13 REIT Mistakes That Investors Should Avoid
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Here are REIT mistakes that investors should avoid.
Due to the Federal Reserve’s aggressive rate hikes, real estate investment trust (REIT) investors have taken a significant hit.
Real estate investment trusts (REITs) invest in real estate, lease it to tenants, and trade like stocks on the stock market. Due to their substantial dividend payouts and track record of growth, they are a favorite among investors.
Even more so than the Standard & Poor’s 500, the typically less volatile Vanguard Real Estate Index Fund ETF took a beating in 2022. It may surprise you that this index has underperformed the S&P 500 considering how frequently it has done so over extended periods of time.
Money, the fundamental building block of REITs, is getting more and more expensive as rates rise so quickly. Additionally, rising interest rates reduce the value of the real estate owned by REITs, and falling property values can cause a REIT’s net asset value to fluctuate even more quickly when debt is taken into account.
Selling your REITs may seem like a good idea at the time, but doing so could end up costing you a lot of money in the long run and making the situation worse than it already is.
Investors in REITs should make an effort to stay away from these common blunders so that their portfolios are shielded from the economy’s downturn.
13 REIT Mistakes That Investors Should Avoid
1. Selling at a Loss
Maybe one of the biggest REIT mistakes that investors should avoid is selling at a logss.
Buying high and selling low are the two fundamentals of investing. Determining whether you’re selling because the REIT has declined or because you believe the market will continue to decline due to fundamentals is important when the market declines significantly, as it has in 2022.
A REIT stock price takes into account the expectations of the potentially millions of investors who are analyzing a wide range of information (vacancies, economic growth, tenant issues, and many more) to arrive at their best estimate of the business’ value. Even though the price may change in the future, investors’ perceptions of the REIT are frequently changed by new information.
The market is frequently good at making future predictions. Unexpected good news can occur, and frequently, it can be attributed to an overall decrease in investor pessimism.
Even though it may seem like the economy is in bad shape, REIT values may rise rather than fall if circumstances change in your favor, leaving you with a sale that was made at a discount.
2. Having A Trader’s Mentality
The majority of people typically realize that they are making a very long-term investment when they purchase physical real estate, whether it be a home, piece of land, or commercial property. It might gain value over time, possibly generate income, and gradually compound its returns going forward.
But for whatever reason, most REIT investors don’t hold this viewpoint. Too many investors trade in and out of positions and put too much concentration on daily market news and fluctuations because REITs are much more liquid than owning real estate outright.
Investors need to keep in mind that REITs are long-term investments that will continue to generate income and capital growth.
To quote renowned investor Jesse Livermore, “be right and sit tight,” it is best to secure a strong position in a strong company at a strong price. By switching positions frequently, you run the risk of producing a taxable event every time.
Furthermore, many REITs routinely increase their dividends, so by selling the position, you risk losing future income gains on your yield on cost and the new position you’re establishing might not have a yield as attractive as the one you held.
3. Disregarding the Growth of Dividends
Today, everyone is concerned about inflation due to the rapid increase in the cost of everything from food to gasoline.
However, inflation is a persistent problem that can significantly lower the value of the income from your investments if your living expenses increase but your income stream remains constant. Due to the fact that interest payments typically don’t change, bonds can be a risky investment during periods of accelerated inflation.
The dividends of some REITs simply stagnate for extended periods of time. For instance, the owner of senior housing, LTC Properties, has not raised its dividend since 2016.
This REIT offers a recurring dividend payment, a high yield of 6.3%, and a recovering portfolio as some of the benefits you might want to consider.
A static dividend might not be as bad as it sounds because some of LTC Properties’ larger competitors, such as Ventas and Welltower, ended up reducing their dividends in 2020 as the pandemic hit.
However, you must keep in mind that when you purchase this REIT that LTC’s dividend’s purchasing power is still declining.
It might be acceptable if your only goal is to maximize your current income. If you intend to hold it for many years, you might want to give the REIT’s dividend policy a little more thought or wait for an even higher yield to counteract the risk associated with the lack of dividend growth.
4. Not Carefully Analyzing a REIT
It’s crucial to thoroughly research a REIT and the sector before taking any action, whether it be buying, selling, or staying put. Healthcare, lodging, apartments, retail, and data centers are just a few of the industries that REITs work in.
It is impossible to apply a “one size fits all” strategy because the dynamics of each of these sectors are so drastically different.
For instance, while lodging and retail REITs might struggle in a sluggish economy, data center and tower REITs might fare better. Even healthcare REITs, which typically experience steady demand, could take a bigger hit than anticipated. Therefore, you must comprehend the dynamics of each sector.
Take these things into account, as well as the more particular circumstances at each company, before deciding how to move forward. Do renters pay their bills on time?
Is the amount of debt manageable? If the economy doesn’t get better, will the business have to raise money in the future? Will the REIT, like a theater owner, do well in the “new normal” economy?
These are only a few of the queries you should think about before acting, of course. Instead of making decisions based on assumptions, let the facts guide you.
5. Paying Excessive Prices For Major Brands
Your safety margin and the possibility of future appreciation are determined by the price you pay for any given investment. In other words, even for a company of the highest caliber, buying at an excessive price can result in a bad investment choice.
Investors may also have the propensity to concentrate on a REIT’s more glamorized features, such as its backstory or properties’ exterior design.
Since price and value are the deciding factors in any investment, a less “sexy” alternative investment may, in fact, have a much higher long-term potential.
According to Warren Buffett, “For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”
However, despite being excellent businesses, blue-chip REITs like Prologis (PLD) and Public Storage (PSA) seem to receive all the attention on Seeking Alpha. The majority of investors consequently end up paying more for these businesses.
The smaller, less-covered REITs are typically where you can find the best values. For instance, despite being one of the strongest in the apartment REIT sector, Boardwalk REIT (OTCPK:BOWFF) is significantly more affordable than its larger competitors.
Just because a stock is popular and everyone seems to be talking about it doesn’t mean you should invest in it. Instead, you ought to work to find the greatest possible value on the market.
6. Concentrating Too Much on Yield
One of the REIT mistakes that investors should avoid is focusing too much on yield.
For income-focused investors, chasing yield is another error that is simple to make. A good illustration of this is Global Net Lease. The dividend yield for this net lease REIT is greater than 10.7%.
Net lease REITs own real estate, but the majority of the costs associated with maintenance are covered by their tenants. That is more than twice what Realty Income, a leader in the sector, would offer, with a yield of only 4.5 percent.
In contrast, Realty Income’s dividend increased in 2020 while Global Net Lease’s was reduced. Furthermore, Realty Income benefits from its low yield because it can issue stock at more desirable prices.
To put it more simply, the cost of capital for each share of Realty Income it issues is 4.5%, while the cost of capital for each share of Global Net Lease is 10.7%. This is significant because REITs frequently turn to the capital markets for growth capital because they must distribute 90% of their taxable earnings as dividends.
The high yield of Global Net Lease might seem alluring, but it actually works against the company. REITs that are better positioned for long-term success frequently have lower yields.
7. Assuming Things Will Quickly Go Back to Normal
It might be erroneous to believe that the stock market will recover any time soon because the Fed is still actively raising interest rates.
Since inflation is still strong, experts continue to predict that the central bank will raise rates for some time to come. Therefore, even great companies will find it challenging to recover quickly in this environment.
The fact that REITs frequently borrow a lot of money to pay for their operations adds to this problem. Homeowners frequently take out large loans to pay for their homes. Numerous REITs will need to refinance with more expensive capital as rates rise and debts renew, reducing their profit.
Longer term, REITs as a whole should be fine, but expecting things to continue as usual right away could be a mistake. Dollar cost averaging may be a wise tactic for this reason as well.
8. Not Realizing REITs are Businesses
One of the REIT mistakes that investors should avoid is not realizing that REITs are companies too.
Unlike simply being a collection of properties, REITs are operating businesses. VEREIT, for instance, was formerly known as American Realty Capital Properties before being acquired by Realty Income. Rapidly occurring acquisitions were used to create it.
However, management overreached too quickly, which resulted in accounting problems and a restatement of earnings. This error led to a complete management team shakeup, a dividend reduction, and a comprehensive portfolio overhaul as new leadership assumed control, even though the overall financial impact was minimal.
After getting back on track, the business sold itself. In essence, the company’s fundamentals were neglected under the previous management because it was so focused on growing. Investors ultimately suffered as a result.
This wasn’t the only instance, though it was a particularly notable one. Investors also need to be aware of other operational issues. For instance, hotel REITs have a one-day effective lease term. Therefore, any economic downturn has a tendency to have a rapid negative impact on results.
Then there is the matter of location, which is now very crucial for mall REITs. Due to their ownership of malls in undesirable areas, several of the big names in this niche went bankrupt during the pandemic.
Overall, REITs are businesses, so you need to know what you’re buying to avoid regretting adding them to your portfolio.
9. Yield Traps
One of the REIT mistakes that investors should avoid is a yield trap.
More and more investors are looking for dependable income investments in today’s increasingly yieldless market. But it’s possible to be seduced into high-yielding investments that can’t keep paying dividends over the long run.
Not all REITs that pay high dividends are unsustainable, but many do have high payout ratios or use a lot of leverage in order to pay a high yield in order to draw in investors. These dividends are eventually reduced, which causes investors to abandon the stock, which causes the share price to plunge.
It is advisable to aim for a yield in the range of 5%-8% for the High Yield Landlord portfolio. A high yield is thus not always cause for concern. To ensure that the company is reputable and that the yield will be long-lasting, you must do your research.
An externally managed high yield REIT, managers who are dilution shareholder equity, and an excessive dividend payout ratio are a few things to be on the lookout for. Most of these warning signs apply to Global Net Lease (GNL), which despite yielding 8% to 10% for many years has had a dismal share price and track record overall. As a result, the dividend has been reduced.
With a yield of about 5.3%, WP Carey (WPC) is a better comparison. The share price is low in this instance, however, so the yield is high. The payout ratio and balance sheet of WPC are both in good shape, and the company has competent management. This may be the reason why over time, its performance has consistently outperformed that of GNL.
High-yielding REITs are therefore acceptable, but you should check to see if the payout is sustainable and not invest simply because of the yield.
10. Allowing Fear to Prevent You from Purchasing Quality REITs
It might be a mistake to refrain from purchasing more shares if you’ve researched the company and the long-term outlook is favorable, particularly if you’re getting a sizable discount from what you anticipate the REIT will be worth in the future. Therefore, it’s crucial to avoid letting fear keep you from a good deal.
That is not to say that all discounted REITs are excellent buys. And as new information becomes available or investors become more pessimistic, even good companies may become less expensive.
For this reason, a lot of experts advise using dollar cost averaging when investing in stocks. You can average into a stock by spreading your buying out in this manner.
Although REITs are renowned for their consistent dividend payments, a REIT will struggle to make dividend payments if it isn’t collecting rent.
As a result, it’s possible that investors have already factored in a substantial amount of the possibility of a dividend cut. But if the dividend isn’t cut, the stock could be ready to rebound higher.
If the fundamentals of the REIT are strong and it can continue to grow in the future, but it isn’t currently priced for this possibility, now might be a good time to buy shares. You’ll frequently need to get past your fear, though. You can dispel any uncertainties by conducting a thorough analysis of a REIT.
11. Overconfidence in External Management
Words are less powerful than deeds. Prior to our conversation, some REIT executives had assured me that they had no plans to issue additional shares, only to subsequently erode shareholder equity.
Contrary to what some REIT CEOs may claim, not all REITs prioritize their shareholders’ interests. The management team of the REITs you invest in cannot be completely trusted. Unfortunately, a lot of them are just looking to enrich themselves.
Because of this, we generally steer clear of REITs that are externally managed. Many of them are actively seeking equity because doing so will increase their AUM (assets under management) fees. Avoid REITs with external management teams and look for those that actually pay out to shareholders.
12. Positions are Being Concentrated, Not Being Diversified.
One of the REIT mistakes that investors should avoid is concentrating a position instead of diversifying.
It can be a mistake to concentrate only on the REITs you already own when looking to purchase them during a downturn. Instead, it might be a chance to purchase some of the successful stocks that previously appeared to be overpriced.
Utilizing the benefits of diversification, you can increase the number of high-quality companies in your portfolio while they are still relatively less expensive.
For instance, some REIT sectors, such as warehouses, data centers, and telecom towers, have benefited greatly from the expanding digital economy over the past few years.
Despite the fact that many of these sectors have fared well, they remain below their 52-week highs. However, the long-term outlook for these industries is still positive.
You can lower the risk of your portfolio and possibly add some high-quality gems by diversifying. Given the significant debt that REITs frequently carry, it also helps to balance the risk of one imploding.
13. Making Hasty Profit Claims
One well-known investing maxim is that “No one ever lost money taking profits.” However, it is advised to exercise caution if you notice a lot of green and are tempted to lock in your gains.
Many made this error early on their investing career by selling their REITs too soon and then watching them rise to higher gains.
Taking profits along the way may be alluring, but you should be careful to avoid rewarding losers and punishing winners, or as Peter Lynch would say, “trimming your flowers and watering your weeds.”
Selling a stock solely because it has increased in value can be just as foolish as selling a stock solely because it has decreased. You should continue to pay attention to the company’s core values. A REIT is not necessarily overvalued just because its share price has increased.
For instance, iStar (STAR) has recently been on fire, but even at these higher prices, it’s still a fantastic investment.
STAR keeps streamlining its operations and reinventing itself as a ground lease pioneer. Selling at this point would be a prime example of selling out too early because of the value’s rising underlying value, which fully justifies the appreciation.
Therefore, if you’re considering selling, stop and consider your options before acting because you might be taking profits too soon.
Long-term real estate investments through REITs are appealing, but during this downturn, investors must exercise caution and walk a fine line between careless optimism and myopic pessimism.
The market’s decline may provide excellent opportunity to position your portfolio for years of superior returns, including a rising stream of dividends. However, you should weigh this potential gain against the risk of loss, particularly if the economy continues to deteriorate from here.
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