Widen Your Margin Of Safety With A Well-Balanced REIT Portfolio

by: Brad Thomas

Every investor and financial planner has a differentiated approach to asset allocation: how much of one's portfolio should be in stocks, how much in bonds, how much in real estate, and how much in cash. Most agree that a shift from stocks into bonds will reduce risk and overweighting (your portfolio) with lower risk assets are certain to decrease volatility.

When determining how much real estate should be in your portfolio, an investor should examine his or her financial objectives, ability to absorb losses, and tolerance for risk. These criteria may help you decide how much of your portfolio should be in Real Estate Investment Trusts (REITs).

Controlling risk is essential and investing in high-quality REITs can provide added diversification that reduces overall portfolio risk and volatility. Accordingly, most investors should structure an investment strategy and asset allocation mix consistent with the principles of diversification, as well as their specific needs and investment goals.

As legendary author and investor, Ben Graham believed, a fundamental principle of investing is that over time, diversification is the key to stability of performance and capital preservation. Graham wrote in his timeless classic, The Intelligent Investor:

For most investors, diversification is the simplest and cheapest way to widen your margin-of-safety.

Risk is Inescapable, So Diversify

As all have learned, risk is the potential for loss when things go wrong. Accordingly, most investors have structured investment strategies aimed to achieve a suitable level of diversification (risk control) while also generating sound returns. As Ben Graham wrote (from The Intelligent Investor):

There is a close logical connection between the concept of a safety margin and the principle of diversification. One is correlative of the other. Even with a margin in the investor's favor, an individual security may work out badly. For the margin guarantees only that he has a better chance for profit than for loss - not that loss is impossible. But as the number of such commitments is increased the more certain does it become the aggregate of the profits will exceed the aggregate of the losses. That is the simple basis of the insurance-underwriting business.

As Graham believed, portfolio diversification is an "established tenet of conservative investment" and by accepting a universal diversification strategy "investors are really demonstrating their acceptance of the margin-of-safety" principle, to which diversification is the companion."

10 REITs with Exceptional Diversification Fundamentals

Investors and financial planners acknowledge that there is no standard rule or percentage of a portfolio that should be allocated to REITs. In addition, there is no secret formula that will enable an investor to arrive at the appropriate sub-allocation among the different property sectors, investment characteristics, or geographic locations that REITs offer.

Of course the starting point for most depends on the absolute level of cash invested. Then, an investor should determine the level of exposure (diversification) within each sector and each geographic area. By assembling high-quality assets in broad geographic regions, many REITs make it much easier for investors to subscribe to diversification and risk-control.

Many "blue chip" REITs have evolved into highly skilled investment companies, led by widely respected real estate executives, offering very predictable and steady growth. These highly-diversified REITs are distinguished by their remarkable record of consistency and by their ability to recognize risk by skillfully acquiring and managing diverse income property portfolios.

The following REITs are distinguished by their exceptional diversification fundamentals that have allowed investors to gain broad exposure to income while generating consistent growth and profitability:

These ten REITs own and manage a diverse portfolio of assets that allow broad exposure to both geographic and economic risks. By owning shares in a REIT with highly diverse revenue fundamentals, an investor is insulated from future risks of capital losses or dividend reductions.

Successful investing is about managing risk, not avoiding it. These ten equity REITs have all all built their diversification strategies on exceptional occupancy fundamentals - the essence of a repeatable dividend platform.

One REIT That Separates the Best from the Rest

Often I am asked to recommend just one REIT that could enable an investor to balance an overall diversified asset portfolio. Of course my answer is always that one should diversify with around six to ten different REITs so that the contemplated portfolio would provide a minimally acceptable level of sector and geographic diversification.

However, if there is one REIT that embodies the absolute best diversification strategies and overall risk control fundamentals, I always recommend Realty Income (NYSE:O). This triple-net REIT has a over 2,600 individual properties and the remarkable record of paying dividends (monthly) have soundly provided investors with 502 consecutive common stock monthly dividends throughout its 43-year operating history and increased the dividend 65 times since Realty Income's listing on the New York Stock Exchange in 1994 (Realty Income recently declared the 503rd consecutive common stock monthly dividend).

In addition, Realty Income's risk-control fundamentals are distinguished by an exceptionally diverse portfolio of around 137 different tenants and 39 categories that range from auto parts to theaters to beverages. This broad revenue platform has enabled Realty Income to maintain a minimum occupancy rate of 96 percent or greater for over forty years (since 1970) and the triple-net REIT has a current occupancy rate of 96.6 percent (as of Q1-12).

As Ben Graham wrote, "the margin-of-safety concept may be used to advantage and distinguish the differences in an investment operation and speculative one" and Realty Income's strategically enhanced diversification platform has provided investors with an extraordinarily consistent dividend record.

Graham considered an "intelligent investment" to be differentiated by the way it turns the sources of income into sources of competitive advantage. Accordingly this unique REIT alternative promises to deliver investors with sustainable differentiation over repeatable cycles. As Graham explained,

One of the most persuasive tests of high-quality is an uninterrupted record of dividend payments going back over many years. We think that a record of continuous dividend payments is an important plus factor in the company's quality rating.

"The Monthly Dividend Company ®" has paid consistent and increased dividends for eighteen years and this repeatable model is the mark of a great investment alternative that is distinguished by intelligently bearing risk for profit - and doing it exceptionally well is what separates the best from the rest.

Sleep Well At Night With a Diversified REIT Portfolio

As Sir John Templeton said, "The only investors who shouldn't diversify are those who are right 100% of the time." By diversifying your portfolio with high-quality REITs, an investor is guaranteed a better chance of generating consistent returns and controlling risk. More importantly, controlling risk in your portfolio is important and worthwhile - and perhaps the essence of a diversified SWAN (sleep well at night) strategy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.