- I invest very differently from most other investors.
- My portfolio is unique in that it's heavily allocated toward real asset investments that generate steady cash flow.
- I believe that most individual investors would do much better following a similar approach.
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Most people invest most of their wealth into stocks and bonds. Coming from a private equity background, I never really understood the appeal of this approach to investing.
Bonds pay literally nothing when you account for inflation and taxation. A long time ago, when you could still earn something from bonds, they were pictured as safe income investments, but in May of 2020, with the 10-year Treasury at 0.6%, I would not even invest in them for diversification:
Stocks, on the other hand, could produce attractive long-term returns in theory, but in reality, they have produced very disappointing returns for most individual investors.
You often hear that you can expect 8%-12% per year investing in stocks, but in reality, the average annual return of individual investors was just 2.6% over the past 20 years:
Why is that?
There are five main reasons why traditional stocks are poor vehicles for most investors:
- They are very volatile.
- They pay little income.
- They feel like speculation.
- They can be traded in a few seconds.
- They are very difficult to understand.
And because of that, investors are quick to lose patience when things don't go their way. You end up trading way too much. You make poor emotional decisions. You incur a lot of transaction costs. And finally, you never really understand in what you are investing so you bail at the worst time.
Think about it for a second.
If you own a portfolio of 20 stocks, each operating a different business, how realistic is it really for you to understand all those businesses?
Business is extremely complex. In fact, it's so difficult that most who try at it fail miserably. Yet, when investing in stocks, most investors think of themselves as some type of business guru that can predict what succeeds and what fails. Suddenly they think they understand what drives the long-term success of Amazon (AMZN), Gilead (GILD), Coca-Cola (KO) and other highly complex organizations.
You think that you can accurately understand everything, from tech to pharma, consumer goods, and everything in between. These are multi-billion dollar organizations that are highly complex, and yet, you think that you have a real grasp of what drives their performance.
I hate to break it to you, but if that's the case, you are grossly overstating your capacities. In reality, you don't really understand what you own, and this is one of the main reasons why you make such poor decisions.
Based on all the drawbacks that we discussed here:
What asset class could be better suited for individual investors?
First off, it should pay significant income. Income helps you to remain patient and it removes the feeling that you are just speculating on the share price going up. It allows you to earn a return in cold hard cash, regardless of how the stock price behaves in the short run.
Secondly, it should be very simple to understand. Most businesses are way too complex for someone who's not closely involved. If you don't understand what drives your investment, you are assured to make a mistake sooner or later.
Finally, it should offer good long-term prospects. Investors are greedy and they won't stick to investments unless they have the potential to generate attractive long-term returns.
The answer is real assets. This is where I invest more than half of my net worth. I started in private equity, investing in private deals. Today, I do most of my real asset investing through the public stock market. Below, I provide an overview of real asset investment opportunities and how I invest in them.
Real Asset Investing
Before anything else, let me clarify what I'm talking about. Real assets can be anything that is tangible and a valuable part of our infrastructure.
Think of apartment communities, rental homes, office buildings, distribution centers, factories, airports, railroads, farmland, windmills…
Real assets are ideal investments for individual investors because:
- They pay high income
- They are simple to understand
- They offer good long-term prospects.
Let's take the example of an apartment community investment.
You buy an apartment community that has 20 units, each generating $800 of monthly cash flow after expenses, for a total of $16,000 per month, or $192,000 per year. Such properties are generally bought at a "cap rate," which represents the expected yield of the property.
Assuming you buy the property at a 7% cap rate, you would be paying ~$2,750,000 for it. You finance half of your purchase with a 4% mortgage, so you only have to come out of pocket with $1,375,000 to earn $192,000 of cash flow minus the interest on the debt, which would be $55,000 in this case. Your net cash flow is then $137,000 per year, which equates to a ~10% annual cash on cash return.
If your property is well located and maintained, it's reasonable to expect rents to go up 2-3% per year, which results in an additional 4%-6% return because of the leverage. All in all, after property management expenses, you may realistically expect to earn 12%-15% annual returns, with most of it coming from rental income.
The point here with this example is to show you that:
- It's simple to understand: Real asset investing is not rocket science. We understand that everybody needs a roof over their head and there's always demand for good apartments. It's much easier to understand the future prospects of an apartment community than that of Amazon. There's less uncertainty, less risks, and therefore, you are likely to stick around for the long run.
- It pays a lot of income: Two-thirds of the total return comes from rental income. It helps you to remain patient because this portion of the return is very consistent and predictable. Unlike Amazon, which pays you nothing, you don't feel like a speculator when investing in real assets. You feel like a landlord who earns steady returns.
- It has attractive long-term prospects: Finally, the expected total returns are often superior to what you would be earning with regular stocks anyways.
In a world of 0% yielding Treasuries, and highly uncertain stocks, real assets like apartment communities have a lot to offer.
But don't take it just from me. Large institutions and professional investors have been loading up on real assets over the past 10 years, and they are expected to double down with even greater investments in the coming decade.
Brookfield (BAM), a pioneer in real asset investing, expects up to $45 trillion of institutional capital to shift to real asset investments in the 2020 decade:
With bonds and stocks providing insufficient or unreliable returns, real assets are the only remaining alternative to generate high and resilient income and total returns in 2020.
We believe that this will keep pushing valuations to higher levels and investors who position themselves today can profit from the rush to real assets.
How Do I Invest in Real Assets?
I used to invest just like every other private equity investor, by buying private properties. I used to work in private equity and once thought that this was the only way.
But later on, as I learned more about REITs (VNQ) and other publicly-traded real asset options, I shifted most of my portfolio to them. The beauty of REITs is that they essentially combine the positive attributes of real assets:
- High income
- Simple to understand
- Attractive total returns
With the positive attributes of stocks:
- Easy diversification
- Professional management
Most investors would expect REITs to fare relatively poorly relative to private equity counterparts, but it's actually the opposite. REITs have generated 15% annual total returns on average over the 20 years and far outperformed other asset classes, including private real estate investments:
The reason why REITs do so well is because they are able to put the economics of real assets on steroids. Most importantly, they enjoy significant economies of scale and have access to cheaper capital which boosts their growth potential.
However, if there's one downside to REIT investing, it's that the volatility can at times become extreme. While unsophisticated investors are quick to panic and jump ship, more sophisticated REIT investors view this as a blessing in disguise as it allows them to buy real assets at pennies on the dollar.
Right now, many high-quality REITs, are available at 50% discounts to the real value of the assets they own. It provides enormous margin of safety and superior long-term appreciation potential as valuations eventually normalize.
Earlier, we used the example of an apartment community to highlight the appeal of real asset investments. Let's now take a look at an apartment REIT.
Independence Realty Trust (IRT) is a publicly-traded REIT that specializes in Class B value-add apartment investments. It owns a well-diversified portfolio of 49 properties and uses a conservative level of leverage at 40%. The managers have a track record of significant outperformance and the CEO himself owns 400,000 shares, which provides good shareholder-alignment.
Anyone who understands real estate would agree that this is a fairly conservative investment given that we are talking about a well-capitalized, diversified apartment portfolio. In fact, even in this recent crisis, the rent collection has remained very strong. Everybody needs shelter.
Yet, in the recent stock market crash, IRT was pulled down with all other companies and it's now trading at an estimated 40% discount to the value of the underlying properties. The dividend yield also has expanded to 5.5% and it's fully covered even in these difficult times. Ultimately, as we put this crisis behind us and the economy opens up again, we expect the shares to reprice at its former highs, unlocking up to 70% upside to investors who buy today. The CEO just bought another $300,000 in shares, despite already having a lot of skin in the game. While you wait you earn a 5.5% dividend yield.
I cannot think of more attractive investments for individual investors. IRT is just one example among many others, but the point here is that these publicly-traded real asset investments have a lot more to offer than your traditional stock.
- It pays much more income.
- It's much easier to understand.
- It has stronger long-term prospects.
Most importantly, you are less likely to lose patience and do something stupid because you understand what you own and receive consistent cash flow while you wait.
That is exactly why most real estate investors do so much better than your average stock investor. Today, you can do even better than the real estate investors by investing in discounted REITs.
The Numbers Behind My Real Asset Portfolio
Our Core Portfolio is fully invested in publicly-traded real assets. It's currently valued just shy of $100,000 and it's expected to pay out over $9,000 in dividends over the next 12 months:
Source: High Yield Landlord Real-Money Portfolio
That equates to a 9.2% dividend yield, and the dividends are safely covered with a 62% payout ratio. This means that our portfolio holdings retain plenty of cash flow to reinvest in their properties for future growth.
Normally, the yield would not be that high, but we are in a bear market and valuations are exceptionally cheap today. On average, our holdings are currently priced at a staggering 50% discount to net asset value, offering great long-term upside potential.
We expect this portfolio to generate ~12-15% annual total returns with two-thirds of it coming from income. While this sounds too good to be true, it would actually be less than the historical average for real assets. Valuations are today very opportunistic, and therefore, we think that this forecast is quite conservative.
Finally, an additional tailwind for our entire portfolio is the rush to real assets that is happening right now. Bonds and stocks simply cannot satisfy the income needs of pension funds, insurance companies, retirees, and other income investors. Therefore, they are forced to move into real assets and as the rush progresses, we expect valuations to ultimately expand to new record highs as we put the crisis behind us.
Just 20 years ago, no one would pay attention to real assets. Those who invested then made a fortune. Today, the market is more competitive, but we are still in the early innings. In 10 years, it's expected that most institutions invest the way we do: with a large 40% allocation to real assets:
By positioning yourself ahead of the crows, you can today build positions at exceptionally low valuations, earn high income, and ultimately profit in the long run from the rush to real assets.
Historic Market Opportunity! Act Now!
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This article was written by
Jussi Askola is the President of Leonberg Capital, a value-oriented investment boutique that consults hedge funds, family offices, and private equity firms on REIT investing. He has authored award-winning academic papers on REIT investing, has passed all three CFA exams, and has built relationships with many top REIT executives.He is the leader of the investing group High Yield Landlord, where he shares his real-money REIT portfolio and transactions in real-time. Features of the group include: three portfolios (core, retirement, international), buy/sell alerts, and a chat room with direct access to Jussi and his team of analysts to ask questions. Learn more.
Analyst’s Disclosure: I am/we are long IRT; BAM. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.