{"id":177805,"date":"2024-09-25T14:44:00","date_gmt":"2024-09-25T20:44:00","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=177805"},"modified":"2024-09-25T14:50:53","modified_gmt":"2024-09-25T20:50:53","slug":"why-im-buying-reits-instead-of-rental-properties","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/why-im-buying-reits-instead-of-rental-properties","title":{"rendered":"Why I Continue to Buy REITs Instead of Rental Properties"},"content":{"rendered":"\n

Last October, I wrote an <\/span>article<\/span><\/a> explaining why I had stopped buying rental properties to buy real estate investment trusts (REITs) instead. I argued that REITs <\/span>were mispriced<\/span>, <\/span>offering an opportunity for<\/span> investors to <\/span>buy<\/span> real estate at a discount to its fair value.<\/span><\/p>\n\n\n\n

Since then, REITs have risen by 36% on average, even as private real estate has <\/span>mostly stagnated<\/span> or even slightly declined in value:<\/span><\/p>\n\n\n\n

\"vanguard
Vanguard Real Estate ETF Total Return (2023-2024) – YCharts<\/a><\/span><\/em><\/figcaption><\/figure>\n\n\n\n

I would also add that this<\/span> is just the average of the REIT sector, represented by the Vanguard Real Estate ETF (VNQ), which includes the good and <\/span>bad<\/span>.<\/span><\/p>\n\n\n\n

If you were selective and invested in the <\/span>right<\/span> REITs, you could have done <\/span>a lot<\/span> better. As an example, our <\/span>largest<\/span> REIT investment during this <\/span>time period<\/span> was Essential Properties Realty Trust (EPRT), and it is up 57% in just 11 months:<\/span><\/p>\n\n\n\n

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Essential Properties Realty Trust Inc Total Return (2023-2024) – YCharts<\/a><\/span><\/em><\/figcaption><\/figure>\n\n\n\n

But are REITs still a compelling investment opportunity, or has the window for investing in them already closed? <\/span><\/p>\n\n\n\n

I believe the<\/span> former is true.<\/span><\/p>\n\n\n\n

Even after the recent rally, <\/span>a lot of<\/span> REITs are still trading at <\/span>large<\/span> discounts relative to the fair value of their real estate.<\/span><\/p>\n\n\n\n

Take the example of BSR REIT (HOM.U<\/span>:CA<\/span>), which I discussed in last year’s article. It\u2019s an apartment REIT that specializes in rapidly growing Texan markets. <\/span>It was priced at a whopping 42% discount <\/span>back<\/span> in October 2023 and has recovered somewhat since then, but <\/span>still<\/span> trades at a 24% discount today.<\/span><\/p>\n\n\n\n

In other words, you can still buy an equity interest in the real estate of BSR at 76 cents on the dollar, a better deal than what you would get in the private market. It trades at ~6% implied <\/span>cap rate<\/span><\/a>, but its properties are worth closer to a ~5% cap rate in the private market.<\/span><\/p>\n\n\n\n

But <\/span>I think<\/span> the days of REITs trading at <\/span>large<\/span> discounts <\/span>are now numbered<\/span>.<\/span> The only reason REITs <\/span>are priced<\/span> as they are today is because the market overreacted to the surge in interest rates.<\/span><\/p>\n\n\n\n

REITs generally use little leverage, and their fundamentals have not <\/span>been heavily impacted<\/span>. <\/span>In fact,<\/span> REIT cash flows and dividends kept rising in 2022, 2023, and so far in 2024, <\/span>even despite the surge in interest rates<\/span>.<\/span><\/p>\n\n\n\n

However, it still caused their share prices to crash because <\/span>a lot of<\/span> income investors sold their REITs, regardless of their fundamentals, to reinvest in bonds and Treasuries instead. These investors were never <\/span>truly<\/span> interested in owning REITs, but they had invested in them to earn yield in a yieldless world. But as soon as bonds and Treasuries offered a decent yield, they sold, causing REITs to crash.<\/span><\/p>\n\n\n\n

This<\/span> is very clear if you look at the strong inverse correlation between REIT share prices and interest rates in this bear market:<\/span><\/p>\n\n\n\n

\"\"
Vanguard Real Estate ETF Price vs. Federal Funds Rate (2022-2023) – YCharts<\/a><\/span><\/em><\/figcaption><\/figure>\n\n\n\n

But we will now see the opposite happen as interest rates return to lower levels, which is why REITs have begun their recovery.<\/span><\/p>\n\n\n\n

The debt market is predicting that interest rates will drop by roughly 250 basis points within a year from now:<\/span><\/p>\n\n\n\n

\"\"
FedWatch – CME Group<\/a><\/em><\/figcaption><\/figure>\n\n\n\n

This anticipation has already pushed some investors to reinvest in REITs, and as rates gradually return to lower levels, I expect many more investors to reconsider their fixed-income allocations and return to the REIT sector.<\/span><\/p>\n\n\n\n

REITs are still relatively cheap, trading at discounts to their net asset values, and it is not uncommon to find good REITs still offering 5% to 7% dividend yields. <\/span><\/p>\n\n\n\n

REITs were less tempting when you could get a 5% yield on money market funds and short-term Treasuries, but as that turns into 2.5% to 3%, REITs will become a hot commodity again. <\/span><\/p>\n\n\n\n

How Much Upside Do They Offer?<\/span><\/h2>\n\n\n\n

Historically, REITs have <\/span>typically<\/span> traded at a slight premium to their net asset values, <\/span>and this<\/span> makes sense, given all the advantages they offer relative to private real estate.<\/span><\/p>\n\n\n\n

You are essentially getting the best of both worlds, stocks and real estate, in one package, and that’s worth a premium:<\/span><\/p>\n\n\n\n

Private Real Estate<\/strong><\/th>Public REITs<\/strong><\/th><\/tr><\/thead>
Illiquid<\/td>Liquid<\/td><\/tr>
Concentrated<\/td>Diversified<\/td><\/tr>
Costly, work-intensive management<\/td>Cost-efficient, professional management<\/td><\/tr>
Unlimited liability<\/td>Limited liability<\/td><\/tr>
Limited access to capital<\/td>Superior access to capital<\/td><\/tr>
Discount valuation<\/td>Premium valuation<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

Yet <\/span>there are still a lot of REITs that<\/span> trade at a 25% to 50% discount relative to the fair value of their real estate, net of debt.<\/span> This<\/span> is <\/span>ultimately<\/span> why I have kept buying more REITs instead of rental properties. <\/span><\/p>\n\n\n\n

I <\/span>am not able to<\/span> invest in the <\/span>equity<\/span><\/a> of rental properties at a 25% to 50% discount. <\/span>This<\/span> means that simply returning to their fair value could unlock 50% to 100% upside in some cases, and we now have a clear catalyst for this upside to <\/span>be realized<\/span>. <\/span><\/p>\n\n\n\n

For this reason, I <\/span>just<\/span> don’t get the point of buying private real estate today.<\/span> You are paying more to buy an illiquid, concentrated, private asset that’s management intensive and taking a greater liability risk <\/span>to likely earn lower returns <\/span>in the end<\/span>. <\/span><\/p>\n\n\n\n

Research studies clearly show that buying REITs at a discount is a strategy to earn much higher returns:<\/span><\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

Follow the Leaders<\/span><\/h2>\n\n\n\n

But don’t take it just from me. The leading private real estate investment firm, Blackstone (BX), which controls over $1 trillion worth of assets, is today choosing to buy REITs instead of private real estate. <\/span><\/p>\n\n\n\n

Earlier this year, it bought out Tricon Residential (TCN) and paid a 30% premium <\/span>for it<\/span>. Then, a few months later, it acquired Apartment Income REIT (AIRC) and paid a 25% premium <\/span>for it<\/span>. Now, it <\/span>is rumored<\/span> to be attempting to buy out a third REIT, Retail Opportunity Investments (ROIC), and this move has already caused its share price to surge by 25%. <\/span><\/p>\n\n\n\n

Blackstone is spending tens of billions of dollars to acquire REITs because it is the cheapest real estate <\/span>that<\/span> it can buy today\u2014so <\/span>cheap<\/span> that Blackstone is willing to pay ~30% premiums to their latest share prices and still <\/span>think that<\/span> it is getting a good deal.<\/span> <\/span><\/p>\n\n\n\n

I am following the same approach but on a smaller scale. As REITs recover, I will likely get back to buying private real estate eventually, but right now, I cannot make sense of it because REITs are so much more attractive. <\/span><\/p>\n\n\n\n

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\n \"passivepockets\n <\/div>\n <\/div>\n<\/div>","protected":false},"excerpt":{"rendered":"

Last year, Jussi Askola explained why he believes REITs are better investment vehicles than rental properties. This year, he explains why nothing has changed.<\/p>\n","protected":false},"author":613706,"featured_media":177813,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[4433,7363],"tags":[],"class_list":["post-177805","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-opinion","category-reits-passive-investing"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/177805","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/613706"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=177805"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/177805\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/177813"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=177805"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=177805"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=177805"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}