As most intelligent investors recognize, one way to become a "second-level" thinker is to look for people who are already successful. That could mean finding role models who have similar investment characteristics, people who share the same DNA for risk-tolerance.
For those who subscribe to my monthly newsletter, The Intelligent REIT Investor, it's understandable to see that I have an alignment of interests with my role model #1, Benjamin Graham (i.e. The Intelligent Investor). Without a doubt, the most intelligent three words that Graham taught me and millions of others are the same prophetic words that describe the metric by which hazardous speculations are segregated from bona fide investment opportunities:
Margin of Safety
Of course I have other role models, other than Ben Graham, who have modeled me into the defensively risk-averse investor that I am today. One of those is Howard Marks, co-founder and chairman of Oakstreet Capital Management. I have not yet met Marks, although I have him on my wish list of people I would like to meet one day. I consider Marks to be somewhat of the "modern day" Ben Graham and Marks even ties his investment philosophy to my #1 mentor, as he explained in The Most Important Thing:
Successful investors manage to acquire that necessary "trace of wisdom" that Ben Graham calls for.
In his book, Marks provides meaningful "second-level thinking" for investors and I have learned to analyze my investment opportunities with a more critical eye aimed to protect principal at ALL costs. By paying close attention to Marks' investment style, I have become a more systematic investor; always remember that "recognizing risk is an absolute prerequisite for controlling it."
Accordingly, my investment style has become much more rooted in accepting the fact that risk is inescapable. Part of my more risk-averse research and analysis is now standard, and as Marks explains:
"When you boil it all down, it's the investors' job to intelligently bear risk for profit. Doing it well is what separates the best from the rest".
Another mentor that I admire is Donald Trump. For those who don't know, I'm now writing a book on Trump and although I'm no apprentice (yet), I consider him to be a meaningful part of my foundation in real estate investing. I was first introduced to Trump in 1988 when I read The Art of The Deal, and that love for creating sustainable wealth in the form of "brick and mortar" became a pivotal ingredient for my investment career. Trump said:
It's tangible, it's solid, it's beautiful. It's artistic, from my standpoint, and I just love real estate.
I'm excited to be writing a book on Trump and I think you will see that there are some striking similarities in the billionaire investor's strategies and those of Graham and Marks. It's true, all of us must take some risk in order to score points and I have observed that the most successful investors (like Trump) have been determined, even when they have failed, they always got back up. Trump said:
Sometimes by losing a battle you find a new way to win the war.
So What Have I Learned from Sir John Templeton?
Sir John Templeton was knighted by Queen Elizabeth in 1987, and he is deemed one of the greatest global stock pickers of the century (Money Magazine, Jan, 1999). Sir John was a value investor, meaning he was great at picking unfavored stocks and holding onto them long-term for great returns. Like another investor in the next generation (of value investors) Warren Buffett, Sir John was also great at ignoring the conventional wisdom. Sir John once said:
Search for bargains. You should try to buy that particular investment whose market price is lowest in relation to your estimate of its true value.
Much like Graham, Sir John preferred to use fundamental analysis rather than technical analysis in his investment decisions. He is famous for making investment decisions counter to what the herd is doing. For example, during the technology bubble of the late 1990s, he is said to have made $86 million shorting Nasdaq stocks before the market crashed in 2000.
Sir John, who lived to be 95 years old, was definitely a product of the Grahamian-era where he continually taught that "wise investors must recognize that success is a process of continually seeking answers to new questions." Accordingly, Sir John was broadly recognized to be an extraordinary supporter of diversification as he often explained:
The only investors who shouldn't diversify are those who are right 100% of the time.
Of course, now I gave you a hint as to why I admire Sir John and consider him an amazing mentor and role model. It's not just the fact that he was a successful investor who created incredible wealth. It has more to do with how he earned his fortune and the lessons that live on for generations.
You see, Sir John believed that diversification is a risk-management tool that embodies the maxim "don't put all of your eggs in one basket." It's widely held within the investment world that company-specific risk can be reduced by holding somewhere between 15-50 stocks. Industry-specific risk can be reduced by holding stocks from varying industries, country-specific risks can be reduced by holding stocks from varying countries, and so on.
REITs provide excellent diversification by reducing risk without inhibiting returns. The more money you have to invest in REITs, the bigger your average position size should be, particularly if you are trying to achieve an optimally concentrated portfolio. I generally recommend that one should own between 10% to 20% in REITs and in some cases, depending on risk tolerances of course, 25% to 30% may seem reasonable (I'm targeting 40% as my maximum concentration. But remember, I have a "circle of competence" that most of you don't).
Today, there are 25 countries around the world that have adopted the REIT (or REIT-like) structure as a tax-efficient way for small investors to achieve the many benefits of owning an indirect interest in high-quality, well-located, and professionally-managed, income-producing real estate. The industry has grown from a backwater with less than a dozen public companies, to a mainstream asset class with over 290 public companies with an aggregate market cap of over $800 billion. In the US, there are over 180 publicly-traded REITs (equity and mortgage) with a combined market cap of over $660 billion.
Another lesson learned from Templeton and rooted in the same Grahamian-based value investing era is explained by Sir John:
Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.
I'm sure that some investors might look at the sharp sell-off in REIT-land and think this high-paying dividend sector is way too risky. Like Templeton taught me, I see it differently: Prices have already fallen hard, so fears of rising interest rates are already baked into REIT prices. As I see it, REITs are actually less risky now than they were when everything seemed euphoric a few months ago. As the late fund manager Sir John Templeton once said:
The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.
Will REIT prices fall further? I don't have the answers. But maybe Sir John does:
Focus on value because most investors focus on outlooks and trends.
Most of my REIT picks have actually rebounded a little since I added to my recent positions. As a long-term dividend investor, my goal is to build a portfolio of solid companies that will pay me a growing stream of cash for the rest of my life. If I can add to my positions when prices are down, I get more income for every dollar I invest.
Take for example, Digital Realty (NYSE:DLR). I bought shares late in 2013 (under $50.00 a share), and so far this year the stock has climbed by over 6%. Not bad. But I also got in when the dividend yield was around 6.3% (today the dividend yield is 5.96%), so my Total Return is over 12% with less than 30 days into the New Year. Digital releases earnings on the 24th of February. Let's hope there's a little less drama this time around. (Note: Digital management: BE PREPARED please).
Another REIT that falls squarely into my "Templeton" list is Ventas, Inc. (NYSE:VTR). I purchased shares in the dominating Diversified Healthcare REIT late last year when the stock went on sale (see my latest article here). Timing could not have been better and since January 1st (2014) the shares are up over 7%. I was fortunate to get in with a robust dividend yield of around 5.3% (bagging me 12% total return so far this year). Also, my outlook is well-secured by the fact that S&P recently upgraded Ventas from BBB to BBB+. Shares are currently trading at $61.39 with a dividend yield of 4.72%. Sir John would be proud of me!
My final "Templeton pick" combines a few philosophical investing attributes (of Sir John) into one REIT. American Realty Capital Properties (NASDAQ:ARCP) recently approved the merger-related voting procedures and is now set to acquire Cole Real Estate Investments (NYSE:COLE). Upon closing, ARCP will be valued at around $11.2 billion and the combined REIT with have an enterprise value of around $21.5 billion. ARCP's portfolio is expected to grow significantly to a projected 3,732 properties, ranking the company the largest Triple Net REIT in the world. Without a doubt, ARCP will be one of the most diversified REITs in the world; that is by tenant, by sector, and by geography.
I started nibbling on ARCP shares back in September (2013) and I'm now, thanks in large part to the COLE merger, starting to see strong movement in the stock. It took a while to get Mr. Market comfortable with this mega-merger but now, in the words of Sir John, "the time of maximum pessimism is the best time to buy." The bet paid off (for me) and since January 1st (2014) ARCP shares are up over 9.1%.
I still see value in ARCP, primarily the tremendous diversification of the asset base; however, I'm not increasing my exposure until I see how ARCP's management team integrates with COLE. Also, ARCP needs to continue to deleverage its balance sheet and increase its debt to match-fund its lease expirations. I'm going to hang onto the shares though and perhaps look for a more attractive entry point or maybe when Mr. Market reacts negatively to the mega-merger.
Finally, let's remember what caused the "Templeton opportunity". Rising interest rates signal an improving economy, which is good for REITs that own self-storage, industrial, data-storage, retail, and other types of property. In addition to enjoying solid occupancy levels, many REITs will be able to renew expiring leases at higher rates, providing a boost to cash flow and, ultimately, dividends to shareholders - all will help to offset any interest rate-related pressure on share prices.
However, as Howard Marks reminds me, REITs aren't risk-free. If bond yields rise sharply, REIT prices will likely come under pressure. What's more, individual REITs face specific risks with respect to financing, occupancy levels, and rental rates depending on the type of real estate they own and the geographic markets they serve.
In summary, by owning a diversified collection of REITs, an intelligent investor can minimize company-specific risk and create an ever-lasting stream of dividend income. Conclusively, REITs are hard to beat as a long-term investment. Businesses will always need storage space, office space, industrial space, and consumers will need restaurants, medical space, apartments, and retail stores. While real estate values - and REIT prices - will fluctuate, these bricks and mortar investments will likely provide growing distributions for years and years to come.
Finally, I have always admired Sir John for his insightful wisdom of using wealth for later good (Sir John was one of the most generous philanthropists in history, giving away over $1 billion to charitable causes). His investment philosophies were all stitched together by the same thread called "gratitude". I admire Sir John's humility the most and although I may not be the most intelligent REIT investor on the planet, I am thankful for my mentors who have enabled me to enjoy the most durable education called self-education. As Sir John explained:
If we become increasingly humble about how little we know, we may be more eager to search.
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Source: SNL Financial.
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
Disclosure: I am long O, DLR, VTR, HTA, STAG, UMH, CSG, GPT, ARCP, ROIC, MPW, HCN, OHI, LXP, KIM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.