Brad Thomas (03:29):

So what this means essentially is REITs have been around a long time. This is not a nude sector not like the NFT space, which a lot of people are learning more about or crypto. This is an asset class that has been around many decades, five or six decades now, and has survived multiple recessions and done quite well. Also now, we can say REITs have survived a global pandemic and gone through that, not unscathed, but certainly, there’s been some opportunities to invest in this space.

Brad Thomas (03:57):

So it’s much larger today than it was obviously back 60 years ago, even back in the ’80s and ’90s. There are a number of new categories of property sectors, I should say, that have given investors access to categories like cannabis, categories like data centers and cell towers, and we can talk about any of these on this program, but it’s a 1.7, almost $2 trillion space, and there’s 217 different REITs. These are in the US, both on the equity side as well as the mortgage REIT side of the business. So very broad coverage across a number of different property categories. There are 28 REITs that are part of the S&P 500. That’s also meaningful.

Brad Thomas (04:38):

The last thing I’ll say is it used to be considered this little alternative space that was covered under the financials in the JICS, but today, real estate has its own category. So it’s really opened up a lot of doors for financial planners and investors, registered investment advisors to get into the space and own shares and REITs. It’s a very predictable income stream, and that’s one of the primary attractions, of course, to REITs is because you get very predictable income, but also higher yielding income than you get with some of the other stocks.

Robert Leonard (05:09):

You mentioned it, REITs as a whole have performed quite well over the past two years or so with the Vanguards REIT ETF, which is ticker VNQ. It’s up over say 90% or so in that time period. Why do you think REITs have performed so well in the face of a pandemic?

Brad Thomas (05:27):

What’s interesting, I can remember March of 2020, I was driving around and not going to the office. Nobody really knew, and none of us had gone through a pandemic before. I would drive through past … I was a developer for about 25 years before I became a real estate writer or analyst, and I was driving by a shopping center that I had built about 25 years ago. This is in March and April, and there weren’t many people in the parking lot, but we saw the share price. I’d go home and I’d see the share prices of these REITs that are just getting punished.

Brad Thomas (05:59):

I thought, “Wait a minute. This is not logical to me.” You can buy shares in a shopping center REIT or a mall REIT or an office REIT, frankly any REIT because all REITs were being sold off in March and April of 2020, and I thought to myself, “That shopping center is worth the same today than it was a month ago before the pandemic, and it was not rational.” I thought, “Wait a minute. This is going to come back. Logically, these shopping centers or the markets giving them a 50% discount, they’re going to come back.”

Brad Thomas (06:30):

We felt like it was almost like the quintessential kid in the candy shop. We started to buy and buy and buy and looking at a lot of the different property sectors that were really sold off hard, and they came back really strong. So look, people have gotten out now, and even today, I’m working on an article in the hotel sector and we think that’s going to be a really good attractive category for us now because people are getting back. I mean, we’re seeing that recovery right before our eyes. People are getting into cars. They’re going onto airplanes.

Brad Thomas (07:02):

Now, certainly, gas is more expensive today, but this is not this end of the world scenario. I do think a lot of it just has to do with we’re getting back to our normal routines. We like to focus on a lot of the necessity type of business models like grocery stores will be a great example in retail. I mean, you’ve got to go to that grocery store, and that’s a day-to-day function almost for everyone. You have to go to the doctor. So we like the medical office building space. Unfortunately, everyone goes to the hospital from time to time or have their relatives go, and hospitals are critical part of that healthcare infrastructure.

Brad Thomas (07:41):

I think it really comes down to the fact that real estate is a necessity product. I mean, if you think about it, real estate does holds together. A lot of our businesses across the country rely on real estate in some form of fashion. It may be a manufacturing facility. It may be a storefront brick and mortar facility. It may be a critical office facility. It may be the cell towers. It may be the data centers. Even this call we’re on right now relies on the real estate, i.e., the data centers that take all of our communications into the cloud, into a data center to be distributed to that end user.

Brad Thomas (08:18):

So real estate is such a critical, critical part of the investing process. Owning REITs gives the individual investor access to all of these property categories that frankly just did not exist about 10 years ago.

Robert Leonard (08:33):

Everything you just mentioned is exactly why everybody listening to the show loves real estate, people that listen to the show, all the audience, and myself. That’s why we invest in real estate, but why would someone consider REITs specifically instead of buying the physical real estate deals themselves?

Brad Thomas (08:51):

I’ve got really three answers. Really, this goes back to why I’m sitting in this chair today. Again, I was a real estate developer for over 20 years, and I learned a lot about the private side of the business, and there’s some good, and there’s some bad. I’m going to tell you that, I guess, some of the good things may be bad and some of the bad things may be good. It depends on this individual investors, but for most investors, there’s three things, three attributes that I like to talk about that really differentiate the listed REITs from private real estate.

Brad Thomas (09:21):

First and foremost, I will say is the transparency. REITs, because they’re publicly traded, they have to provide quarterly reports and annual reports and communications to investors. It’s a requirement under the SEC. So to be a public company, you have a lot more transparency than you’ll see with regards to private real estate. That’s number one.

Brad Thomas (09:45):

Number two, you have diversification. I used to own some duplexes, and I own some other real estate, but I was not very well-diversified. I didn’t have of hundreds of properties, if not thousands of properties to diversify, not only from geographic diversification, but also from a customer or a rent check diversification. So with REITs, most of these portfolios are very well-diversified so that if you’re investing in those companies, you have very broad diversification. So if one customer or one tenant were to get into trouble, the business is going to keep running and hopefully producing the same earning stream that it was before it got into trouble.

Brad Thomas (10:24):

Let me give you one classic case of this would be Realty Income, ticker symbol O. I do own the stock. It’s one of my largest holdings. Realty Income owns thousands of properties now. They just completed a merger recently with another company called VEREIT, and they’ve got over 10,000 rent checks now in the US, all 50 states, as well as Europe, but one of their top customers in the top 10 list was AMC Hotels.

Brad Thomas (10:49):

Well, you can imagine what happened in 2020 with AMC. You went to the movie, you didn’t go to the movie because of COVID. So that meant that Realty Income, some of their rent checks were not getting paid on time from AMC, but because Realty Income was so incredibly diversified, they were able to continue to not only maintain their earning stream, but also continue to grow it, one of the few net lease REITs that was able to grow that earning stream in 2020. So that diversification is very, very powerful.

Brad Thomas (11:23):

The third attribute that I want to tell you about, which I think arguably is the most important, is the liquidity because unlike private real estate, again, I did this for over two decades, unlike private real estate where if you have to monetize your property, you have to go hire a broker, you have to find a buyer and seller that connect on price and terms, and then a bank usually is required. Then if all of that comes together, you create liquidity. It may take three months. It may take six months, but there’s not instant liquidity.

Brad Thomas (11:59):

We found that out, I found that out the hard way in 2008-2009. There was very little liquidity in the marketplace, thanks to the banks that were failing in that time period, but today with publicly traded REITs, you have full liquidity. You can buy and sell anytime you want. I’m sitting at my computer, you’re sitting at your computer. You know what happens? You can sell your stock by clicking a button and get your cash.

Brad Thomas (12:23):

So liquidity’s very important, especially for retirees because you always need access to cash. I mean, I’ve got five children. I’ve got four of them have had braces. We’ve got cars, we’ve got clothes. There’s always a need for cash and liquidity. So I think owning shares in a REIT is probably one of the primary attributes because of that liquidity. So again, I’ll summarize, again, transparency, diversification, and liquidity. Those are the primary elements or reasons to invest in publicly traded REITs.

Robert Leonard (12:55):

I think most people will agree that transparency is good pretty much no matter what you’re investing in, but it’s interesting the last two that some people, I think there’s no really right or wrong. I think some people will use diversification and liquidity as a pro for REITs, and some will use them as a pro for actual physical real estate.

Robert Leonard (13:11):

So like Warren Buffett says, “Diversification is for people who don’t know what they’re doing,” right? So some people will use that as an argument, and then liquidity on the liquidity front, I’ve heard people argue that physical real estate, actually, illiquidity of it is actually a pro because people will day trade or they’ll hear a little bad news on their REIT that they’re owning and they’ll go into their portfolio and sell it. Whereas they can’t do that with physical real estate, and they can’t watch the price go every single day. So that illiquidity is actually a pro for that.

Robert Leonard (13:41):

So it’s interesting to hear how the pros and cons of each is really how you want to spin it and what really … I think it just comes back to what speaks to the investor himself, what fits them best.

Brad Thomas (13:51):

Exactly, and there’s not an answer. You said every investor is going to have his or own risk tolerance. I think it’s important to have even a well-balanced portfolio, both private and public real estate, and really that trade off comes down to this. It’s either the liquidity or the volatility. So some investors don’t like that volatility. They’d much prefer just to collect those checks and not worry about what Mr. Market is going to say every day when he gets up in the morning and values the share of the stock.

Brad Thomas (14:17):

So I think having that trade off is important. I mean, again, I was in the private side for a long time and certainly, you don’t experience that volatility in the stock market that you do, but again, going back to REITs, REITs have been around such a long time, unlike crypto and NFT, and I don’t want to pick on those categories. My son is really a big, big crypto and NFT player at all. So I’ve learned a lot from him, but realistically, REITs have been around a long, long, long time.

Brad Thomas (14:43):

So they’re very proven. They’ve managed through multiple cycles. We’ve gotten through that volatility. Now, the pandemics, again, we can prove that out again and go back and rely on that history to see how REITs have performed, and they’ve really bounced back. They were one of the top, if not the top performing sector last year in 2021, year of the recovery, and things are going very smoothly this year. Now, we had a little bit of sell off in certain property sectors, primarily due to this other big risk in the room called rising rates.

Robert Leonard (15:12):

For me, personally, I own physical real estate and I have a stock portfolio. So when I think about the money that I’m allocating towards the stock market, I typically, personally, tend to stay a little bit away from REIT not because I don’t like them. I actually like them a lot, and I find myself going back and forth as to whether I should invest in them because I think I have a little bit of a competitive advantage because I am a real estate investor myself. So I think I know it a little bit better maybe than some investors who don’t own physical real estate, but then from a portfolio allocation and diversification perspective, I’m like, “Okay. Well, I already own physical real estate. I don’t know if I want to allocate my stock market dollars to real estate as well. Then I’m over diversified or oversaturated in real estate.” Do you see it that way or are REITs and physical real estate different? Is it different from a diversification perspective?

Brad Thomas (16:01):

Yeah, it is. I use this term. I don’t know. I may have created it, I may not have created it. I use it a lot, but I call it the 3T. So you, as a property owner, you probably have a management company that oversees real estate, but it’s management intensive. Even if you have a property manager involved, you have to communicate with that property manager. You have to communicate with your bookkeeper, make sure rents are getting paid. When the tenants move out, you have to deal with that releasing that property. Is there some capex required to release the property? Did they leave it damaged?

Brad Thomas (16:33):

There’s all these factors. I mean, real estate is an operating business model, and if you’re not in that business, it can be very challenging, and a lot of your profits can be really squeezed through some of those costs that I’ve outlined. Again, I call it the 3Ts. Avoid the 3Ts, the taxes, the trashes, and the toilets.

Brad Thomas (16:55):

Now, I had a lot of duplexes, had a lot of rental properties. They’re a lot more management intensive. They’re shorter term leases, and you have these tenants who come and go, but really in every property sector, you’re going to have some level of management.

Brad Thomas (17:08):

Now, one of the other attributes that I failed to mention in the public REIT side that is extremely important is management because one of the things I’ve learned over the last say decades since I’ve been doing this is that a number of these REIT management teams, in fact, most arguably are very qualified. They’re professional management teams. They get paid a lot of money, but they do this to manage these properties because they are experts at whatever they’re doing, whether it’s medical office buildings or cannabis or whatever that category is.

Brad Thomas (17:40):

So you’re paying as an investor, shareholder, stockholder, you’re paying essentially. When you buy a share, you’re actually paying the salary. You’ve got to think of it like this. You’re actually paying the salary of that management team who’s running that real estate for you.

Brad Thomas (17:56):

So as a private owner, you’re having to pay somebody or you’re doing it yourself, but it’s very time consuming and can eat up a lot of time, and most importantly, I’ve shown all the math and done all the analysis, REITs have outperformed private real estate over time, I mean, not every single year, but you can see, especially when you compare private equity and companies that are very large private real estate owners, REITs have outperformed those companies.

Brad Thomas (18:25):

Even in the public arena, REITs have outperformed traditional stocks, C corps, BDCs, MLPs, take your pick, and why is that? So that’s the big why in the room and always I get that question. How come REITs are so great? Well, not every year REITs are going to perform well. So far this year, REITs have not outperformed. They did last year.

Brad Thomas (18:45):

The really secret behind this business has to do with that law that I referenced earlier that was created 1960. It was actually part of the Cigar Act, and don’t ask me why it was included in the Cigar Act, it was, but that law basically is this, that REITs must pay out at least 90% of their taxable income in the form of dividend.

Brad Thomas (19:10):

Now, that’s very similar to the MLP structure or the BDC structure. It’s that forced requirement. They have to do that. By the way, this is not a loophole. I get this a lot, that REITs are loopholes, that these companies convert to REITs because they don’t have to pay taxes. That’s not true because you know who pays the taxes? The person who gets the income. It’s the dividend income. It’s reported, and the IRS is going to get their cut of that tax. So I want to debunk that myth that REITs are a loophole for taxes, but 90% of taxable income is paid out in form of dividends. Most REITs pay out 100% of taxable income.

Brad Thomas (19:47):

That is why these yields are so high, but more importantly, it’s not the higher yielding dividends that I’m concerned about. It’s the sustainability of these dividends. So essentially, these rent checks, whether it be multifamily rent checks, net lease property rent checks, shopping center rent checks, whatever the rent checks are, even lodging rent checks, those rent checks are very predictable in certain sectors.

Brad Thomas (20:09):

Now, lodging is probably another category we can talk about. It’s not as predictable and they haven’t done well in recessions at all for obvious reasons, but for the large part, most of the equity REITs that we cover and, again, there’s quite a few of them now. We have very predictable income and that creates very predictable earnings growth and, of course, very predictable dividends growth.

Brad Thomas (20:28):

So if you look at this, here’s the simple math of the matter. The average dividend yield today is something in the range of just call it 4% and maybe 3.5% to 4%. I don’t know exactly today the average dividend yield. Then the average growth is something say over the last four to five years, something like 4% to 5% growth. So when you can invest in a company and a REIT that has say a 4% dividend and say 5% or 6% growth, that’s going to get you a total return package of about 10%.

Brad Thomas (21:00):

If you look back over time, and I’ve wrote about this in my book over the history of REITs, REITs have outperformed because they have generated annual returns in the range of about 11% to 12% per year going back say 40 years, and it’s that predictability, and it’s because of that dividend income, that very predictable dividend income that REITs have performed well. Again, now we’ve gone through some time-tested, some really battle-tested events like a great recession, like a pandemic and seen how REITs have continued to perform.

Brad Thomas (21:29):

The last thing I want to throw in here is this. REITs own about 10% of all institutionally owned commercial real estate in the US. Now, what does that mean? That means it’s a very fragmented marketplace. There’s a lot of buildings that you drive around every day. When you drive home to the grocery store or driving to wherever your location is in your town, you’re going to see a lot of real estate and just think about it like this, that about 90% of those buildings you see, warehouses, shopping centers, 90% of those are not owned by REITs.

Brad Thomas (22:00):

Now, that means that REITs have a huge opportunity to continue to scale and grow. There’s a significant pipeline of properties that can be consolidated and become owned by publicly traded REITs, and that’s what we’re seeing continue. What’s driving this business model, there are really two things. A REIT’s success depends on its cost of capital advantage and its scale advantage.

Brad Thomas (22:22):

So the company, the top players that we see like Realty Income are like Ventas or like Simon Properties or Avalon Bay. They’re all the dominant players in their categories. The reason they’re able to do that and generate quality returns for investors is because they recognize that to scale their businesses, they have to have that cost of capital advantage. They’ve got to be able to transact and utilize their capital, both debt and equity, at some of the lowest costs to achieve superior shareholder returns.

Brad Thomas (22:54):

So that’s really what’s driving this industry is that fragmentation, and now we’re seeing a number of REITs expand outside of the US once again to scale their businesses, lower that cost of capital because companies, again, like Realty Income can borrow cheaper in Europe than they can in the US. That gives them even a better cost of capital advantage, gives them a better diversification and scale advantage. That’s really the sum of the parts.

Robert Leonard (23:20):

When I talk to some relatively new investors, I hear sometimes that they are chasing not REITs, but other just normal stocks that have really high dividend yields because they want the cash flow, and what they don’t realize is that that’s unsustainable, that if it’s significantly above say the average for that industry, then there’s probably something going on there. There’s something underlying, and they don’t necessarily realize that.

Robert Leonard (23:44):

You gave us the averages, 3.5%, 4%, 5%, and are pretty good for a dividend yield. At what point do those dividend yields become worrisome? I want investors, who are listening to the show, to know when a dividend yield might be too high and too good to be true.

Brad Thomas (24:01):

I didn’t coin the word sucker yield, and actually, I think Josh Peters, who was at Morningstar did. I was a big fan of his writing when he was at Morningstar. I’m still a big fan, Josh, if you’re watching, but I think I first heard of the term sucker yield with Josh Peters, and then I thought, “Well, what is that?” Sucker yield is simply a yield that’s too good to be true.

Brad Thomas (24:19):

So we look very closely at these payout ratios of not only the REITs, but all the companies in our coverage spectrum to see if that payout ratio is elevated. Obviously, if the company is paying out more dividends than they are earnings, then they’re in trouble. That is not a good sign.

Brad Thomas (24:36):

Now, there are outliers and there are certainly quarters that may be different, unique. So we can’t say that just because companies move to elevate it to say 100% payout show in one quarter, that over time we really look very closely at the debt ratios, and more specifically at the balance sheets of those companies just to see what is that cost of capital, how are investors being rewarded. We don’t want to rob from Peter to pay Paul and borrow money from a credit line to pay a dividend.

Brad Thomas (25:02):

So we really look very closely and make sure there is an adequate margin of safety in that dividend that’s being paid out. Each property sector is going to be a little different in REITs because, for example, in the net lease REIT space, net lease, of course, these are the freestanding buildings like Walgreens and CVS, O’Reilly Auto Parts. Typically, those are longer term leases, 10 to 15 years in term. I used to build those in my past as developer. So I know the lease structure pretty well. They do have annual bumps, so they’re not bonds. They do have some growth built in organically, but those REITs can afford to pay out more dividends because they are longer term leases. You’re not going to see those operating costs because the tenant is paying for all of those 3Ts, the toilets, the trash, and the taxes, and everything, frankly. Insurance as well.

Brad Thomas (25:47):

Also, because they’re longer term leases, there’s not as much capex that goes into replacing the next tenant. A self-storage facility requires more capex or, really, office is a great, probably even a better example here, where an office customer moves out. They’re going to require more capital to replace them, take out the car, put in a new carpet, paint, higher leasing agent that pay a leasing fee to get the new tenant in. So there’s a lot more operational components that go into say an office building.

Brad Thomas (26:13):

So net lease, we’re comfortable with those companies paying out around 85% of their cashflow adjusted funds from operations in their dividend, which leads in about a 15% margin of safety, which we think is very adequate, but you’re right. When we get to these companies that are trending at a 90%, 95%, even a over 100% payout ratio, that is definitely, in Josh Peter’s words, a sucker yield, and we try to avoid those companies and really tell investors to avoid those companies.

Brad Thomas (26:40):

My goal is to help navigate away from some of these dangerous stocks. So I do spend a lot of time not only recommending stocks that we’d like to own, but we also recommend stocks that we advise people to avoid. Again, that payout ratio is really a good trigger, a good signal for us to determine the overall quality of that company.

Brad Thomas (26:59):

Now, dividend growth is another factor. Obviously, that’s highly correlated to the payout ratio, but we’d like to see companies just like Coca-Cola, FedEx, and all those traditional C corporations that you cover on your show, we’d like to see those REITs also growing those dividends because, again, Josh Peters also said, and I’m giving him another shout out, “The safest dividend is the one that’s just been paid.”

Brad Thomas (27:21):

So we look for these companies that are growing that dividend because that dividend is really meaningful to that investor. It signals that company is in sound footing and it’s rewarding that investor for that performance. So dividend growth is extremely, extremely important, but obviously, if the company has an elevated payout ratio, they can’t cover that dividend.

Brad Thomas (27:41):

So we like to see that balance. We want to see a low payout ratio. We want to see dividends growing, and that is only going to lead to superior total returns. We’ve seen this time and time and time play out. We cover a lot of these high yielding companies, some of these residential mortgage REITs that are yielding 11%, 12%, 13%. I just wrote a piece couple days ago on the residential mortgage REITs. They’re all in that 12% rage. That’s just not sustainable, especially in a rising rate environment where these residential mortgage REITs are getting squeezed and squeezed and squeezed. So we think we’ll see more dividend cuts in the residential mortgage REIT sector. That’s definitely a space we would avoid.

Brad Thomas (28:19):

I like BDCs. We cover BDCs. Same thing. We’ve got to look at those payout ratios, make sure they’re sustainable. We look at the revenue drivers of those BDCs, same thing for the MLPs as well. So it’s very important. Like you said, I mean, when you get close to that 10% number and we’ve got a couple right now, very few, there are a couple companies that we have recommendations on that are yielding in that 9% to 10% range. We’re watching them closely because we think there’s an elevated risk to investors when you get closer to that double digit coupon.

Robert Leonard (28:50):

That cashflow is one of the favorite things of real estate investors, whether it’s REITs or physical real estate. A lot of times people are looking for that cashflow, but when it comes to REITs, you don’t want to just totally disregard the valuation. You’re still buying a company. You still want to make sure you’re buying it at a good price. I know valuing a REIT is a little bit different than a normal stock. So talk to us about the differences between valuing a normal company stock like Apple versus a REIT, and what are the metrics that you’re looking at for a REIT when you’re doing your valuation?

Brad Thomas (29:20):

Sure. Well, there’s really three ways to value REITs, and the first one, of course, is probably the easiest for individual investors, and that is the dividend yield itself. We just talked about that. Again, we like to compare not only the dividend yield to the sector, but also to the broader universe.

Brad Thomas (29:38):

So say for example, American Tower, and American Tower is a lower yielding REIT, but their payout ratio is around 50%, and this American Tower is the largest cell tower landlord in the world. Their name is American Tower, a little misleading. They own a lot of cell towers in America, but they also own a lot of cell towers outside of America, but they have a lower payout ratio, lower yield. It’s probably in the low 2% range, I’m guessing, maybe sub two. I haven’t checked today, but a lower yield company, but, again, they have tremendous growth because they’re technology-based. Obviously, these technology companies like cell towers and data centers, even logistics, which is arguably part of that technical trifecta, we’ll call it, the dividend yield is one aspect of it.

Brad Thomas (30:24):

The next thing is the price to funds from operations. Now, remember in the REIT space, one of the earnings metrics we use is not traditional core earnings, which we would use if we had traditional stock, a C corporation. We use this funds from operations. Break that down, that is net income, plus we add back depreciation in amortization because it’s a real estate product. So we add back that depreciation, which you wouldn’t have if you just utilized traditional earnings, and then you subtract out the gains on the property. That leads you to a REIT metric, which is a gap metric called funds from operations.

Brad Thomas (31:02):

We also take that metric we call FFO, funds from operations. We can subtract out the straight line rents and recurring capex plus equity-based composition, and that gets us into really a more pure form of cashflow for a REIT, which is adjusted funds from operations, and that’s the metric we prefer to use, either the FFO metric or the AFFO metric.

Brad Thomas (31:27):

So I get this almost every day. I write on a company and they’ll say, “Hey, these shares are really expensive. The PE ratio is 57,” and I’m like, “No, no, no, no. You’re using earnings. You have to use FFO,” and when you use the FFO metric, that puts you into the real REIT terminology, the right earnings metrics, which frankly are the right valuation metric because you got to look at the right earnings metrics.

Brad Thomas (31:53):

The last one we use, and I don’t use this often, but it’s certainly more on the institutional side is net asset value, and that’s essentially almost like when you get an appraisal for your house, you look at comparables and you look at comparable cap rates. Net asset value is a little more subjective because this is where you go into a little more granular observation of the security and look at the total, how do you value the income stream based on the cap rates that are being sold in the market. So it’s, again, more like an income approach if you’re valuing a piece of say commercial real estate. You value that entire portfolio. You divide that number by the number of shares out there, and that’ll, of course, give you your net asset value of the company.

Brad Thomas (32:41):

Again, I don’t use it as much because most of my subscribers and followers I consider retail investors. They’re not as much interested in a liquidation value of that company. They’re really more interested in earnings. Earnings are the primary driver for stocks, not only REITs, but any public company is going to be earnings. So we really focus on those earnings metrics. So that funds from operation is really the key driver there.

Brad Thomas (33:05):

Across the board, I mean, we’re seeing, again, every sector’s going to be different. We’re still seeing some sectors like healthcare, specifically skilled nursing, that are still coming out of this, this COVID environment. Thanks to the government health in ’21, a lot of these skilled nursing stayed in business, but we’re still seeing the tail end of that now with skilled nursing.

Brad Thomas (33:24):

So the multiples or the valuations with those stocks are pretty low right now. In other words, the price of funds from operations to say a skilled nursing REIT today would be 11 or 12 times. Then you go up to the industrial sector, which has just been on fire, you’ve got some valuations in the 35, even touching 40 times range. So you’ve got a pretty broad spectrum in terms of how the various sectors are being valued today. Those are the valuation metrics. I think the most important for your audience here is to look at the dividend yield and the price to funds from operation and compare those with the peer group, but also with the overall REIT sector.

Robert Leonard (34:04):

That price to FFO metric is exactly what I wanted the audience to hear because there’s a lot of misconceptions around REITs and their valuations like you said is somebody … I pulled up Realty Income, like you mentioned, one of your largest holdings. You just look at the PE. It’s over 70, nearing 80, which most people would say is not cheap, but then you look at the price to FFO and you’re much lower. It’s around 20, 22 today. There’s a really big disconnect between price earnings and price to FFO.

Robert Leonard (34:31):

Another similar asset class or industry that has similar valuation differences is banks. A lot of times, banks, you can’t just necessarily value them the same that you would other stocks. So it’s important to keep into consideration what asset class and industry you’re valuing.

Brad Thomas (34:46):

Yeah, for sure. Again, I get that a lot, but I’ll tell you, I’ve been doing this 10 years, and I really feel like the investor market is becoming a lot more educated. Hopefully, that’s thanks to a lot of the work that I do and the books that I’ve written, but it’s great. It’s great to see the demand for income is really driving this sector. Again, it’s purposely designed, just what Eisenhower and his administration had in mind, which is to give the individual investors access to really high quality, the highest quality commercial real estate.

Brad Thomas (35:16):

I will say on that point, it’s hard to be, and I tell this. I’ve got a lot of developer friends, some pretty large developer friends, and I tell them it’s hard for them to be competitive with REITs today, especially these dominant names because they’ve got the cost of capital advantage. They can transact on these very large portfolios. Certainly, Blackstone is an outlier because they’ve got plenty of money coming in, but for most these midsize developers, it’s very hard to compete with a REIT because of that costly capital advantage, and frankly because of that superior management teams.

Brad Thomas (35:49):

We interview a lot of CEOs. I’ve got one CEO interview this afternoon and usually do several a week. These management teams, C suite teams are doing a great job of managing, and they’ve learned a lot, by the way, coming out of that great recession. Again, the reason I’m sitting here talking to you today is because I went through some challenging times myself in 2008-2009. There was no work to be done if you were a developer. That was a bad word. Take it off your resume. Nobody wanted to deal with a developer. There’s no banks that would lend money, and the REITs saw that, too.

Brad Thomas (36:21):

I mean, there was some pretty substantial dividend cuts. There was some higher leverage REITs going into 2008 and 2009. So a lot of these management teams have really done a good job of de-leveraging their balance sheet, frankly preparing for that next what if, and that happened to be the pandemic. So I think if it weren’t for the fact that these REITs have been de-leveraging their balance sheets and recycling their assets into core markets, I think we would’ve seen a lot more pain in the pandemic, but I think because of the fact that the great recession set up these REITs to take advantage or learn from their mistakes, as Ben Graham said, “Adversity is bitter, its uses may be sweet.” So you just want to take some of those lessons learned and apply them, and I think we’ve seen that unfold in the REIT sector.

Robert Leonard (37:07):

Your book is called The Intelligent REIT Investor. So I would say you’re a Buffett fan, and two of Buffett’s most common things that he looks for in companies are their moat and their durable competitive advantage. How are moats and competitive advantages considered when analyzing REITs?

Brad Thomas (37:23):

Well, that’s a great point. I think those are the primary advantages, I mean, and for any company, I mean, I think having been that low-cost leader in that area is a key, and being able to achieve … We’ve watched companies now over the last 10 years have gone from not being rated to moving up, to getting a rating, and then moving up to investment grade, say a triple B- S&P up to a triple B, up to a triple B+. A company like Realty Income, which was upgraded just maybe two years ago or something to an A- and just looking at the transformation of that company, really the evolution of a company being able to utilize that cost of capital.

Brad Thomas (38:02):

What’s really interesting, again, I think Realty Income is probably a textbook example of that. I do teach, by the way, at NYU and a number of schools in REIT. I’ve got some interns now from Penn State. I just lectured up there about two months ago, and I came back with quite a few interns, and they’re all excited about real estate. So Penn State has a great real estate program, but looking at the evolution of Realty Income over the last two decades, 20 years, as the company, they’ve been public for about 27 years. They’re dividend aristocrat. They’ve been able to increase their dividend every year, but they started out with Taco Bells, which really non-investment grade tenants, just really franchise credit, I would call it. Then over the years, they were able to reduce that cost of capital and acquire higher quality businesses or properties, lease to higher quality companies, and they can only do that because they kept improving their cost of capital advantage.

Brad Thomas (38:56):

Now, more recently for one example, they just announced, this is Realty Income a few weeks ago, an acquisition of a wind property in Boston. It’s a trophy property that they acquired. I think it was $1.9 billion. I believe it was at a 5.9% cap rate. The reason they did this is nobody could really compete with them. It was a pretty large deal. If one of their competitors would’ve bought it, that would’ve provided not enough diversification and too much concentration for that company. So it’s really interesting to see that moat go to work.

Brad Thomas (39:27):

So you’ve got that cost of capital working in tandem with your scale and just continue to grow and grow and grow and consolidate. So it’s very important. Those are the primary two levers in terms of those moat advantages. Frankly, a lot of these companies like Realty Income, they’ve now developed their own brand. They call themselves the monthly dividend company, and that is exactly what they do. They pay monthly dividends. They really target the retail investor for income. So I think having those advantages are really critical.

Brad Thomas (39:55):

Now, you mentioned The Intelligent Investor and, of course, Ben Graham and Warren Buffett, and, of course, that’s the title of my book, The Intelligent REIT Investor. I actually sent a copy of my first book to Warren buffet. Actually, since that time, his company has invested in a couple REITs. So one of those is store capital. Berkshire Hathaway is still invested in store, ticker STOR.

Brad Thomas (40:16):

Funny story is we upgraded STOR about 60 months prior to the Berkshire Hathaway announcement. We felt like we telegraphed that one pretty well. Again, we knew that company was a strong buy because they had all of those wide moat advantages. They had a very attractive cost of capital. They had been able to scale significantly, reducing their exposure to certain categories, certain tenants. Frankly, the book on your shelf back there, The Intelligent Investor, every chapter I think Graham mentions the margin of safety.

Brad Thomas (40:44):

So we felt like STOR was extremely attractive to us because the valuation market was reflecting a price that we felt like was much, much lower than it should be. We’ve done very well with owning STOR. Frankly, there’s a lot of net lease REITs today that we like. I think that sector has been hit a little bit harder primarily due to the rising rate environment, which we think there’ll be some normalization here to occur with that net lease sector.

Brad Thomas (41:08):

Of course, that includes gaming. We now cover three gaming REITs. It’s getting ready to go to two gaming REITs because one of the gaming REITs, VICI, is being inquired by MGM Growth Properties. Should close this year in the second quarter of this year, but we think those are certainly some places for investors to look today in the net lease sector.

Robert Leonard (41:26):

Buffet himself and a lot of other actual super investors, Mohnish Pabrai, and Guy Spier, and some others, they’re also in the real estate space with Seritage Growth Properties, SRG. So even outside of just what you mentioned is they’re also making some bets in the real estate space as well.

Brad Thomas (41:44):

I’m glad you mentioned Guy. I actually bought his book. I think I’ve got it down in Florida. Great book. I’ve actually reached out to Guy, and he’s a great investor. I like him a lot. Yeah. Seritage was interesting. I mean, Berkshire Hathaway ended up, I think Buffett had some personal chips in Seritage, but also, smartly, they got involved in the debt piece. Obviously, they want to be as close to the capital stack as they could. So basically, being the bank Berkshire Hathaway, essentially the bank for Seritage as well, that sector has obviously been beaten down very hard. The mall space is very capital intensive. The name of the game there is to have access to capital, be able to redevelop it, patient capital because REIT is redevelopment. I wore this hard hat for 25 years.

Brad Thomas (42:24):

Simon is obviously the leader in this space. They do have those. Go back to the moat again. Simon has those wide moat advantages. They have the fortress balance sheet. They’ve got the liquidity. They got the scale. We do think that Simon will probably transact another deal. We think there’s a potential M&A target out there for them. I’ve written about that. They did close on the Tallman deal during the pandemic. Actually, they shaved about a billion dollars off of the price. Again, goes back to that management team.

Brad Thomas (42:50):

David Simon is probably one of the most skilled CEOs in the REIT space. He understands how to make money, frankly, and he’s done a great job of that. I like what Simon’s done in the e-commerce space. I think he’s being able to acquire the affiliated brands and all of the JC Pennies and put all that under one umbrella makes a lot of sense. The market’s not really reflecting, not seeing the value in what Simon’s really created, and I think Simon is going to be a great company to own long-term.

Robert Leonard (43:19):

Buffett says that most people should put most of their money into an index like the S&P 500. When it comes to REIT investing, is it the same philosophy? Would most people be better off just buying REIT index like Vanguards, VNQ, rather than buying these individual REIT companies?

Brad Thomas (43:37):

Well, that’s a tough question. The reason it’s a tough question is because in terms of an ETF, all I can say is stay tuned. In terms of deciding whether you’re … It really depends. I mean, I found there’s really two types of investors. I write an article every day, and I write these articles for the DIY investor. That’s the do-it-yourself investor. I’m sure a lot of your audience are do-it-yourself investor. They go out, they do their research, they read my research, they build their own portfolios, their retirement portfolios themselves. They don’t rely on others. They’re pretty sophisticated. Those are really, I bet, 6,000 subscribers now around the globe.

Brad Thomas (44:13):

I mean, I know my subscribers pretty well, but I think the other group, and we do have some subscribers who fit in this category, what I call to do-it-for-you investors. They want somebody to do it for them. A good example would be my mother. My mother, I love her, but she’s not going to invest in my do-it-yourself investor product. She doesn’t the time, the patience or, frankly, the knowledge to go out and build her own, read all my research, understand what FFO and AFFO, and all the nuances are, and speak to management teams, and vet out these companies.

Brad Thomas (44:44):

So I think the other part of this market are the do-it-for-you investors. Frankly, that is the marketplace that I see growing substantially, thanks to technology today and all the different products. ETFs, good example. Why spend all this precious time trying to build out a portfolio when you can just buy the basket of REITs.

Brad Thomas (45:04):

Now, we understand, we know the ETFs space extremely well, and I know who the competitors are. As I said, just stay tuned. I think there are some really interesting products on the market. There’s some others that are coming as well.

Robert Leonard (45:15):

I mentioned this earlier, but one of my favorite parts about investing in physical real estate myself is that I can’t see the value of my property change every day. There isn’t a ticker that changes by the minute playing with my emotions. I think there isn’t the stock market, and that’s not to say I don’t like the stock market. I still invest heavily into the stock market, but how do you consider the correlation between REITs and the overall stock market? How do you manage the price of your REIT investments going down solely because the stock market is selling off, not because the value of the underlying assets is actually decreasing?

Brad Thomas (45:47):

What I try to do and, again, I really wear two different hats here. I mean, for me personally, I’m overweight REITs because I know this space in and out. I should be overweight REIT personally because this is what I know best. I’ve also learned that I need to diversify because one of the big, big failures in my life, and there are many, but one of the big failures in my life was having all of my eggs in one basket, and I’ve written about this. So this is nothing new, but I had a business partner and it was great for about 20 years and then it wasn’t. I had everything tied to this one partnership and it was very difficult because I wasn’t very well-diversified to get out of it, to unwind that mistake. That was one of my biggest mistakes is just not being adequately diversified.

Brad Thomas (46:33):

So I’ve learned to be more diversified, but I’m still overweight REITs because I know the sector, I know the space, and I know how to get in and get out. Again, going back to liquidity, we see a company that’s not performing or the management team’s not performing, we can get out of it immediately and we will, but in terms of individual investors and how that impacts the other stocks, look, I think you look at REITs as that, again, it’s an income stock. Really, the three spaces or sectors that most individual investors like are the REITs, MLPs, and the BDCs. REITs have been around longest. They have been less volatile. There’s a lot more diversification.

Brad Thomas (47:12):

Again, one of the questions I get very frequently is, “How much should I own in REITs?” A lot of people like you own private real estate. A lot of people own their house. So outside of the private real estate, outside of the house, I think a minimum allocation is 10%. I think you’re not crazy if you want to go to 20%.

Brad Thomas (47:30):

When you start going over 20%, you really need to either be like me and know what you’re doing because like I said, I’m well beyond 20% allocation in REITs, but again, I know what I’m doing. So you’ve got to maintain that diversification. I think that’s really the key, but what you’re going to get with REITs? Again, going back to that simple math, five plus five equals 10. Just expect to wake up every year if you want to look at your portfolio and think to yourself, “Five plus five equals 10. I can get 5% income and 5% growth, and I’m going to get 10%.” You’re not going to get that every year, but again, we can go back now a long time to 1960 and we can show you the stats to see average returns have been in between 11%, 12%, 13%, depending on the time period. It’s that very predictable income that’s really been the driver for this space.

Brad Thomas (48:17):

I mean, look, think of it like this. If you own Starbucks, you don’t know how many shares of Starbucks coffee or lattes are going to be sold every year. The analysts can go out there and guess, the company’s going to guess, and everybody can say, “Well,” but you just never know. I mean, you’ve got a war, we’ve got a recession, whatever, but you can go out and predict.

Brad Thomas (48:37):

This is really one of the few asset classes. You can really predict how much growth you’re going to see. So when I look at these analyst reports for REITs, if I can see the company’s going to … If I’ve got 15 analysts that say on average company’s going to generate 10% growth in 2022 and 2023, you can almost take that to the bank. I trust that a lot more than I trust the Starbucks analyst group because you’re selling coffee. I’m selling rent checks. That’s what REITs do. They provide rent checks.

Brad Thomas (49:05):

These are lease contracts that are long duration lease contracts. So you can do a much better job at estimating the future growth of these companies by simply looking at their asset base, looking at their lease contracts, and being able to determine what the growth prospects look like for the company over time.

Robert Leonard (49:22):

A lot of our audience is real estate investors, but they also like to invest in the stock market. That’s one of my favorite things about our audience is that a lot of real estate shows think that real estate is the only asset class and they really try to encourage people to stick away from the stock market. What I like that we do is that we’re really open to the stock market in real estate. So I think a lot of people listening to the show today are really going to enjoy this conversation because they get to combine their interest in the stock market with real estate. So for anybody that’s interested in learning a little bit more about you, Brad, and all the different things you have going on, where is the best place for them to find you?

Brad Thomas (49:55):

We’re going to talk about moats again. My website is called widemoatresearch.com. See, that’s my primary website. Of course, I write regularly on Seeking Apple. A lot of people know me from there and I have another site called, the easy button is bradtom.com. That’s Brad T-O-M dot com. So either of those websites would be great. It’s been a pleasure to be with you today. I’ve heard so much about your show and I’m excited to finally get on it, and I want to make sure my book is on your shelf next time I see you.

Robert Leonard (50:25):

We will be sure to get that added to the bookshelf so everybody that tunes in to all the video episodes could see it, see it right behind me. Brad, thanks so much for joining me. I really appreciate it.

Brad Thomas (50:34):

You bet. Take care.

Robert Leonard (50:35):

All right, guys. That’s all I had for this week’s episode of Real Estate Investing. I’ll see you again next week.

Outro (50:41):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday, we teach you about Bitcoin, and every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consultant a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.