Today’s episode is an insightful conversation with Brad Thomas, the editor of the Forbes Real Estate Investor publication and a Senior Research Analyst for iREIT. Brad researches and writes on a variety of real estate-based fixed-income alternatives including publicly-listed real estate investment trusts. Brad is the co-author of The Intelligent REIT Investor: How To Build Wealth With Real Estate Investment Trusts. His investment universe includes approximately 100 U.S. equity REITs, mutual funds, and REIT ETFs.
In this interview, we discuss Brad’s due diligence process for REIT investing, the differences between equity REITs and mortgage REITs, and Brad’s new book The Trump Factor: Unlocking the Secrets Behind the Trump Empire. Please enjoy this unique conversation with Brad Thomas.
Full Transcript Below
Nick: Brad I just wanted to begin by giving you a hugely warm welcome and thanks for the interview on the Sure Investing podcast you’re known on Seeking Alpha and elsewhere as an expert on real estate investment trusts or REITs for short.
For a beginner listeners I was curious if you could give an explanation of what is a REIT and why investors should consider an allocation to REITs in their investment portfolio?
Brad: sure well thanks for letting me be on your show today. So a REIT of course is a real estate investment trust. REITs were formed in 1960 – so over five decades of history that we can point to in there in the REIT space. REITs come in many shapes and sizes. Over the last several years we’ve seen a number of real estate products that have made their way to the REIT sector that you normally wouldn’t think of as real estate.
But for example we now have data center REITs, we have cell tower REITs, we have prison REITs, we have practically any type of product that can be defined as real estate now we’ve seen those types of businesses. So it’s a it’s a very broad sector – over a trillion dollars in the US in market capitalization. So I think that’s a big part of the sales pitch for REITs is just these companies have offered diverse categories in property sectors across the country and some of the REITs invest in the US some of invest in the US and internationally as well. We also have commercial mortgage REITs as well as residential mortgage REITs.
It’s a growing sector one of the big laws related to REITs is that they must pay out at least 90 percent of their taxable income in the form of dividends. Most equity REITs pay out a hundred percent and so that makes them higher dividend paying stocks compared to their other dividend-paying C corporations or other stocks.
I think that you know the higher dividend yields is really part of the attraction and of course REITs are publicly traded so that the fact that they’re liquid and offer the ability to sell buy and sell shares every day. As I said it’s a trillion dollar proven asset class so there’s no problem when you want to sell a share you can immediately get your principal.
Also last year, actually two years ago, 2016 REITs were at one time housed under the financials pillar if you will under the S&P index so that we call the GICS and now as of October 2016 REITs really moved into their own new pillar of real estate. So what this really means is that REITs are not an alternative asset class. They’re now validated based on the fact that S&P categorizes REITs as their own universe, if you will, and so it really has forced a number of financial planners, advisers and investors to really understand this the REIT space because it is a it is a core food group as I like to say.
I will say one last thing to get myself a plug. My co-author and I wrote a book late 2016 called the Intelligent REIT Investor that was published along with our Wiley and Forbes and that book has sold quite well. In fact I found out just a few days ago that we have the book now translated in China and so there’s a lot of demand in Asia for the for the REIT product as well so you can find that book on Amazon.
Nick: So tell us about the book – that was actually one of the questions I had written down to talk about later. Now that it’s up in the conversation I’d love to hear more about the book.
Brad: sure so again I have a co-author Stephanie Krewson-Kelly and she’s great. She’s got a lot of experience in REIT and in real estate, she’s been a sell side analyst, prior that she was a Wharton graduate and now she is the head of Investor Relations at what actually one of the REITs I cover called Corporate Office Properties Trust ticker symbols OFC.
But Stephanie and I decided that there was a big demand for this for a book like this that was educational but also could be utilized in the classroom and so this book is really aimed for not only individual investors, retirees or pre-retirees really anyone that wants to understand REITs. But also we make it a little bit more granular in the later chapters of the book and we actually have that book in a number of classrooms now around the country, in fact, some of the some of the highest ranking real estate schools in the country like Georgetown University, NYU, and others now utilize this this book in the classroom.
So it’s been very well received and I was grateful that Marty Cohen who was the co-founder of Cohen and Sears – one of the largest REIT managers in the world – also write the foreword for the book. So we’re really excited and as I said last week we just had that book translated in in China so I’m very excited. I’m actually going to China here in the next couple of months so I’m really anxious to visit the country but also talk to some investors about REITs.
Nick: the title of the book is the Intelligent REIT Investor and it obviously looks like it was inspired by Benjamin Graham’s the Intelligent Investor is that the case or am I miss reading this?
Brad: no that’s absolutely spot-on I mean I you know really part of my investing strategy if you will if you’ve read any my articles as I certainly consider myself to a value investor I’m the opposite of a market timer. And so we pay very close attention is I’m sure you do as well with your with your line of work in underlying fundamentals of companies and really trying to dissect each individual security to determine the appropriate value or margin of safety.
Of course when Ben Graham was around REITs as I said were formed in 1960 so he was still alive. But when he wrote his book which is in the in the 1920s The Intelligent Investor obviously the reach structure at least as it exists in the US was not it was not available.
Quite simply I mean REITs provide the individual investor access to institutionally held real estate in applying that same value investing strategy to our business is really been successful for us and that’s why I titled the book that way.
Nick: Graham’s book The Intelligent Investor talks about how to value securities based on fundamentals like the price to earnings ratio the price to book ratio you know the lower the better the lower those metrics the higher emotion of safety you have.
How would you compare analyzing C corps with those metrics versus the metrics that should be used to analyze REITs?
Brad: the primary jet well there’s multiple differences and again that’s one of the reasons I decided to write this book with Stephanie. but really that when you look at valuation real estate is a little different when you when you compare real estate securities valuation with ordinary C Corp or stocks and that is that real estate has some nuances that that the C Corpse don’t enjoy or don’t have.
They are certainly beneficial but when it comes to valuing shares in a REIT you really need to understand those differences so the p/e metric is totally not necessary when it comes to REITs I mean earnings are critical for any company as you know but with REITs we derive it a little different to earnings metric to determine the measure of cash flow that the company generates and that really boils down to a number of things like depreciation our capex leasing fees.
In order to derive at a pure measure of cash flow or earnings for REITs we look at things like depreciation in capex and leasing cost maintenance and other things to really determine what the actual you know cash flow is out of these REITs or really out of the real estate and obviously then we look at how that translates into their dividend.
And so I think looking at a company funds a from operations metrics which is commonly referred to as FFO or adjusted funds from operations which is not GAAP by the way but it’s referred to as AFFO and we utilize all of those metric in the articles that that I write and also that we have in our newsletter product as well so I think those are you know when you type in Google or Yahoo Finance and you go look at a stock generally you’re not going to see the FFO or AFFO data.
So that’s what really in you know important for investors to to recognize those earnings metrics. Another different way that we value REITs shares and I’m not as a bigger proponent of this as say some of the institutional investors. But that is the net asset value are NAV nav and that is simple is really much like getting an appraisal on your home or on a commercial property.
It’s a simple simply taken a the assets off of the REIT balance sheet subtracting out the debt and other preferred or what have you and really arriving at a cost per share. Really what I would refer to as almost a liquidation value for you know for the REIT and so that’s another way to value REITs.
Again I’m not as much as I won’t say fan NAV certainly so it has its purposes and from time to time you know I’ll do in a these own companies like Ladder Commercial is a good example which company that recently had a takeover offer I guess you could say and a lot of investors wanted to know what the actual value of the company was if it was sold.
From time to time I’ll look at those underlying valuations of those companies and then I think the third metric which is pretty common for most for most investors is the dividend yield itself and how the how the yield compares with the peer group and with the sector the REIT sector and then overall.
I think usually when you see me go into a deep dive on one particular stock or REIT I’ll usually try to address the price to funds from operations as well as the dividend yield those are kind of the primary indicators evaluation and again from time to time we’ll look at the NAV if necessary.
Nick: and would you say that your aversion to using NAV as evaluation metric is due to its reliance on external appraisals?
Brad: no I tell you on the NAV what I typically do is you know my background is in real estate and I’m not a good appraiser at all. But I usually I do have a pretty good grasp on cap rates and really I should that’s part of my job so sometimes I’ll rely on cap rates from other analysts but I like looking at the individual properties themselves. because a lot of times you can’t paint all the you know properties by the same brush in other words you know I like to break out if say for example it’s a shopping center or a mall I like to determine you know here you know maybe the a B and C bucket so these are the highest quality you know shopping centers and you would apply you know a cap rate on that you know basket and then the same goes for the B basket and the C basket.
I’d like to I like to break down the various properties because you know again each portfolio is not going to have all of the same you know ingredients and so but yeah I mean I’ll usually like to come up with my own cap rates using market data it’s at all possible.
Nick: you talked about your preferred valuation metrics being price of funds from operation or price to adjusted funds from operations and then the company’s dividend yield.
How would you say that funds from operations and adjusted funds for operations are different than GAAP earnings or adjusted earnings for investors who only have experience investing in equities?
Brad: sure so I wrote an article in Forbes awhile back explaining the difference in funds from operations and adjusted funds from operations not all companies will report the AFFO metric because it’s not you know GAAP but all companies do report the FFO metric.
Really the big difference here is in an AFFO basis there’s a couple other subtractions that you would look at to arrive at that that final number things such as capex you know and leasing fees.
And so for example you know you may have like an office building that just for round numbers generates you know a dollar per share but in FFO but say this company has a large number of move outs vacancies and it has some have to reinvest money back into to bring a new tenant in so it would cost money in terms of some capex and leasing forget to pay leasing brokers.
When you subtract off those numbers and they’re there they’re certainly lumpy because you don’t know when those tenants are going to come and go but that actually that that would take out or subtract out those expenses from your FFO to arrive at a pure measure of funds really funds available for distribution.
Which is another term we use called FAT we’re putting together a glossary now a lot of these terms because investors it is really confusing there are a number of those confusing terms in the REIT space.
But in terms of that that’s really AFFO is really the best metric to use because it is the purest measure of cash flow per share and you could when you compare that to your dividend payout and let’s say using that same example that the office REIT has a dollar share and FFO but after these expenses they’re down say 20 cents to say an 80 cent AFFO.
Well if the dividend is say 90 cents a share then you can see that this company is paying over a hundred percent of their dividend is paid out AFFO. So there’s not enough real profit actual earnings to pay or cover that dividend.
It’s really important to drill down to the you know to the cash flow FFO does a pretty good job because it really takes out depreciation which is one of the big I guess differences between regular earnings and funds from operations. But it’s really important to really peel back the fill back the onion and determine which of these companies pays out you know the actual cash flow for the property itself.
And when you do that you can see a number of companies that may look they may look safe on the surface but when you dig deeper and particularly taking a look at the AFFO metric and some of those expenses that I mentioned then you’ll see that there are there’s some there’s some potential danger involved.
And that’s where we come up with word sucker yield and you may have seen that in some of my articles all right on that a quite a bit but that’s simply a yield is too good to be true because nine times out of ten that that company is not generating enough AFFO pure cash flow to cover its dividend.
Nick: do you have any examples of sucker yields in today’s REIT market?
Brad: yeah just wrote on a couple last week so one that comes to mind is New Senior ticker SNR and we were a buyer of that of that particular REIT a while back. it is externally managed this company in there in the senior living space.
But we’ve seen an erosion of earnings or FFO you know now the company is really close to a hundred percent payout and they’re still declining a senior living model is experiencing more of a cyclical event in in the healthcare space. And I think we’re starting to see that come back to life but this particular company a New Seniors one that’s really tight.
Another one that’s tight is Washington Prime again if you that’s WPG small mall REIT they also in a few shopping centers as well. But that company is from an FFO basis they’re not that bad but from an AFFO basis they are getting tighter and have the highest payout ratio in the mall peer space.
Couple others that really helped me guide me away from danger were a few years ago I wrote on a company called Wheeler which is a small shopping center based REIT based up in the up in Virginia and they’ve now cut their dividend twice but you know they were almost chronically paying out more dividend than they could earnings.
And so when you look at that payout ratio that really is a pretty good indicator that the company could you know could cut the dividend and so we saw what happened in 2009 and you know really coming out of the recession most many of the REITs were forced to cut their dividends during that period.
So it’s been really valuable for us to look these companies since 2009 to see how they have really managed that risk and hopefully not you know cutting that dividend again.
So again the good thing about the reach space is there is a lot of history that we can rely upon to determine kind of when the cycles are going to occur. And I’ll also say that you know one of the things we do look at really closely is supply and demand of the underlying real estate. Because when you look at these cycles as I alluded to earlier with senior living.
But you can look at the you know kind of the life cycle if you will of each of these sect property sectors and that really gives you a pretty good indication of whether you want to you know buy into those sectors now or not and that’s part of our strategy is we put together tactical portfolio modeling is to really try to find the best sectors to invest in now that have the best chances for continued earnings and dividends over time.
Nick: Are there sectors that particularly stand out to you as being really appealing in terms of earnings growth and dividend growth for the foreseeable future?
Brad: yeah I think there is I think you know retail has obviously been hammered and you know I think the you know the breaking news is that you know malls are dying and retails dying and Amazon’s going to own everything.
But the reality is there are some really high-quality real estate REITs out there that that are continuing to grow their earnings and dividends Simon Property is a good example of that ticker SPG one of the largest REITs in the and the that we cover and Simon has consistently been able to grow their FFO and their dividend your earning year out.
They did cut their dividend in the last recession but they actually paid out stock instead so a little bit of compensation some would have preferred the dividend. But Simon has done a really great job in their balance sheet as A rated you know they’ve got a very diverse portfolio so when you look at the pillars for you know for investing I think when you know that the primary two that we look at are the cost of capital which Simon has exceptional cost to capital as well as the diversification in Simon has arguably the best diversification the mall reach space today.
I like those I like the I like those and on the shopping center side I would site Kimco they just also announced their year-end and fourth-quarter earnings and they’ve done extremely well and again these are higher quality companies and so those are the kind of stocks that We like recognizing the the miss pricing that we’re seeing in the market as it relates to retail.
Another sector that I like but you have to be cautious is healthcare again you I mentioned earlier this senior living and then the cycle of senior housing as well as skilled nursing. But you know I believe that if you maintain some tactical diversification within health care you can you can do well.
I just wrote an article today on Ventas and ticker VTR which is the one of the largest health care reach of course they’re diversified across most all sectors. However what Ventas has done very well is they were able to manage their risk and avoid the pain of the skilled nursing space that’s when they’d spun off Care Capital Property Trust and they have really been focusing on more defensive health care sectors such as medical office buildings in life science.
And so you know I like health care but again you got to be careful of those more dangerous sectors. You know net lease has always been a favorite asset class of mine it’s not it’s not an asset class that’s going to always outperform and currently right now it’s underperforming.
Given the you know the right fear of rising rate environment that we’re living in a number of these net lease REITs have traded off year today I think this the net lease sector is probably the third cheapest sector there is today and it’s really irrational in my opinion because REITs have performed very well and they’ve been very consistent with their earnings and dividend growth as evidenced by the latest earnings results of Realty Income last week.
And so net lease is one of those sectors again that I would argue would generate somewhere in the range of 10 percent total return per year that that would be comprised of roughly a 5% dividend yield and 5% growth and the cumulative is 10 percent annual returns.
And so while that is not you know very glamorous for some having a very stable company in the portfolio that can consistently knock down you know 5% yield and 5% growth is very attractive as far as I’m concerned.
Nick: for our listeners that are unfamiliar with the term could you explain to us what a net lease REIT is?
Brad: sure so when you’re driving to work or driving out to the grocery store you’ll pass by McDonald’s and in Walgreens and a number of these free-standing properties and so I used to be a prior to what I do today I was a net lease developer I used to build stores for companies like Advance Auto Parts and O’Reilly Auto Parts Walgreens and CVS.
And so I’d like to tell people what a net lease really means is that you don’t have to the landlord is not responsible for what I call the three T’s and that’s the toilets, the taxes, or the trash. but what that really means is that the tenant is responsible for the three T’s for all of those necessity all those expenses the taxes and the insurance the management the maintenance .
So for example if you owned a Walgreens drugstore net lease then you’re use the landlord where to collect a rent check and the Walgreens would be responsible for paying the taxes insurance and maintenance any upkeep on the property.
So it’s a net that’s why we have the three net net stands for the taxes when that’s the insurance and one net is the ongoing maintenance.
Nick: interesting you also mentioned that certain rates have been hammered as rates begin to rise.
How do you expect REITs to perform in general in a rising interest rate environment?
Brad: well when we look at history you know we can see how REITs have performed and they’ve actually performed well you know I think the you know it what’s really interesting is when we look back at May of 2013 when the when the when the Fed just announced they were going to increase rates and we saw that reaction in May of 2013.
But think we call taper tantrum here and it was a pretty big sell-off in number of investors including me took advantage of that sell-off and really started physicians you know in in the REIT space and so now we’re kind of seeing that you know that cycle you know we had that psych cycle happen though you know time and time again. I certainly was not suspecting to see you know the sell-off we’ve seen year to date with REITs in the fear of rising rates.
But again I think the the fundamentals are strong and again it is always recognizing that the earnings growth is really what’s going to move the market and in the long run. I’m we’re really maintaining obviously coverage on the REIT space but also believing that eventually the market will understand what REIT really do.
And if you really look back really on both sides of the of the rate discussion one of those being you know how are the REITs going to respond to rising rates and remember most of the REITs have been deleveraging and really focusing on a fixed rate balance sheet going all the way back you know it’s really 2010 2011.
I think when you look at you know REITs today I don’t expect many of these companies will we’ll see you know any immediate danger as it relates to rates that are increasing within their within their debt. again most of them have deleveraged we’ve seen a number of companies that have actually improved their credit profile over the last several years and I’m anticipating another a couple several other companies perhaps will even see A rating in the next year or so. And I’m referring to Kimco and Ventas is those companies that are really right at the goal line for an upgrade to an A rating.
When you look at the companies that are you know considered high quality you know they’ve really been able to manage their debt very well. So when you look at it on the other side which is the tenant side and well these tenants be more strained due to due to rising debt.
Well first off look at the shorter term leases mainly the hotel space and the cell storage space you know hotels adjust their rents overnight. So they’re not really they really have have the less the least you know impact to rising rates.
Same goes for self-storage they can adapt to a rising rate environment rapidly given these are shorter term leases. so when you get out to the longer duration leases like the net lease REITs that I mentioned again that’s where we’re part of the misconception if you will because you know these companies they actually do have rent growth they that the market perceives them to be bonds they the market perceives them to be you know long-term leases that have no rent growth whatsoever.
But that’s part of the misconception because most of these companies do grow their rent by at least got lease escalations. So for example Store Capital take our STOR which has some of the highest annualized rent growth in the REIT sector which is around two and a half percent. They’re able to obviously leverage that using leverage and can get their returns up to you know to closer to four to five percent without any acquisitions.
And then you look at companies like Realty Income and two-thirds of Realty Income comes growth is external which means acquisitions and so Realty Income just announced last week one point roughly 1.5 billion dollars think at the high end of acquisitions for 2018.
When you combine a company that can grow without acquiring it’s a you know three to four percent and then add to that the external lever which in the case of Realty Income is 1.5 billion a year of new investments that are highly accretive they have the lowest cost of capital in the in that sector.
They’re able to generate you know very favorable growth so I think you know where we’re seeing this connect misconnection today with especially net lease REITs is that they aren’t bonds.
You know this is we’re not buying Walgreens or FedEx or Walmart bonds that are yielding 2 to 3 percent you know we’re buying a diversified bond portfolio that has rent growth. So you have a real income that generates their yield is around you know five point one percent somewhere in that range and they can also generate you know growth of around four percent.
So that’s kind of how I see this market today there’s a little confusion still out there and again that’s creating excellent opportunity entry opportunities for investors in the space.
Nick: so short story is you’ll think you think REITs will be fine even if rates rise it’s just part of the cycle.
Brad: absolutely no question about it you know again it’s just it’s an irrational behavior and that’s the time when you go in and buy these companies and eventually you know the fundamentals will prevail and you know the last you know earnings period that we’ve just are going through right now it really validates that.
We’ve had most of the companies that have an out on earnings growth for 2018 so I think that’s really the best evidence we have right now.
Nick: rising rates is one of the big stories in the markets right now with another being the recent tax reform. How do you anticipate that this tax reform will impact REIT investors?
Brad: it’s going to be huge, I guess full disclosure I serve on the president’s campaign advisory board so I’ve been very involved really from the beginning in terms of president Trump’s agenda his tax reform agenda.
I’ve been involved with several people close to the White House and watching this unfold. So I think what I what I was not anticipating and I don’t think a lot of people are anticipating is the positive impact to REITs but also commercial real estate.
First off you know commercial real estate as you know we have in the US several things that that have been advantageous for us one of those being the 1031 exchange law. Which has been created almost 100 years ago and there was some there was some skepticism over whether or not that law would change.
But it did pass there are some changes to that law which prohibits exchanging now and just say art or airplanes but real estate which is really how why this law was created is staying on the books and I think that’s huge for not only individual investors but also REITs.
Because reach use a number of 1031 and again these 1031 eventually the taxes get paid. But it is a way for a company or an individual to defer the taxes enroll and create more wealth by investing into a light kind piece of real estate.
I think the other things that have really been beneficial is the text the corporate tax reform in itself there have already been hundreds and hundreds of companies that have announced they are going to redeploy their capital into new machinery and new equipment in employees. And obviously those three things new buildings you’ve got to have buildings for machinery equipment and new people.
And so I think you’re already seeing a number of of retailers for example who are expanding their business as it relates to their beneficial tax reform treatment. So I think that’s certainly a catalyst for a number of sectors and I think it’s going to continue from the individual perspective.
We’re also seeing it in in sectors such as hotels where demand should escalate as it relates to more disposable income that’s being cycled through the country and retail as well. Number of people now another of number of Americans are are seeing now that disposable income and in the terms of their tax reductions.
I think overall that’s been a huge catalyst and then I guess the last thing which was unexpected is that now the tax rate is now being dropped to roughly twenty percent from 39%. You know obviously will not impact someone in a tax advantaged account like a 401 K.
But for family office investors or for you know high net and were net worth investors who were depending on that that dividend income that’s a huge extra that REITs are going to be treated in the same in the same spot light if you will as some of their closest peers.
I think overall I think tax reform is very beneficial I infrastructure which is next is going to also be beneficial to REITs there a number of REITs now that have infrastructure platforms in place and I think REITs will definitely be beneficiaries as the public-private partnerships unfold and you know we start to see evidence of the infrastructure plan unfold.
Nick: do you have any suggestions for investors who are looking to learn more about the tax reform and how it’s going to impact their investment approach?
Brad: um yeah I’ve written a number of articles on that. Number one number two you know Nar REIT is a great source for investors and that’s the National Association of Real Estate Investment Trusts.
So you can Google NARREIT number of articles they’re written by some of their economists that they’ve done an excellent job and they’re just a great lobbying company for REITs in general and I think that was a big reason why reach got such beneficial treatment as it relates to the tax reform. And does those really kind of my first my first two places. But absolutely I think you know you know I’ve gone through a number of these earnings transcripts over the last couple of weeks and know quite a few CEOs are really talking about tax reform as a catalyst for their company and I really think that’s going to be you know a good reason for investors to really jump in now.
Even though we’re seeing this interest rate you know volatility I think now is certainly a good time and you know tax reform is absolutely an undeniable catalyst for most of these REITs.
Nick: we’ve talked a lot in this discussion so far about the different categorizations of REITs whether it mall REITs or shopping center REITs or retail REITs or healthcare REITs.
Another important categorization of REITs is equity REITs versus mortgage REITs. Could you talk a little bit about the differences between the two what the trade-offs are and whether you prefer one class over the other?
Brad: sure and I guess first off before we go into the mortgage REITs let’s go ahead and bifurcate that into two different mortgage REITs.
You have commercial mortgage REITs which really are more like banks they’re like the you know the commercial banks that that that lend money to on or on you know commercial real estate and then you have the residential mortgage REIT which are higher risk and because they have typically these REITs have substantially more leverage and it’s a totally different you know business model.
So we tend to shy away from the mortgage REITs that you know the residential mortgage REITs space. because of that leverage which because that volatility there are some prefer we do cover the preferred fairly broadly and there are a number of preferreds that we do you know like in the in the mortgage REIT space.
But all in all I think the two sectors we cover really extensively or the equity REITs and then the commercial mortgage REIT. And so you know we like we like them both commercial mortgage REITs are really more like preferred. You know we don’t use the FFO metric because they don’t own real estate they lend money on real estate.
Again it’s the reason mortgage REIT versus equity REIT and so you know typically we’ve seen a number of new companies that have come out and listed shares over the last 6 to 12 months I just finished up for our Forbes newsletter the mortgage REIT article and I think we’ve got now 12 roughly about a dozen commercial mortgage REITs in the US that we cover.
And those are yielding anywhere from you know from probably the mid seven and a half range all the way up to maybe the ten to just above 10% range. So they are higher yielding and obviously these companies pay out about a hundred percent of their of their core earnings. You know again they really function more like banks and one of the biggest ways to analyze a commercial mortgage REIT is credit risk. Because really what these companies do is they manage their credit risk within the portfolio now as they make loans they don’t like defaults.
And so it really boils down to how good is that company in and analyzing their underlying you know credit on the equity REITs I’d I mean as I mentioned earlier with there are just a growing number of sectors and sub-sectors and you know that we cover and that’s great because you know it provides our readers and our investors and subscribers with access to really broader portfolio management tools and really trying to find you the best companies to own.
One of the secrets we’ve really been successful at here of the over the years is a portfolio we call the Durable Income Portfolio and the way we’ve modeled that portfolio is pretty simple.
It’s I kind of call it it’s the anchor in the buoy model and what I mean by that is we anchor the portfolio with roughly 50% of REITs that that have more long-term lease attributes. So primarily this would be net lease REITs and healthcare and those have been arguably the most predictable you know paying stocks because of those long-term leases and by weighting those 50% we kind of got a very solid anchor and we’ll even overweight you know that portfolio may be too closer to 60%.
That’s the anchor component the buoy component or is basically everything else it’s the companies with shorter term leases that we believe will generate you know higher returns than 10% because they have you know especially if we can get in there if we could you know accumulate shares the right time in the recognizing that certain these sectors may be out of favor for whatever reason.
Whether it be hotels whether it be shopping centers whether it be data center again pretty much everything except net lease in healthcare we try to go in with at least a 50 percent or less that’s the buoy component. And by combining you know those names last year we generated returns of around 12 and a half percent in the durable income portfolio that was about 30 stocks so we’ve got a pretty broad composition in the portfolio.
But again diversification is one of the best risk mitigators and we were able to really you know find those sectors that that we could we could own and you know retail was tough obviously last year it pulled everybody under but we were able to mitigate a lot of that retail risk because we diversified into other sectors like industrial or like cell towers and like data centers which really outperformed in 2017.
I think that’s really important to not you know I tell people all the time not just to own you know one REIT five REITs or even ten REITs but really make a conscious decision to build a portfolio that’s a long term you know portfolio just like you would with your investors overall.
Nick: talking a little bit about portfolio management. what allocation would you recommend most people give to REITs is it ten percent 20 percent 50 percent or does it really depend on that individuals goals?
Brad: yeah I think you know obviously the disclaimers there you know each investor has his or her own risk tolerance. But I would say you know 10 to 15 percent I mean it depends on what stage you are in the game if you’re just getting in today I would even argue because we’ve seen this kind of irrational sell-off in the quote that margin of safety in in the market today.
I would even say maybe fifteen percent would be appropriate given what we’re seeing with the fundamentals today. Now I have a much larger exposure I tell people all the time and this is what I do just like you know your core of confidence I know mine. So I’m not all in that I’ve got a fairly you know out sized position in REITs today.
But again this is what I this is what I do and I should have but for the average investor I would I would argue you know 10 to 15 percent would certainly be a regional composition and keep in mind that does not include your house or your rental house or any you I’m referring just to REITs in general.
Nick: talking about physical real estate you mentioned earlier on this call that you had a previous career as a commercial real estate developer which I did not know. I’m curious as to when you first became interested in real estate and when and why you made the transition from owning tangible real estate to investing and analyzing REITs?
Brad: sure well you know I always first I’ll tell people always try to maintain bipartisan comments as it relates to investing. But I’ll say that we’re how you asked the question so I’m going to answer it.
When I got it at college I read this book called the Art of the Deal and so that gives you my age that book was published quite a number of years ago about 30 years ago and you know I remember my first job I was sitting in the cubicle leasing space and I read the Art of the Deal it was an inspiration for me to become a developer. Not necessarily be like Trump but to certainly create wealth in real estate and that was really what that original book was all about the Art of the Deal.
So you know I became a leasing agent a number of years later I just to roll up my sleeves and become a developer and started with one Advanced Autoparts store and probably you know 1990 and then I built close to a hundred stores for Advance Auto and Blockbuster and Hollywood Video and a number of other single tenant properties.
I found out that you could actually build a you know put two or three tenants on a piece of property use the economies of scale and make more money so I started building a little shopping centers for Blockbuster Video and Payless Shoes.
and then I started to add on more space because I could see the margins get better when you could add more to it and hence the shopping center platform and I started building shopping centers for companies like Walmart a number of grocery stores and then I got into some industrial space and kind of touched on all the major food groups. So you know once you once you know get in real estate I guess its part of the as part of your DNA.
Both of my parents were we’re in real estate my mother still is and you know it’s just a great way to build wealth but I also went through some painful lessons right before the recession and really leading into the recession and I lost a considerable amount of money as it relates to poor economic conditions or bad partnerships and number of things.
And so when I came out of that again the recession officially ended in 2009 I started writing on Seeking Alpha in 2010 so it really last eight years you know kind of learn from those mistakes and you know nobody likes losing money and so I try to consistently remind investors that really the number one rule is to protect principle at all costs.
And so by giving you know by creating this platform and being the voice in the REIT space you know I hope that my you know my service is valuable for people because you know I certainly want to see them succeed in real estate. Recognizing that REITs have something that’s really unique and that you know having this as I alluded to earlier the liquidity the being able to sell shares I couldn’t sell a shopping center in 2000 2008 there were no buyers.
But certainly REITs or liquid their public traded so you could you can sell at any time REITs have diversification which I didn’t have great diversification when I was out as a developer and you don’t have the transparency that you have with you do with public company.
So when you collectively look at the attributes of REITs you know I mean I love real estate I think REITs offer the best of both worlds. plus most importantly you get professional management and this is why I spend a lot of time with a number of management team CEOs GFO CIOs really -to see how they perform and how they’re managing risk.
Those pillars that I mentioned earlier the cost of capital pillar of the diversification pillar I want to see how they’re how they’re able to succeed so I think when you look at collectively all of that I mean REIT there certainly deserve to be you know a core asset class and I’m glad that I was able to really go through these painful losses.
Because if I hadn’t I probably would be doing what I’m doing today and by the way I did write a book just published it in October 2016 just as the election was winding down called the Trump Factor: Unlocking the Secrets Behind Trump and that was basically that book has allowed me to visit all his properties in the world and really come up with my own net asset value or NAV on President Trump and the brand of Trump.
Nick: so there’s been lots of people who have questioned his net worth figures because he hasn’t published his tax returns. So it sounds like your book is an authority on Trump’s net worth would you mind giving us your figure is that secret is only for the books readers?
Brad: no and absolutely not it’s available in Amazon but I’ll have no problem that essentially you know the hard assets. I’ll call them so this is all the properties the golf courses the hotels and office buildings and other assets.
You know that we had those valued at tag that roughly six billion total sic between just over six billion and again I mean we looked at comparable properties on each market so in obviously in Manhattan you know we looked at assets like 40 Wall Street and his trophy property there on Fifth Avenue. But those we looked at those comps in great detail. He also his partners would suit with a REIT called Vernado into one in Manhattan and one in San Francisco.
And then you know looking at all the golf courses I’m no expert in golf nor am I a good golfer so I was able to partner with a leading golf expert who sells golf courses all over the world and we came up with the valuations of all the you know international and domestic golf courses. It’s interesting that you know his golf courses are certainly unique to many others they are all branded by Trump but they all enjoy really hiked the high barrier to entry real estate attributes.
So Doral for example which President Trump required for around 150 million. You know we had substantially more equity in that deal just because of the real estate 800 acres located you know within a few minutes from the Miami Airport. Just these types of attributes that you see but they all really lead to one thing they’re all very high quality even the latest development that he opened just before going into the White House over in Washington DC the hotel I visited the hotel throughout the construction process.
but looking at the location of that real estate it’s irreplaceable and so adding up all of those pieces you know we arrived at around just over six billion dollars of value after debt and we went through every property at the debt level to see exactly what debt he did have and it was actually surprising to see that low leverage.
He certainly had learned his lessons from his difficult times which was basically in the late 90s and early 2000s with the casinos few other things investments. So now he is you know he has certainly become a more risk averse investor at least before he was in the White House and so the low leverage was great to see.
But the brand that the brain was a hard piece really a hard chapter for me to write arguably I mean he was he was running for office it was in the primary I was trying to find a publisher and I think I went to at least a dozen publishers and or literary agents and nobody really wanted to publish a book on the brand of Trump and what that was real suggesting is that nobody really believed he was going to win.
And so um the remarkable thing is I went ahead and wrote the chapter I did find a publisher I now self-published the book by the way I just have a new addition out now on amazon was on so I had to write a very consider subjective chapter recognizing that he could win he could lose.
But certainly a brand was going to impact that you know it was be impacted by whether he won or lost and I remember having a conversation with President Trump before he before he before he won this was probably maybe in just a couple of months before he before the election. And we were talking about the brand equity he actually asked me whether or not you know he should run for president and I remember the remember responding to him I said well I can tell you that the you know your real estate is going to be worth the same in a year from now than it is today.
Arguably it’ll be worth more because the market you know because market cycles I said but your brand you could lose it all I said you know so what you’re really betting on here is if you win your brand could be worth a lot more. But if you lose you could wipe out any brand equity that you have generated and I knew what that brand X I knew what I was going to include because I’d come up with some with some data quite well quite a bit of research on how to value the brand of Trump.
But of course I’ve never valued the brand of a businessman who became the president of the United States. so I didn’t have that information but I felt compelled to go ahead and include it in the book and do the best I could and I think if you read the chapter today it hadn’t been it has not been edited since the original version of the book which was published in October 2016. That chapter is the same and the brand is the same and basically what I said is you know he’s argued that he was worth 10 billion.
I’m have hard assets valued at 6 billion I could certainly see a four billion dollar number or larger especially if you look at the value of names like Ford and look at how the Ford brand has developed or perhaps look at the Richard Branson Virgin brand. Because there weren’t many brands that I could really go to that I could you know use as a direct peer group of Donald Trump and the Trump Organization.
But now he’s in the White House now we’ve got a you know a president in the White House and so I think you know that that’s an interesting exercise and I think I’m writing another book now about the way that that I’m really excited about. But um but I think you know the answer question is I gave him every bit of that ten billion and I think now he’s in the White House I think I certainly can prove the you know the brand equity of not just Donald Trump but of the you know of the Trump brand and the generations and the generations and the generations of trumps.
So I think that’s really the important takeaway here again I know this has nothing to do with investing but you know again as I said I try to try to bifurcate my political views. But he is in the White House and he’s doing a good job and the corporate tax plan is working infrastructure is working and you know I think he’s doing a great job and that’s one reason I served with the capacity on his campaign advisory board today.
Nick: awesome well thanks for that elaborate explanation that’s really awesome in for someone like me who doesn’t have that much knowledge about Trump’s net worth that was very interesting.
I thought we could close up by asking a few more fun questions. The first one I have is do you have any mentors who have had an outsized impact on your decision to pursue REIT investing in research full-time?
Brad: yeah I mean there are a number of REIT CEOs again before I was an analyst I was a developer and I built you know shopping centers for uh a lot of net lease probably at least than anything. And really to names come to mind in the reach space and really I’d say three one of them is Tom Lewis.
Tom was the former CEO of Realty Income today he’s retired and he lives in Hawaii with his wife and Tom and I had you know I’ve known Tom since he was um you know since I was a developer which is a long time ago and I used to sell stores to Realty Income and Tom has been an excellent mentor for me because he’s taught me a lot not only in the REIT space but really Tom before he was at CEO Realty Income he was in work for a company called Proctor and Gamble.
There’s a little bit about marketing and really if you look back at it and how at Tom’s you know marketing capabilities at Procter Gamble and his leadership capabilities at Realty Income and what he’s been able to do when he was at the company what Realty Income is doing now I think that is Tom is definitely one of the one of the best that probably the other one would be Milton Cooper over at Kimco.
Milton was the co-founder of Kimco. I know Milton pretty well um he’s still very active in the you know in the REIT space. he actually is on the board of Getty I didn’t know that till I wrote an article on Getty yesterday and but he’s also still obviously on the board and one of the largest shareholder in KImco. But Milton is great and just has an amazing knowledge in the retail space.
And I think finally is Debra Cafaro. Debra is the CEO of Ventas arguably one of the best CEOs in the REIT sector and maybe overall. Doing a splendid job I just wrote an article and hopefully it’ll pop up here any minute on Ventas and you know I think those three really in terms of managing risk and really you know you leveraging those pillars that I mentioned the cost of capital and diversification pillar.
Managing the capital for the best you know interests of investors and helping investors protect their principle at all costs I mean those three really to me sum up you know the best of the best in terms of leadership and people that I would certainly mentor moving forward.
Nick: this next one’s not necessarily about investing but it’s a question that I like asking people anyway. What’s the kindest thing that anyone has ever done for you?
Brad: the kindest thing oh wow well I’ll say I don’t know this this may this odd but about six months ago I was doing a hit on five on Fox and Friends quite a bit I was doing a hit on Fox and Friends.
And my daughter was with me my oldest daughter I’ve got five kids my oldest daughter works for CNBC her name is Lauren Thomas it was early in the morning and we were she was at the studio with me. she was going off to work I had just finished a interview of at Fox and my daughter said hey I bet I bet the president will tweet you and I said to her I said well you know maybe I doubt it he’s too busy to tweet you know and I didn’t think I did a great job you know on the you know so I’m really expecting it.
So a couple hours later she goes to work I go to work I was I had a meeting in the Chrysler Building and I never will forget where I was standing when I got the phone call it what a tweet it was a phone call from the White House and she said can you hold for the president and you know I had a had a great you know 15 minute discussion with our president.
That was probably one of the kindest things he didn’t have to do it there’s a lot going on in the world then having to call up you know his friend but it was great to hear from him and again I think you know you know you look back at my career it kind of where I’ve been and you know it’s just been an amazing has been amazing to see this and you know I’m just glad to do what I can do for investors.
You said I have no interest in in the politics whatsoever my main my main job and what I do every day is I want to wake up and really help investors you know create wealth through real estate and that’s really my number-one objective.
Nick: awesome and this next one’s more of a philosophical exercise than anything else. I know you practiced a pretty high level of diversification so this will go against your very nature.
But if you had to liquidate your own personal investment portfolio and rebalance to just five core equally weighted holdings so 20% each what would you own and why would you own them?
Brad: you saying core within the REIT space or outside REIT base?
Nick: both is it can be some REITs or all REITs and no REITs actually up to you.
Brad: I would say you know I would definitely diversify I would say REIT because I mean to get I don’t know I’m not an expert in in you know outside of my space and I believe circle of competence is key and so I would steer you know within that within if I sold it off the whole 35 stocks only today REIT and I said when bought five I would diversify those five across sectors. And so I would have Realty income again ticker O there’s 20% I would have Simon Properties SPG malls and there’s a big difference between by the way I just wrote the article in that days a big difference between malls and Realty Income we can save that for another day but Simon Properties Realty Income been tossed VTR take her VTR that gives my healthcare exposure my mall exposure my net lease exposure.
I would like to get a hold of data today digital may be a little pricey but you know for over the long term you’re fine the company generates very consistently five six percent annualized growth nice dividend so I put Digital Realty in there and probably would put in American Tower and that’s ticker AMT and it’s funny because I if you take those top those letters there’s ticker symbols and add them up there’s three letters and that’s also that the file excuse me five letters and there’s the five letters of what I call the Davos portfolio which is my FANG version for REITs.
So it’s Digital American Tower Ventas Realty Income that’s the O in Simon is S. So I’d invest right now today I put them in Davos and go to sleep at night.
Nick: awesome well thanks so much for taking some time to talk with us today Brad. I know I certainly learned a lot of them sure most of our listeners can say the same so thanks again.
Brad: you bet. Thank you.
Nick: thanks so much for listening to today’s episode everyone I invite you to check out our website at sureinvesting.co see our premium and investment research at suredividend.com and also check us out on YouTube where we publish videos under the name Sure Dividend.
See you next time!