- 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.
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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:
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:
- Stocks and bonds are overpriced and risky.
- Real assets offer high yield in a yieldless world.
- Real assets are great inflation hedges in a world of crazy money printing.
- Real assets can be leveraged with historically cheap debt to boost returns.
- 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:
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.
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.
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:
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
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.
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):
How to invest?
You have two main options here:
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.
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
- Skilled Nursing
- Ground leases
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:
We simply cannot find such attractive opportunities in most other market sectors, and this is why we invest so heavily in real assets today.
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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 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.
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.