Why REITs can be both an income and growth investment.
David Sobelman was invited to write the following article for the February 15th issue of Commercial Property Executive.
The growth of all the REIT’s aggregate market capitalizations has increased 68,074 percent in 45 years. NAREIT reports that from 1971 (Market Cap = $1,494 million) to 2016 (Market Cap = $1,018 billion) the REIT industry has grown to an extremely substantial industry. Granted, this growth is highly skewed as the REIT industry has drastically changed in the last almost-half century, and there are considerably more REITs in existence today than at the genesis of the industry. But what if you did invest in the REIT industry at the beginning and continued to invest along the way? Would you have more of a generational investment outlook?
There is a common perception among the investment community that a REIT is a “dividend machine.” Registered Investment Advisors (RIAs,) money managers, stock brokers, among others, explain the merits of REIT investing by the dividend in which it pays shareholders as one of their primary underwriting factors. But a REIT is really just a tax status in which the IRS dictates the percentage of profits (90 percent) that must be paid to investors.
Despite this, REITs are rarely seen as growth stocks; there seems to be a constant unwritten directive to always provide a certain dividend to an investor instead of increasing the stock price by practicing disciplined company decisions. Companies that are not hamstrung by operating under REIT rules have the benefit of reinvesting into their companies and growing their stock price by increasing the value of their firm. They pay either a low dividend or no dividend at all (i.e., Costco, Berkshire Hathaway and Amazon.com.) Therefore, how can a REIT adopt a strategy to grow its value while continuing to pay out its prescribed dividend?
One could look at the net asset value (NAV) of a company, which has a lot of emphasis on the share price of that company. The higher the value of the assets, typically the higher the share price. When incorporating traditional real estate investing fundamentals, there is a strong possibility that an asset, or a portfolio of assets, will increase in value. Choose better real estate and there is a much higher likelihood of that asset increasing in value over time, which will, most likely and subsequently, increase the NAV of the company and therefore the share price. REITs using the public markets to own and grow the value of the real estate allow an investor to realize the growth in asset values during its ownership of their shares, whereas private investors would have to wait until there is a sale of that asset in order to profit from it.
REITs that focus on growth, rather than solely on providing a dividend, could earn an investor a higher compounded annual growth rate than those that just provide a steady dividend. REITs don’t have the benefit of reinvesting large amounts of capital into their companies, and they are therefore forced to make philosophical business model decisions from the outset—do they solely want to provide a dividend or would it be possible to purchase assets that increase in value and provide a dividend? Growth companies are the darling of any investor’s portfolio and there is no reason why REITs can’t be both an income and growth investment. While it may not result in a 68,000 percent return, there is a lot of room for a REIT to be a growth model and a dividend model. Most current and future generational investors would see that as a very attractive scenario.
David Sobelman is the founder & CEO of Generation Income Properties (a public net lease REIT)