The global health crisis has been terrible—that much is clear. In addition to deaths and serious health concerns, economic damage has been substantial. Stock values have plummeted as investor uncertainty has risen. The same is starting to happen with real estate, which tends to lag a bit behind the general stock market. Commercial REITs have already been hit pretty hard by the market drop, and likely have a lot more room to dip.
This will create a big buying opportunity for those looking to add to their real estate holdings, assuming it’s not one already. But maybe you are not comfortable with buying real estate directly since you do not want to manage the property yourself or have to worry about hiring a manager. Or maybe you want to get into high quality, commercial buildings without needing to fork over millions of dollars.
In order to capitalize on this opportunity, I have created a portfolio on M1 Finance geared towards getting a broad exposure of the real estate industry. You can start buying fractional shares of many different real estate companies to start diversifying your real estate portfolio with little effort. It’s organized by its different sectors (i.e. apartments, retail, office, industrial, etc.) so it can easily be rebalanced to your risk preference. You can actually copy the exact portfolio by using this link. I’ll explain the holdings in detail later so you can make your own, informed decision.
Of course, I have to emphasize that I am not a financial adviser and this article should not be taken as financial advice. I could be 100% wrong, or 100% right, or 50% right and wrong. Only time will tell. Either way, you should carefully consider your options before making any investment decision.
Without further ado, let’s talk about real estate.
What’s Coming for the Real Estate Market?
Unlike many other businesses, real estate tends to react more slowly to market changes. Transactions take a longer time to complete, and rents are typically due once at the beginning of every month. In other words, data lags in real estate.
Unfortunately, business closures, often by government order, have frozen commerce all over the world. Mass layoffs and a rising unemployment rate have followed. Battling the health crisis that we have found ourselves in has been very expensive in many ways.
However, the stock market has already dropped significantly, REITs included. Not sure what a REIT is? Don’t worry, I’ll get to that. In short, many investors are expecting a drop in real estate values. But there likely is still more pain to come.
A number of U.S. states have extended quarantines as the news surrounding the pandemic has continued to grow worse. The longer that the quarantines go, the more tenants will be unable to pay rent. And the more tenants that do not pay rent, the more landlords will struggle to pay mortgages. There likely will be at least a slight, if not drastic, increase in foreclosures in the coming months. Mortgage forbearance is rarely a free pass, after all.
But real estate will not stay down forever. Real estate seems to be primed for a rapid recovery following the health crisis, perhaps even more than the rest of the financial markets. Whereas many firms may struggle to reacquire customers once the world opens back up, people and businesses will still need a place to stay. Either way, the coming months will likely be a fantastic buying opportunity to buy shares of quality real estate. But how do you buy shares of real estate? Don’t you need to own the whole building? That’s where the aforementioned REITs come in.
What is a REIT?
A REIT is a real estate investment trust. It’s basically a company that sells shares of its real estate holdings. Rather than buying the property directly, you buy a share of the company that holds the properties.
REITs get tax benefits in exchange for distributing the vast majority of their rental income to shareholders. They are great tools for building an income-oriented portfolio.
One drawback as an investor is that REIT income is taxed as regular income. You also do not have direct control over the property management or the day to day operations of the buildings within the REIT, which is a blessing and a curse at the same time.
REITS are an easy way to get broader exposure to real estate, particularly expensive commercial real estate. They also come with far less headaches than investing in real estate that you own and manage directly!
I Created a Portfolio of REITs for Each Sector of the Real Estate Industry
I made a real estate portfolio on M1 Finance. If you want to dig through it yourself, click on this link. If you already have an M1 Finance account, you can copy it into your own portfolio. But if you don’t have an account, sign up using my affiliate link. M1 Finance is a free brokerage that is ideal for the long-term investor as it auto-rebalances your portfolio with any cash that you add or dividends that your holdings earn. Be sure to check out my review of M1 Finance, here.
Every major sector of the real estate industry is covered by this portfolio. It can easily be tailored to your risk preference and strategy when it comes to real estate!
As you can see, this portfolio, which has a broad exposure to the commercial real estate industry, has dipped hard in the last month or two. But, then again, so has everything else. The question that has yet to be answered is “where is the bottom?” For the long-term investor, this is less important as long as the expected long-term returns of real estate remain strong and steady, like the rest of the stock market. Trying to time the market is often counterproductive. But it is hard not to assume that the real estate market will go at least a bit lower as the pandemic continues and rent payments are missed. This can allow an investor to get a very high medium to long-term return on his or her money with relatively high-income producing potential.
Let’s look at each section of the portfolio now.
Multifamily properties have been the cream of the crop in real estate over the previous few years. However, given the wave of unemployment threatening rents, the industry has already taken a sharp hit. Cheap debt has encouraged many landlords to become highly leveraged, so there is an additional threat to those who lack the necessary cash.
The apartments slice is headed by AvalonBay Communities, a REIT that owns over 79,000 units. Its apartments are spread throughout New England, New York, Washington D.C., Seattle, and California. Such a large portfolio will undoubtedly be affected by both the down and upswings of the real estate market. One would expect the upswing to be particularly strong in the New York area once the pandemic ceases to ravish the land.
With 25% of the industrial slice devoted towards the blossoming self-storage sector, the rest is split between 4 multi-billion-dollar REITs. With the rise of companies like Amazon and other online retailers, industrial space is critical for maintaining their operations and storage facilities. Prologis Inc. and its $54 billion market cap, along with its 786 million square feet of industrial space, heads the list.
Office is divided among 14 different REITs. It will be interesting to see what happens to office space following the health crisis. Many workers have begun working remotely out of necessity. Depending on how worthwhile companies feel this arrangement is, they may choose to lower overhead costs by reducing office sizes. This would definitely hurt the office REIT space over the long run. This pandemic will be the ultimate case study in how effective remote work can be at scale. It will fundamentally change the office landscape if it is worthwhile.
Perhaps no real estate sector was hit harder by the crisis than retail. Already struggling to combat the growth of e-commerce, retail landlords are now often stuck with closed buildings and tenants with no way to pay rent.
The retail slice has a plurality holding in Realty Income Corporation, a very popular REIT focusing mainly on higher quality tenants in triple net leased buildings. Realty Income has invested in industrial and office properties too, but retail still makes up the bulk of its holdings. It has a particularly stable dividend and should be able to weather the real estate storm.
Otherwise, mall REITs, like Simon Property Group, are in a do or die position. If they succeed in continuing to transition their malls to focus on lifestyle and entertainment over simple, straightforward shopping, they are primed for a large payout. But, if they cannot do so before running out of cash, they are in serious trouble, just like most of the retail sector. Generally, you can call this slice “high-risk, high-reward.”
The current health crisis has been similarly unkind to senior housing, which makes up a large portion of this portfolio. However, long-term, with America’s aging population, one would expect senior housing to do quite well. Oversaturation in this niche market has threatened some businesses, however, so it will be interesting to see how firms adjust.
The United States healthcare industry is one of the most interesting in the world, and the real estate it uses is always threatened by new regulations or other disruptions. The health crisis may even spur new demand for hospital or clinical research space, increasing revenues for many of these REITs, potentially in the near future.
There aren’t many agriculturally focused REITs out there, so Gladstone Land Corporation and Farmland Partners occupy the whole slice. Agriculture is a fairly stable business, in much part thanks to government subsidies, though foreign demand swings can add to volatility.
M1 Finance allows you to invest in ETFs as well, so 3 broad ETFs make up the international slice. ETFs allow you to quickly gain market exposure in a particular industry, if not the entire market. The Vanguard Global ex-U.S. Real Estate ETF alone has 662 holdings alone! The FlexShares Global Quality Real Estate Index Fund does include some significant U.S. holdings as well, but, overall, this slice should give you greater geographical diversity outside of the robust U.S. market.
Mortgage Backed Securities
Mortgage backed securities (MBS) are basically baskets of mortgage loans that are divided up into well diversified revenue streams for investors to buy. Pension funds are a particularly large buyer of these securities, but you can invest in them directly yourself through an MBS REIT. Each share of an MBS would give you a tiny portion of many different mortgage loans. However, with the growing default crisis, MBS REITs have seen a massive dip in share price. This is because many landlords, homeowners, and other borrowers may be unable to pay their loans, so the mortgage backed security becomes worth less. Share prices may continue to drop for the foreseeable future as credit risk remains relatively high.
There is only one publicly traded REIT that focuses on student housing at the moment: American Campus Communities. You can look at this as an extension of the apartments slice, since the business models are very similar, although student housing tends to have a greater focus on amenities and rents by the room rather than the unit. Rents in many of these buildings are extremely high as demand for college education continues to rise. Long term, this could be an especially lucrative sector.
I have a soft spot for billionaire real estate investor Sam Zell. Not only does he have a great autobiography, he seems to be very well positioned to capitalize on the downturn, as he seemingly always is. His three public REITs make up this slice.
What Should I Do with This Portfolio of REITs?
That is entirely up to you. If you believe we are already at the bottom of this dip, buy now! If you think we have a long way to go, then don’t! Or maybe you do not like the risks associated with real estate compared to other assets, so you don’t even care!
I am planning on investing in this portfolio in stages through the summer of 2020 as the economic crisis likely worsens and real estate prices lower. I will increase my contributions to this portfolio if I am unable to find a rental property for myself in the meantime. We will see if that ends up being a good decision either way!
You do not need a massive pile of cash to invest in commercial real estate. REITs make that easy. You are buying shares of the company that owns the building, getting a piece of that rent pie.
If you want to use my portfolio of many different REITs in every major sector of real estate, use this link. And be sure to sign up for M1 Finance here so you can easily import this REIT portfolio into your own account. Then you can adjust it, add or subtract holdings, and fine tune it to your liking. Everyone’s risk tolerance and preferences are different, and some people might be less real estate biased than I am. But it is always worth considering all of your options when investing for your financial future.