I Put Half Of My Net Worth Into These Investments - Part 2

Summary

• I invest most of my wealth into real assets.
• But that does not mean that I am bullish on all real assets. Opposite of that, I am very selective and only invest in specific real asset sectors.
• I present 3 real asset sectors to avoid and 3 to favor.
• Looking for a portfolio of ideas like this one? Members of High Yield Landlord get exclusive access to our model portfolio. Learn More »

Photo by utah778/iStock via Getty Images

In a recent article, I explain that my portfolio is very unique in its composition.

The majority of individual investors invest most of their wealth into stocks and bonds and then diversify with real assets.

But I do the exact opposite.

I invest most of my wealth into real assets and then diversify with stocks and bonds.

These two pie charts illustrate the difference:

Source: Author

Why would I do that?

You can read my thoughts in great detail in part 1 of this series, but put shortly, there are 5 key reasons for favoring real assets in today's market:

1. Stocks and bonds are overpriced and risky.
2. Real assets offer high yield in a yieldless world.
3. Real assets are great inflation hedges in a world of crazy money printing.
4. Real assets can be leveraged with historically cheap debt to boost returns.
5. Finally, we expect real asset valuations to expand in the coming years as increasingly many investors decide to invest a larger portion of their portfolios into them. This is already happening:

Source

But not all real asset investments are created equal.

Just like in every other market sector, you need to be selective to find the best opportunities and avoid stepping on potential landmines.

Many of you requested that we share more thoughts on our selection process, and therefore, in today's follow-up article, we will discuss 3 real asset sectors to avoid and 3 real asset sectors to favor to limit risks and earn better returns.

3 Real Asset Sectors to Avoid

As you read this section, keep in mind that at the right price, some of these investments may still make sense. We are generally bearish, but at a deeply discounted price, almost any real asset can become an attractive investment.

1- Avoid: lower-quality malls and outlet centers

The US retail market is overbuilt and Amazon-like (AMZN) e-commerce companies are quickly stealing market share.

Source

It does not mean that all retail properties are poor investments, but you want to stay away from properties that are located in more remote locations and lack an "experiential" component.

This is often the case of outlet centers such as those owned by Tanger (SKT). They are generally in more remote locations and they focus mainly on fashion retailing. Their unique layouts and locations make it difficult to diversify tenancy and for this reason, they are highly exposed to the growth of e-commerce.

2- Avoid: business hotels

We dislike hotel property investments because unlike most other real assets, they don't have a long-term lease to protect you during recessions. Your guests only stay for a few nights at a time and the demand can be highly volatile.

Moreover, Airbnb (ABNB) is expanding the supply of places to stay and Zoom (ZM) is reducing the demand from business travelers.

So you have a mix of potentially declining demand with rising supply, which isn't favorable to hotel owners.

Surprisingly, hotel REITs have already recovered most of their losses and now trade at pre-pandemic levels. As an example, Host Hotels (HST) is priced at an even higher level than before the crisis. The risk-to-reward does not appear to be particularly compelling.

3- Avoid: office buildings

At the exception of the very best office buildings located in supply-constrained high growth cities, we would avoid this sector:

source

The office sector was overbuilt already before the pandemic, and the recent rise in popularity of remote working will only makes things worse in the future.

I would add that it is very expensive to maintain and release office space. Many landlords will likely need to heavily reinvest in their properties in the coming years as they compete with an increasingly large number of other landlords who are looking to release empty spaces.

Some office REITs like Boston Properties (BXP) have the right asset mix, management, and balance sheet to deal with these challenges, but most don't. It is a sector to avoid, or underweight at the very least.

3 Real Asset Sectors to Favor

As you read this section, remember that valuation always plays an important role when investing. While we like these real asset sectors, we don't like them at just any price.

1- Favor: net lease properties

Net lease properties are freestanding single-tenant properties such as Taco Bell (YUM) restaurants, Dollar General (DG) convenience stores, and Walgreens (WBA) pharmacies.

We like these properties because their leases are very favorable to the landlord. We call them "triple net" leases because:

• The lease term is very long at 10-15 years.
• The rent increases automatically every year by 1-2%.
• The tenant is responsible for all property expenses, including maintenance.

As a result, net lease properties generate bond-like cash flow with steady growth and inflation protection. Coupled with some cheap leverage, they can achieve double-digit total returns with relatively low risk, which is very attractive in today's market.

Net lease REITs have historically achieved just that.

To give you an example, Realty Income (O) has generated 15% average annual returns for its shareholders over the past 20+ years. It has also managed to hike its dividend in every single year - without any exceptions.

It is quite incredible to be able to earn such high returns from a low-risk business. Today, we estimate that O is undervalued by 20% and it offers a 4.4% dividend yield.

2- Favor: farmland

Farmland is one of my favorite asset classes because of a simple reason:

People need it.

Source

The supply of farmland is limited and slightly declining each year due to better-use developments.

All while the demand for food is growing each year as the population gets larger and people in emerging countries get richer and increase their consumption of protein.

As a result of that, farmland has historically been one of the best investments, outperforming even the S&P 500 (SPY):

Source

How to invest?

You have two main options here:

You could buy shares of one of the two farmland REITs: Gladstone Land (LAND) or Farmland Partners (FPI). The advantage here is that you get professional management, diversification, and liquidity.

Alternatively, you could invest in farmland through a crowdfunding platform like FarmTogether. I think that this is a good option for investors with a long-time horizon and higher income needs.

3- Favor: warehouses and distribution centers

The growth of e-commerce and the return of on-shoring is leading to a rapid demand growth for industrial space.

The supply is not keeping up with the demand, and as a result, good properties in superior locations are able to grow rents at >5% per year at the moment.

source

Today, industrial REITs are very popular and most of them trade at high valuations, but a few exceptions still exist.

STAG Industrial (STAG) is one of them. It is priced at a near 5% dividend yield and it is set for 5-10% annual growth over the coming years.

Closing Note On Our Real Asset Portfolio:

The real asset market is vast and some segments are better positioned than others. In this article, we highlighted net lease properties, farmland and warehouses, but these are just three examples among many others.

Outside of these three, we are also heavily investing in:

• Apartment communities
• Manufactured housing
• Hospitals
• Skilled Nursing
• Ground leases
• Etc...

Our real asset portfolio generates a near-10% cash flow yield, out of which, half is paid in dividends to shareholders, and the other half is reinvested in growth.

Beyond the cash flow, we estimate that our holdings are undervalued by 30% and offer nearly 50% upside potential to fair value:

Source: Author

We simply cannot find such attractive opportunities in most other market sectors, and this is why we invest so heavily in real assets today.

Analyst’s Disclosure: I am/we are long O; STAG;. 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.

Comments

[saluda01]

How has or will the eviction moratorium affect apartment REITs?

[Jussi Askola, CFA]

@saluda01 Very little impact. REITs focus on higher-quality properties and are selective about their tenants. Rent collection rates have remained at near-normal during the pandemic. Most REITs are collecting 97-98%. It is not in the tenant's best interest to stop paying. It only delays the eviction.

[Snow and Ice]

Thank you Jussi.
You say “we” throughout when talking of HYL. Who is “we”?

[Jussi Askola, CFA]

@Snow and Ice Thanks for your question. we are 5 analysts. You can see our bios here: seekingalpha.com/...

Have a great day!

[3 beach dogs]

Don't forget that LAND has preferreds LANDM and LANDO...LANDO at 5%+ and very stable, almost like a utility for the divi/drip-ers. They just retired LANDP which I held for 6 years. Many holdings in California with irrigated properties. LAND has very different niche portfolio than commodity rise/fall of FPI.

[Jussi Askola, CFA]

@3 beach dogs Thank you for sharing. Not necessarily poor options if you are looking for defensive income. I would favor FPI's preferred shares in that case which participate in the upside of the underlying land. Feel free to join us for a 2-week free trial to access all our Top Picks: seekingalpha.com/...

Have a great day!

[kaplanassetmgt]

Interesting article. As for SKT, we are long for several reasons. Before the Covid, the company had increased its deividend for 27 years in a row. So you know the management cares about the shareholders. They correctly stoppd paying the dividend when the crisis hit as no one knew how severe the pndemic would be and the federal gov't down played the crises. Short sellers buried the stock price. The company pulled out all the protective moves and borrowed the full amount under their loan agreements. That too was the corrct move. The management then was in a position to work with the tenants and delayed (not lost) some portion of the rents. That was in March and April of last year. This year, the stores are paying their respective rent and part of the delayed payments so cash flow is excellent. The company has repaid all of the loan and sold some stock at an average of $19.02 per share and used that money to further reduce the debt. And, in January 2021, the company resumed a reduced cash dividend to shareholders. About 45% of the outstanding shares have been sold short. hence, at sometime, they will be buyers. Debt reduction means less cash interest costs leaving more money for shareholders and more debt reduction. I am quite sure that th eBoard is considering another increase in the dividend. The short sellers would hate that as they slowly get squeezed. I believe you have underrated the expereince and determination of the management to "bring home the bacon".

[Jussi Askola, CFA]

@kaplanassetmgt Thanks for sharing your thoughts. I agree that SKT has great management. However, I prefer to own urban class A malls than more remote outlet centers. Therefore, I would favor MAC or SPG in this space.

[Jussi Askola, CFA]

Hi,

Thanks for reading!

We just published our monthly portfolio review for members of High Yield Landlord. You can read a portion of it for free here: seekingalpha.com/...

Have a great day!

Jussi

[Tar Heel Fan]

.....the "assets" listed are just pieces of paper....they'll come in handy to stuff the holes in your shoes in Winter; that's about it.....forget "assets".....buy tangibles that'll keep you alive....that means spare magazines, tourniquets, anti biotics, non-perishable food, land that you can live on ect....Jan 6, BLM, Antifa, George Floyd ect are merely the warm up acts for what's to come....and one more thing....move out of urban areas while you can still get something for your house....tempus fugit!

[Jussi Askola, CFA]

@Tar Heel Fan REITs are real estate investments traded in the form of stocks. As a result, they can be quite volatile at times. However, despite occasional periods of high volatility, it should be noted that REITs have historically always recovered from past crises, and tracked the performance of the real estate market in the long run.

In other words, they behave like stocks in the short run, but correlate with real estate markets in the long run. A study by Cohen & Steers (CNS) confirms this as it found that the returns of REITs and real estate are near-perfectly co-integrated in the long run. This is not really surprising when you consider that REITs do not own anything else than real estate.

[birder 4000]

I am in agreement with your analysis except for farmland. Too much depends on the weather and commodity prices and the farmland REITs are too unproven for me. Give me O, STAG, STORE, MAA, EQR, CCI, and DLR. Long solid records.

[Jussi Askola, CFA]

@birder 4000 Note that the nice thing about a REIT is that the weather and commodity risk can be diversified. But this generally comes at a price. REITs like LAND trade at a premium to NAV today. Feel free to join us for a 2-week free trial to access all our Top Picks: seekingalpha.com/...

Have a great day!

[c4dancer]

I have exactly the opposite feeling. While farmland might depend on weather and commodities in the short term, it seems like a better inflation hedge than gold or bitcoin for the long term. The other REITs might be a good inflation hedge as well but depend more on management IMO.

[Jussi Askola, CFA]

@c4dancer Thank you for the addition.

[TheHarlequin]

I cannot completely agree with the analysis that real assets are a safer investment than stocks and shares. Real estate and land still have significant inherent risks that will generate volatility in the value. This volatility is less transparent because the liquidity value of real estate/land- the price someone is prepared to pay for it when it is actually sold- is not published on a daily basis like share prices are. This means REIT NAVs can never be accurate because the value of the underlying properties are only estimates not real liquidity values. REITs therefore feel safer and less volatile but this is an illusion. When people buy equities they tend to check the price movements on a regular basis and this can have a draining affect on their decision making. The Warren Buffet approach is useful, do your research before you buy and then put the shares away, forget short term volatility and then only sell if you have to. Over trading is the greater cause of underperformance not market volatility.

[Jussi Askola, CFA]

@notpersonal Thank you for sharing your thoughts. Historically, however, REITs have been less volatile than regular stocks during most time periods. This is not surprising given that they earn steady rental income from long term leases and well-diversified portfolios. As long as you don't overdo leverage, it is much safer to own real estate than to operate a business. It is more durable.

[Aquarama]

Hot tip: real estate in Ohio

[Jussi Askola, CFA]

@Aquarama It is relatively cheap, but I am not sure that's where I would invest. There are better opportunities out there.

[Adrian_L]

Jussi, thanks for another well written article,
I have a question, I don't live in the US but I read a lot about water shortages in the US , does this water shortage pose a risk to farmland? I assume when you don't have water the farmland is useless.
Thanks for your insight.

[Jussi Askola, CFA]

@Adrian_L Thank you for your question. Yes, it can pose a risk, but it is also an opportunity if reduces the supply of good land. Buying the right land and diversifying is key.

[Jussi Askola, CFA]

Hi,

Thanks for reading!

We just published our monthly portfolio review for members of High Yield Landlord. You can read a portion of it for free here: seekingalpha.com/...

Have a great day!

Jussi

[User 52337389]

Everytime I see an article of yours where you title it "I Put Half Of My Net Worth Into These Investments", you know it is REITs and it is a good article. I am waiting for the day you throw everyone a curve ball by going "I Put Half Of My Net Worth Into These Investments - Beanie Baby and Pet Rock NFTs!" :)

[Jussi Askola, CFA]

@I_Buy_Quality_REITS Haha :) Thanks for your support, I appreciate it!

[SnufferBottle]

Agree to disagree on office. I had the same thoughts until I started to see that companies such as Google, Amazon, etc. (the most tech-forward, with their own video conferencing software used for many years) will require employees to work from the office. If Google thinks you need a special exception to work from home, I don't see why the rest of the fortune 500 will be able to do without offices. It's much harder to onboard new employees + build culture remotely let alone all of the distractions (kids, YouTube, etc.) that exist at home.

Most companies will move to a hybrid WFH/office in the long run but I doubt many will move to "floater" desks for people to drop into rather than static desks because companies want to incentivize people to work from the office. I imagine they will just have assigned desks that don't have butts in them 100% of the time, but they'll still need to pay for that office space if they want the full benefits from being located in a given market. Unless you are reducing the number of desks/meeting rooms needed for your office, then you are still going to pay the same amount to rent it even if your employees get 2 "work from home" days every week.

I am lightly invested in BXP (high end gateway, which I agree will always be occupied - lower end properties will bear the burden similar to lower end malls) and heavily invested in CIO (Class A in 18-hour cities such as Denver, Portland, Phoenix, Dallas, Orlando). Demand for office depends on the demographics of the working age population, covid has accelerated millennials migrating away from NYC/LA/SF/Chicago to these "18 hour cities". I believe CIO should be trading at least as high as it was pre-covid, it was only lightly impacted and the future is exceptionally bright for their properties.

Fully agree that business travel will be reduced, making business oriented hotels such as PK less profitable. Sales/project management/etc. still benefit from in-person visits, but Zoom has permanently reduced the amount of business air travel/hotels that will be needed. Sold my whole PK stake this morning (my largest Mar 2020 buy, bought at $6, sold for $22) - had my fingers crossed for months that prices would stay unreasonably high so I could exit with long term capital gains.

[Jussi Askola, CFA]

@Snuffer Thank you for your comment. I think that our opinions on the office space differ less than you might think. I am not one of them who thinks that we will see an "office apocalypse".

But already before the crisis, I disliked office buildings as property investments. This is because they are cyclical and require a lot of capex to keep competitive in the long run and that eats into your returns. Back in PE, that was a recurrent theme. Our office building investments were fine as long as the lease lasted, but we nearly always overestimated returns due to capex.

The covid crisis makes things even worse of course. Now we have many more variables at play and a lot of more uncertainty. I think that this will force property owners to double down on capex to please tenants.

So I am not against investing in office buildings, but it needs to be at the right price, and right now, the discount relative to some other sectors isn't large enough for me.

[Report risk]

I’d say that outlet malls have a strong clothing component which online hasn’t had much luck breaking into. I still buy my clothes in person. No idea why. I buy most other things on amazon though.

[Jussi Askola, CFA]

@Report risk Thanks for sharing your thoughts. Fashion is experiencing rapid growth online. The main issue with outlets is that due to their layouts and location, it is very difficult for them to adapt to the changing environment.

[Petermevans]

Last Saturday I visited Stanford Mall, a Simon property, which is near the University. It’s large and in an affluent area. Stores include Nordstrom, Wilkes Bashford, Gucci, many other names. It was so crowded we couldn’t find a place to park. Many people walking around with full shopping bags, especially Nordstrom. All the restaurants had waiting lines. Seeing this makes me want to buy more SPG and MAC.

[Jussi Askola, CFA]

@Petermevans That's great to hear! Thank you for sharing.

High-quality urban malls will do just fine in the long run as they redevelop space and become mixed-use destinations.

[SnufferBottle]

@Petermevans Stanford Mall is a gem, when I worked in Palo Alto I visited at least once a week without fail due to the mix of great restaurants + personal trainers.

This mall was the reason I bought into the investment thesis for SPG/MAC back in the summer. Class A's are curated, not just a mix of random apparel tenants which keeps a constant flow of traffic.

[onebassplayer5]

Well done and thank you!

[Jussi Askola, CFA]

@onebassplayer5 Thank you for your interest!

[HerrmannBrothers]

Many people are over invested in real estate when you consider a primary residence and often times a vacation home. People’s biggest asset is usually made up of these two concentrated sources of wealth. You should look at your home as part of your overall investment portfolio.

[Jussi Askola, CFA]

Note that housing and commercial real estate are two completely different investments and investors shouldn't substitute one for the other.

[Yulay Bikbulat]

Dear Jussi, good article again! are you still long with MAC?
I am also long with HHC (+60%)

[Jussi Askola, CFA]

@Yulay Bikbulat Thanks for your question. Yes, I still own MAC. Thanks for sharing your pick in HHC. What do you see in it?

Have a great day!

[Yulay Bikbulat]

@Jussi Askola regarding to HHC: Net Asset Value per share is much more higher than market price and well diversified. So I see there is good upside.

Have great day!

[Jussi Askola, CFA]

@Yulay Bikbulat Thanks for sharing. I will take a closer look.

[Liquidors]

I own the favorites. Do you have any further thoughts on FPI, which I don't own, Jussi?

[Jussi Askola, CFA]

@Liquidors Thank you for your comment.

I think that FPI is still undervalued, but slowly approaching fair value. For this reason, we would favor other companies at this time. Feel free to join us for a 2-week free trial to access all our Top Picks: seekingalpha.com/...

Have a great day!

[ozhabesh]

Another good piece. Thanks.

[Jussi Askola, CFA]

@ozhabesh Thank you for your kind comment