever been leading up to this recent crash. Leverage is low, maturities are long, and the high inflation led to rapidly growing rents, cash flows, and dividend payments.
So REITs did not crash because of poor fundamentals.
I think that they crashed simply because investors could suddenly earn a decent yield from fixed income, and that caused a major capital to shift from REITs to fixed income, irrespective of their strong fundamentals.
The proof of this is that allocations to REITs are today at their lowest level since the great financial crisis:
Bank of America
As a result, REIT valuations relative to regular stocks are today at their lowest level since the great financial crisis. All stocks are impacted by rising interest rates, but REITs suffered far more than the rest because income-oriented investors sold off in mass to reallocate to fixed income:
Principal Asset Management
I think that this is a historic opportunity because interest rates are likely headed back lower in the near term.
Inflation has now been brought back under control and as a result, UBS, Deutsche Bank, Morgan Stanley, and many others are now predicting significant rate cuts in 2024. So that ~5% that you think that you will earn from a money market fund may really just be an illusion. Bill Ackman just came out and said that he thinks rates will be cut already in Q1 of 2024.
I think that this will push a lot of that same capital that left REITs right back into them and this will then lead to an epic recovery.
Many REITs could easily surge by 50-100% as interest rates begin to trend lower, and that’s on top of the cash flow yield and the growth. Many high-quality REITs now offer 6-8% dividend yields and are set to grow their cash flow by 3-5% over the long run.
So if you now add all those things together, I think that there are lots of opportunities to earn 15-20% annual total returns in the REIT sector over the next 10 years.
6-8% dividend yield + 3-5% annual growth + 50% upside from multiple expansion over 10 years = 15-20% annual total returns
$100,000 compounded at 16% annually for 10 years would turn into $441,143.51 with zero additional contributions.
That’s life-changing money, and these assumptions are quite reasonable in my opinion. This is why I am pouring most of my savings into REIT at the moment.
Financial sites across internet will tell you how you can earn passive income, but let's be honest — a lot of what's touted as passive income isn't actually passive.Take real estate investing. Once you b.......