Scott: Welcome to the BiggerPockets Money podcast where we interview UC Escola about real estate investment trusts or REITs. Hello, hello, hello. My name is Scott Trench and with me today is my MVP CFP co-host Kyle Mast.
Speaker 1: Hey Scott, good to be here.
Scott: All right. Kyle and I are here to make financial independence less scary, less just for somebody else, to introduce you to every money story and every type of real estate investment or other investment, because we truly believe that financial freedom is attainable for everyone, no matter when or where you’re starting.
Speaker 1: Whether you want to retire early, travel the world, go on to make big time investments in assets like real estate or start your own business or learn about new investment opportunities, we’ll help you reach your financial goals and get money out of the way so you can just launch yourself towards your dreams.
Scott: Kyle, I cannot be more excited about today’s episode. UC is just the kind of perfect guest to talk about REITs, real estate investment trusts, a publicly traded, uh in many cases, way to get exposure to real estate, an asset class that’s been hammered over the last 18 months to the tune of like 30% across the board. And just maybe presents a tremendous opportunity that we’ve been ignoring or overlooking here at Bigger Pockets. And wow, is this guy pretty smart on this topic. This is a must listen episode.
Speaker 1: 100%. This this is exciting. I this guy knows his stuff and this is definitely a neglected topic in the real estate sector. So this is people are going to get a lot out of this episode. I’m excited for everyone to listen to this. This is going to be great.
Scott: All right. Next up is our money moment where we share a money hack tip or trick to help you on your financial journey. and today’s money moment is take care of your health. Drink water, take vitamins, get in some sunshine, go to that annual checkup, get that workout in. This may not seem like a money tip, but staying in good health can save tens of thousands of dollars or hundreds of thousands of dollars in the long run. Uh you’ll earn more money, you’ll have more energy, you’ll spend less on healthcare, um and you’ll be better looking. Um all things that contribute to financial success in the long run. So do you have a money tip for us? Email money moment at biggerpockets.com.
Scott: UC Escola is president of Leonberg Capital, a boutique advisory firm specializing in real estate investment trusts. UC also writes the number one REIT investment newsletter on seeking Alpha, which I am a subscriber to and follower of and has a YouTube channel where he discusses REIT news and investment ideas. UC, it’s so great to have you here on the Bigger Pockets Money podcast. Thank you so much for joining us.
Guest: Thank you very much for for inviting me. As I was telling you before this uh before we started, this is my very first podcast ever, so I’m very excited.
Scott: Awesome. Well, we’re honored uh you came on here first and and really grateful. So, would you mind starting off things by telling us a little bit about yourself and how you became interested in real estate and investing?
Guest: I come from Finland. I I was born in a family of real estate professionals. So I’ve been going to from one construction site to another already from a very early age. Um I I decided to go into real estate quite early as well. Basically, during high school, uh I was already running my own small business. It was an e-commerce business and I was earning a bit of profits already from it, uh and so I bought my first REITs at about 15 years old, already back then. I was very interested in real estate investing. I I really love this idea of being able to buy a property with the bank’s money, have your tenant reimburse it. And by the time your your mortgage is paid off, you own the property free and clear that has likely gained a lot of value. But back then, I wasn’t able to to buy real estate just yet because the profits were not quite large enough. So so I bought REITs instead and so that was kind of my introduction to REIT investing. Later on, I went to study finance with a specialization in commercial real estate. It’s quite common in Europe uh to specialize quite early on, already at the bachelor level, so that’s what I did. Uh I also did the the the CFA curriculum, I passed three levels. Then I landed my first job in private equity real estate in Dallas, Texas. So I was there for a little while, but eventually I wanted to set up my own thing and so that’s what I did.
Scott: Awesome. And can you can you define REIT for us for the for the audience? What is a REIT and are there special rules or differences between a REIT and a public stock uh company for example?
Guest: Yes. So REIT stands for real estate investment trust. It’s it’s essentially a company, a corporation, uh that holds a lot of real estate uh for the purpose of generating rental income. And it has it enjoys special tax benefits. And so you have to fulfill a bunch of different requirements. One of them is that you need to pay out 90% of your taxable income in the form of dividend. But there are there are many other requirements and if you if you fulfill those then you can you don’t have to pay any corporate tax. So that’s the main benefit really of the REIT structure. Uh they can be private, they can be public. In my case, I’m mostly invest interested in the publicly listed REITs. Um but yeah, so in short, that’s that’s what a REIT is.
Scott: UC, what what you are an expert at analyzing and evaluating the prospects and uh uh potential, the return the returns, whether whether REITs are going to perform well or not. Um how how does one analyze the performance or expectations of a REIT? Uh do we look at the net asset value of the properties underneath them? Do we look at the income? Do we look at a combination? How do you make these calls and how have you developed expertise in in in in in making these judgments about the potential of of these opportunities?
Guest: Yeah, so that’s a good question. I think it’s important to start here by, you know, remembering that a REIT is a real estate investment. So a lot of the things that you will look in a real estate property uh will also apply to REITs. So, the first thing that you might look for is what are the properties that the REIT owns, what’s their quality, what’s their rent level, what’s their occupancy rate, all these same factors that would typically be interested in as a real estate investor. But then beyond that, because these are large corporations, you also need to uh analyze quite a bit their management. Is the management good? Is it well aligned with shareholders? What’s their track record? What’s what’s the strategy that they are following? Is it really creating value for shareholders or are they trying to extract value for themselves in the form of fees or salaries? Um then the the balance sheet obviously is very important, especially today in today’s rising rate environment. So, so look at a lot of different metrics. So we can discuss those a bit later also if you want to in more detail but things like that to EBITDA, uh the loan to value. Um but yeah, so in short, you know, you’re looking at the same things you’ll be looking in a private real estate investment, but then you’ll add some additional elements so these are large public listed companies.
Scott: Awesome. So what what’s the difference between a a REIT and a syndication investment?
Guest: So those a syndication will typically be a private vehicle, so you’re not going to have as much liquidity in most cases. Uh they’re also typically going to be smaller in size, so much more concentrated. Um the management will typically be external which leads to greater conflicts of interest and less uh economies of scale because the the sponsor will typically charge a fee based on the assets under management as well as maybe a cut of the profits on the back end, maybe also some acquisition fees, some disposition fees, and so on. Whereas a REIT typically is going to be public, it’s going to be liquid, it’s going to be enjoying significant economies of scale because of this uh because of its scale. Uh the management will typically be internalized, which means that the the the executives are working as employees for the REIT. They are not earning fees based on the assets under management. Instead, they will be earning salaries based on the real performance of the REIT. So it’s going to better align the interest between the manager and the shareholder. Uh so, yeah, I think that those are really the main differences and also the reason why I prefer REITs versus syndications.
Speaker 1: Well, that’s a good segue to the next question. We were just going to ask you, you know, what what’s the advantage of a REIT uh for someone who wants to kind of get into real estate investing as opposed to maybe direct investment in real estate? Um and then maybe you can kind of along with that, you know, what’s a typical return? You know, that’s hard to estimate, I know, but kind of give an idea there. And and a time horizon for an investment like this too.
Guest: I could give you a really long answer to this question because I really enjoy this topic of REITs versus rental properties or syndications. Uh I’m going to make it a bit shorter and we can then expand on it, but in short here, I think that REITs offer better returns in most cases than private real estate. They also safer than private real estate in most cases. And on top of that, you also enjoy many other benefits here because this is, you know, it’s gonna improve, I think, your lifestyle and also allow you to really focus on your career. Uh so those in short, better returns, lower risk, and you it actually improves your lifestyle, which is not always the case with rental properties.
Scott: Oh man, shots fired. Shots fired on the on the on the rental property one. Love it. Um well, well, so let me ask you this, but haven’t REITs had a pretty bad, you know, year and a half, two years here and you know, what would you say to the owner of maybe some single family rentals or duplexes out here in the states that uh uh haven’t seen their their properties come down by that much at this point. You know, how how would you make that argument to somebody who’s in that position?
Guest: So you you’re you’re totally right. REITs are down heavily in the recent past. They’ve dropped by about 30% on average since the beginning of 2022. And so over the short run, you’re going to have time periods when when private real estate is going to do far better than REITs. But over long time periods of multiple decades, I believe that REITs are going to do better than rental properties. And uh there is a they’re they’re studies to back this up. There’s also a strong reasoning behind uh this uh this uh this argument and we can go into these these these reasoning in more detail if you want to.
Scott: Absolutely. Let’s let’s do it. That sounds like a a fun topic here.
Guest: Do you want me to give you the long for long answer or the shorter one for this because I can make it really long and comprehensive.
Scott: We want you to make the the strongest case you have and to nerd out to the best of your ability on the topic. That’s that’s the fun thing that that’s where everyone gets smarter.
Guest: So, why REITs are more rewarding than rental properties in most cases? Um before I dive into this, I think it’s very important to correct some misconceptions that are very common on this topic. The first misconception that I see all the time is investors who will assume that REIT are less rewarding because you’re not cannot buy REITs with a mortgage. But this reasoning is wrong because REITs are already leveraged investments. When you’re buying shares of a REIT, you’re buying the equity. And so it’s the equivalent of your down payment. REITs will then add leverage on top of it in the form of a mortgage or it can also be in the form of bonds, convertibles, preferred equity, lots of different uh forms of capital to leverage your your equity. And so you enjoy the same benefit as if you were buying a rental property. I would argue that you enjoy even better benefits of leverage because REITs in most cases will get better terms than you could because these are large diversified publicly listed companies. Uh banks are will be much happier to work with those than with a small rental property investor which is typically a riskier profile. Uh so that’s the first misconception to get out of the way. Then the second one that I see often is that people assume that REITs are less rewarding because they must pay their managers uh large salaries. And so investors will assume that they they can save those expenses by taking care of the properties themselves. But but you know, and it’s it’s true that REIT are paying millions to their top executives. But because they enjoy such a large scale, uh the management cost as a percentage of the total assets is actually going to be very small and much smaller than that of private properties in most cases. Um here we can take the example of realty income, which is one of the most popular REITs in the world, maybe the most popular. It’s management cost as a percentage of its total assets is just 30 basis points every year. Uh if you own a rental property and you outsource the management to a property manager, it’s going to be a lot more expensive than this. If you do it yourself and you actually count how many hours you spend on it, give some dollar amount to this uh to to account for the value of your labor, it’s also going to be more expensive in most cases. Then the third misconception is on taxes. Rental property investors think that they enjoy the best tax benefits that REIT are not even comparable. But once more, this is not really the case in my opinion. I actually pay less taxes investing in REITs than in rental properties. And so rental properties are very tax efficient, I agree with this. Uh they a big part of this is the non-cash depreciation which allows you to defer a lot of the taxes fine to the future. But REIT enjoy very similar benefits. Uh for one, REIT in most cases will retain about 30 to 40% of their cash flow in the for within the company. Uh remember that the rule of 90% applies to taxable income, which is much lower than cash flow because of non-cash depreciation. And so whatever the REIT is going to retain in most cases, 30 to 40% is not taxed because REITs don’t pay corporate income tax. It’s fully tax deferred. Then secondly, a portion of the dividend income is typically going to be classified as return of capital. This is also fully tax deferred. Then third thing to consider is that the the the portion of the dividend income that’s actually taxed is going to enjoy a 20% deductible. Uh so that reduces your taxes even further. And then fourth and final here, um REITs will typically invest in lower yielding, faster growing properties like um e-commerce warehouses, data centers, sell towers, and so on. And so a larger portion of your returns is going to come from long-term growth and appreciation, which once more is fully tax deferred. And if all of that is not enough, you could just put your REITs in a in a tax deferred account and defer the rest of it. So there’s not a significant advantage here for rentals despite seeing that all the time in various comment sections debating this topic. And then the final misconception is I see all the time rental property investors claim that they are earning 20, 25, 30% annual total returns. Um in some rare cases, this may be the case, but in most cases, I think that they are simply miscalculating their returns. Um Warren Buffett became the richest investor on earth by compounding at 20% per year. So I just don’t buy into it that your average rental property investor is doing better than that by doing it as a side gig. I think what’s happening here is that they are miscalculating their returns in two ways. Uh the first and most important is that they’re not accounting for the value of their own labor. They will uh you know, spend countless hours finding the right deal, um negotiating it, financing it, then uh finding the renovating it, finding the tenant, managing the property and so on and and they’re really it’s countless hours that goes into it. If you now decided that each hour is worth $30 and you deducted this amount from your returns, you would see that a very big portion of your return is actually just your labor, it’s not the return on your invested capital. Um and I think you really should deduct this because you could use all this productive time to work extra hours at your main job or side hustle or anything else. So, so if you want to really see the real return on your invested capital, you need to deduct this. And then secondly, I think that investors will also commonly make the mistake of looking at their typical year, the typical good year. Uh they will, let’s say it’s 15%, 20%, the return on on the year typical year, but in real estate, you you have good years. Let’s say you have five good years and then on your six, you have some major expenses because you need to reinvest in your property. This may cost you one or even two years of rental income. If you now calculate the average return over these six years, your your return is going to come down quite a bit. So, so now with these misconceptions out of the way, uh we can uh discuss a few research studies that have been made on this topic comparing the returns of REITs versus those of private real estate as well as private equity real estate fund. You might say something.
Scott: I I just, you know, because I I we have a lot of real estate investors who are probably like he’s kind of right on a couple of those points. I want to agree with you and then provide a couple of other things for your reaction here for a second. So first, I want to see your $30 an hour of finding a good deal and raise you. I think that in order to buy a rental property responsibly, you need to put in and and you’ll find many of our investors do hundreds of hours of self- education, like like the one that perhaps folks are consuming right now, listening to this podcast, right? which is valuable time. Maybe you’re doing something else or driving or at the gym or whatever while you’re listening to this, but that is uh uh on top of the time that you’ve just described there. Um about the dollar per hour value of that time, I often have thought that real estate’s a really valuable activity for someone to get into when they’re perhaps a lower or middle or maybe even lower upper middle class, if that makes any sense, like right? in those ranges because you know, if you’re a doctor or a lawyer, you’re probably not going to want to put in all those hours at 30, 40, $50 an hour, um depending on what you how you value that time at that point in time, but it can be rewarding, um more rewarding than many side hustles that are available to you uh if your dollar per hour time is less than that, for example. So I think you see a lot of folks. And once you pay that price to get into it for the first five years and know how to do all this, you can then reap the benefits for the rest of your career. So that’s one uh nuance I think to your argument that I largely agree with uh see on um around uh straight rental property investing. And then I want to give you one challenge and see how you react to it um on this. One of the things that I enjoy, I think as an advantage as a real estate investor with a portfolio here in Denver over by competition in the or my alternative choice in investing in REIT is the ability to have used and to continue to use fixed 30-year low interest rate uh debt that reduces my risk and maybe amplifies my returns in a way that uh REIT are typically not able to access with the same um the same low risk and low rates. Would you agree with that as a as a potential advantage for the the little guy here.
Guest: Definitely, those are two good counter points and I agree with you here and I also I I don’t want to sound here as if I’m just bashing on private real estate. I think private real estate is a great investment. I’m just making the argument that I think that REITs are slightly better in most cases for most people.
Speaker 1: This is awesome. We want we want the listeners to get a challenge and to think outside of the box and you know, you’re both kind of touching on something here that everyone needs to realize what kind of investor they are. Um what’s your hourly wage normally? What what do you desire to do with your time? If you’re a professional and you know, like the the publicly traded REIT are by magnitude more passive than anything you can do on your own in real estate. I mean, that that in itself, if and we’ll get into these research studies you were referencing, I would love to hear about this next. Um but that in itself, even if someone were to to prove, you know, I can do a lot better if I do it on my own real estate, even with my hourly wage, even if they can kind of make that case, you in my opinion, you actually, you need to do quite a bit better because if if you’re putting that much time and your resources into it and it’s only a little bit better, well, man, I that’s not worth it if you can be fairly passive with these publicly traded REIT.
Scott: And to to reinforce UC’s point here, you know, in though those high returns, 20, 15, 20, 25%, maybe they are being achieved by some real estate investors, but if so, it’s typically going to be in the first few years of the hold and only can be sustained if you’re consistently applying very high leverage um to those deals. And that is maybe another advantage that the uh the little guy enjoys um over REIT where they can actually leverage much higher up to 75% LTV with this kind of fixed rate debt uh and then the acquisition 85 or even 95 to 100, you know, 100% if you’re an owner occupant in those first deals. Um so maybe that’s a a part of that as well. And then one last thing, I’ll I’ll also throw in there uh before we we let you resume your wonderful thoughts here UC is is the uh efficient efficiency of the market, right? Uh a listener might argue with you and say, well, REIT are already priced appropriately because smart guys like UC are constantly debating the actual the the value of those things, but there’s a lot of good deals to be found in my local neighborhood because I know how to add a bedroom or do the do the work there to to create some value on the on the upswing.
Guest: So those are those are three very good counter points. I want to quickly address all three of them. Uh the first one was on the hourly wage and I I completely agree with you that the more you value your time, uh the less sense it’s going to make to invest in rental properties. If you’re a doctor, you’re a lawyer or you’re a busy entrepreneur that’s earning a good amount of profits through his own business, then probably buying rental properties makes less sense. But then yeah, if you’re your hourly wage is relatively low, it makes more sense. But even then, you know, if you really calculate all the amount of time you spend in educating yourself and then finding the deals, doing all the work, even if you valued your time, let’s say $15 per hour, I would argue that the returns would change very drastically in most cases and it becomes quite a bit less rewarding. But here you could also make the argument that if it’s work you enjoy, it makes sense and a lot of people enjoy this type of work. Uh but then to your second point and this is probably the I think the strongest argument in favor of investing in private real estate and I myself own some private real estate. This is one of the reasons why? Uh you you can really leverage use even more leverage and in some specific cases, I think it makes sense with some limits though. There are some limitations to it. Um but but you know, REIT, they they they typically don’t use quite as much leverage, but on the flip side, they’re going to be having they’re going to have access to a much larger variety of capital as I mentioned earlier, so they can use mortgages, they can use bonds, uh convertibles, preferred equity. Typically REIT will have a bunch of debt. Let’s say they will have a 40 or 50% LTV and then they’ll add still a bit of preferred equity to leverage your common equity even more. Uh so, so you’re still getting a very good uh, you know, bump from all of that leverage as a common shareholder of a of a REIT, even if it’s not quite as much of that of in the case of a private rental property perhaps. And then your third counter point that was um, what was it again? Can can you remind me quickly?
Scott: I I wasn’t carrying all my counter points. Uh I wish I could I wish I could remember too.
Guest: Okay.
Scott: I think I think it was the uh the hourly rate of time can be worth it. The uh uh the the and then the leverage, the local neighborhood.
Guest: The local neighborhood. Yes, the efficient market. Right, the efficiencies of the market. So, so I agree that there are efficiencies in the private market. And but I would argue that this applies very much also to the public read market because when you think of REIT, they’re a bit of an earth category because you know, they’re riding between real estate and stocks. And real estate investors typically don’t trust the stock market and then stock market investors typically don’t understand real estate. And as a result, you have quite frequent mispricing happening in the REIT sector. Um I’m I’m a dedicated REIT analyst and I specialize in this sector, but there aren’t actually that many people doing what I’m doing. Uh and this is part of the reason why I have this platform today at such a young age because there are just not many people doing this. Um most investors in the REIT segment, they are generalist, uh investment firms, you know, a generalist analyst looking at them with relatively little understanding about real estate and so not surprisingly you have mispricings occur. Uh I could point you to several examples of REIT and we can discuss this later that are today priced at very large discounts to the value of their properties. Um so, but so these are my three quick counter counter points uh to your counter points which I think are valid and very good. Uh but so there are there are a few research studies that have been made on this topic comparing the returns of both and the the the main conclusion here is that real estate REITs typically outperform private real estate by about 2 to 4% per year on average. And this may sound surprising to some of you, but I think it’s a result that’s very much expected because REITs enjoy significant economies of scale in their management, which we discussed earlier, they also enjoy significant economies of scale in all their other costs. Uh let’s take the example of an apartment REIT here that does a deal with a contractor in a specific city to change 100 carpets each year. Uh naturally, it’s going to get a much better rate with this contractor than you could as a private rental investor changing one carpet every year. Um but this applies to really every cost. They’re going to pay less brokerage fees, they’re going to even their property taxes, REIT are going to have legal team uh working for them full time, they’re going to be able to fight the property tax heights and and so on. So so they’re able to be much more cost efficient on every level. Then REIT will typically also develop their own properties to earn higher returns and create value for shareholders. This requires a lot of skill and resources. Most private investors are not able to do that themselves. Um REIT have better access to a a wide variety of capital which allows them to really take advantage of some uh, you know, distortion in the market. Sometimes they are priced at the discount to the NAV. They can buy back shares, creating value for shareholders. Sometimes they are priced at a premium to NAV, they can issue equity in the public market, raise it, buy more properties at the positive spread, which then results in cash on in growth on a cash flow per share basis. Um what else? REIT have the best talent working for them. That obviously helps. They’re able to pay them very generously because of their large scale and it’s still very much cost efficient. Um REIT can also enter other real estate related businesses to earn additional profits thanks to their platform. to give you an example here, Farmland partners, which is one of the biggest Farmland REIT, it has also a brokerage business. So it’s going to help some third parties sell their farmland and earn fees. You as a shareholder, you participate in these profits as well. So I think these are the main reasons why REITs have been able to be have been more rewarding in the past uh in according to those studies in my opinion, it makes sense.
Scott: How about a how about syndications? We’ve seen a lot of headlines in the last year about syndicators. There’s a lot of social media folks who raised a lot of money and built a big name and built syndications and many of those are in trouble. Some are going to jail and others are facing lawsuits here. Are we seeing those kinds of distractions and problems in the read space or is that more limited to this kind of
Scott: syndication or private fund market, um the private REIT market.
Guest: So bankruptcies in the REIT sector, especially for public REIT are extremely rare. And you know, I think we’ve had a handful of them over the past 10 years. And when you think of it, it makes sense that they are rare because most reads are conservatively financed. They are widely diversified. In most cases, they’re going to own class A properties and so it’s it’s quite hard to screw it up. There are some exceptions, the few bankruptcies have been mall REIT that were overleveraged and so it can happen, but it’s really rare in the REIT sector. Um considering the the syndicators, it’s much more common because they are much greater conflicts of interest and they will typically use a lot more leverage and they will also be concentrated. So, again, normal, it’s quite normal that this happens. Uh the operators, the sponsors also might not be quite as skilled. Perhaps they are skilled at raising capital, but not quite as skilled that actually investing that capital. Um if you ask me, I would think that these syndications are actually the worst option of all uh if you’re going to invest in in real estate, especially those that have been promoted heavily by you know, influencers who have questionable uh backgrounds in the real estate space. Uh I think that it’s a much better option perhaps to do with learn it and do it yourself than invest in some of those syndications that I’ve seen online and I’m sure there are exceptions. This doesn’t apply to all of them, but some that I’ve seen online suffer extremely large conflicts of interest. They’re just incentivized basically to do as many deals as they can and just deploy the capital whether the deal is good or not. They charge huge fees, which will really impact the bottom line and then they will use way too much leverage, uh, and so then they end up in these situations that you just had mentioned.
Speaker 1: Yeah, I think I think you really highlighted on something there that we want to make sure like this is we are painting a pretty, a pretty pretty picture of publicly traded REIT, which is very good. I mean, this is I this is awesome for our listeners to hear this way of investing in real estate that does not include a property with the sewer line breaking and you having to spend three years of rental income to fix it. Um but we also need to, you know, see, let us know some of the risks that are out there. You know, I know some from my CFP background, some of the products that exist. They’re not all publicly traded on exchanges. There are non-traded public REITs, there are things, you’re talking a little bit on high commission products, uh high fee or high fee products, there’s some high commission products that are broker through broker dealers. You know, there’s other there’s other things out there. So if if an investor is hearing a REIT to invest in, it doesn’t necessarily mean this publicly traded uh with a ticker symbol REIT, um which it could be and it could and it could there could also be some risks there. But maybe just hit on like the biggest risks you see, if someone’s like, I need to go down this avenue of looking at real estate investment trusts, what do they what’s a red flag they need to watch out for?
Guest: Yeah, that that’s a great point and perhaps I should have clarified this a bit earlier in the call that most of the time, you know, when I’m referring to REIT, I’m really referring to the publicly listed REITs which have very different from the private non-traded REITs uh which are in my opinion I I would put them in the same category as the syndications that I discussed earlier. In most cases they are not any better. They exist in many cases for the main purpose of extracting fees from investors. Uh they will be externally managed. They will earn a fee based on the total volume of assets under management. They might also earn acquisition fees, disposition fees that will incentivize them to trade in and out of properties. Um they will try to raise as much capital as they can to maximize their fee income and that’s not in the interest of the shareholder or the investor in most cases, they’ll also use too much leverage. Um they are commissions as you mentioned also quite often.
Speaker 1: So that’s a super awesome overview of the risks and I just want to I just want to highlight one of those risks a little bit deeper just because of me experiencing it when I the firm that I first started at, um you know, when someone’s looking for a financial planner, you want to look for a fee only financial planner. You want someone who you’re going to pay, you know what they you’re paying them. And a lot of, there’s a lot of products out there from insurance to investments to non-traded public REITs that offer a commission to certain types of financial advisors and I guarantee someone’s listening to this podcast who has been offered one of these by a quote financial advisor. So if you’re hearing uh from a someone who could potentially sell you a financial product, if you’re hearing about a read, you need to ask a lot of questions because sometimes these they’re they’re called non-traded public read. So they have the word public in there which makes them sound like they’re traded on an exchange, but they’re non-traded. So basically the structure of them is the advisor, quote advisor that’s selling it to you often gets a 7 to 10% commission for selling you this product and there’s basically, they’ll give you a time frame of a potential liquidity event and it’s usually four to seven years or something like that, but it can be 20 years, it can be no, it can be never if it was at the top of the recession, which I saw some of these sold to people and they just completely went to nothing. Um and this is what UC has talked about some of these they they over leverage, they got too excited and the products are created to make fees for the managers and make commissions for the people selling them. Not that the people selling them are bad people, but you just need to ask questions because this is a product that is in uh offices of financial institutions that you know the names of and they will come up if you have any decent amount of net worth, these will be presented to you as an alternative investment of some sort. So just keep your ears open for that. Uh what you see is talking about our publicly traded REIT that have the scale, have the low fees, that can really be a passive investment and they have liquidity too. That’s something we haven’t really touched on here. You know, the liquidity of a publicly traded read, it functions essentially a lot like a mutual fund from a trading standpoint if you want to move in and out of most of these.
Guest: Yeah, no, you’re correct. I mean, uh, if if you’re buying a publicly listed read, it’s just like any other publicly listed company, you can it’s quite easy to buy the shares, it’s quite easy to get out of it as well. Um, if you’re an individual investor, you probably don’t going to run into liquidity issues with a public listed company. But then yeah, there are these public non-traded REITs and with those, it’s quite different. I mean, the biggest one in the world is one run by Blackstone. It’s quite a good uh public non-traded REIT actually. It may be one of the best. Uh so by the way, there are some exceptions, some of them can be decently good uh even though I still probably wouldn’t invest in them. But so Blackstone and its public non-traded REIT recently run into this issue. It has a redemption plan that allows investors to gradually get out of the read if they want to, but if too many of them suddenly want to get out, then they have to just halt it and it’s not possible and that’s what they they experienced recently. Um but but yeah, liquidity with public publicly listed rate, in my opinion, is a major advantage. I feel like a lot of real estate investors see see it more as a disadvantage because it leads to volatility at times, like we experienced now in the recent years, but if you’re a long-term oriented investor with a landlord mindset, you can really take advantage of this liquidity then to pick up more shares at heavily discounted prices.
Scott: So let’s yeah, so let’s dive into all right, we’ve defined all the other alternatives to the word REIT. We know you’re when you’re using the word REIT, you’re C, you’re talking about a publicly traded REIT. Let’s talk about that market and good and bad within the sector now that we’ve kind of thoroughly dissected the alternatives and the the landscape here. Where are we at from a uh overall status in the market? We talked about it being down. And where where should people be looking? Where are you looking for good and bad in the space at this point?
Guest: Yeah, so it’s a very vast and versatile sector. There are over 200 public listed REITs in the US alone. There are also 30 additional countries in the world that now how REITs or REIT-like entities. So it’s a really vast and versatile sector and while I may sound like I’m very bullish on REIT and I only have good things to say about REITs, this really isn’t the case in reality. Um there are a lot of REITs that I would stay away away from. Um some that are public listed still suffer management issues despite most of them being well aligned with shareholders. Um a good example from the top of my head is a REIT called Global Net Lease, ticket symbol GNL. It it has attractive properties but over the long run it’s done very very poorly for shareholders because the the management has really looked out for its own interest in my opinion. Um then there are also some property sectors that you probably want to stay away from. Today, well the most obvious one that probably comes to the mind of most people is our offices. Um myself uh staying away from offices. The valuations may seem cheap today because they’ve come down quite a bit but, you know, if you now account for all the capex, the leverage, and so on, perhaps the valuations aren’t that cheap. Uh so that’s one sector to stay away from. Um there are some others as well that I’m not quite as bullish on. I don’t like hotels quite as much, I don’t like data centers or the so there are many sectors that you don’t I don’t like. There are also some countries that I’m not as bullish on as others, they um there are some exceptions of REIT that are also way overleveraged. Today, the average long to value in the rate sector is only about 40%. It’s even a bit less than that. So, so that’s very conservative, but some REITs have decided to take on more risk and and today they’re paying the consequences following the surgeon interest rate. So, so the bad stuff to look for really is, you know, the wrong property sector at the wrong time, then some overleveraged balance sheets. There are some exceptions of REIT that are poorly managed. And then finally, one point that you want to also consider is that while REIT’s valuation have come down a lot, there are still some REITs that are priced quite aggressively when you when you account for the higher interest rates today and and so while I’m bullish on the sector, it’s still one in which you need to be very selective.
Scott: What what do you make of the fact that a lot in a lot of commercial and multi-family real estate sectors, cap rates, the amount of cash flow of property, the percentage of of cash flow of property will generate relative to its purchase price are are lower than interest rates uh in in a lot of cases. Like do you think that there’s a lot of room for these prices to come down in a lot of these sectors or or, you know, should we stake should we be afraid of REITs for the near time or or is it a buying opportunity because it’s already down 30%?
Guest: Yeah, so I think it depends heavily on what’s your expectation for interest rates in the coming years. I mean, one of the reasons why the cap rates haven’t moved that much in the private market, I think is because most investors are predicting that interest rates are going to come down in the coming years. I think it’s worth remembering here that, I mean, the reason why interest rates were hiked so much is because we’re dealing with high inflation. I think, I still buy into the the idea that the inflation was transitory. It happened because of the pandemic, the stimulus, then Russia’s brutal invasion of Ukraine, obviously, also made things worse. But then we hiked interest rates, now inflation is coming back down. Um if you adjust for real-time shelter, I think it’s already back at the target rate of the Fed of 2%. And so do we need these high interest rates for for much longer? Um I would argue, I mean, anyone who makes predictions about interest rates is always wrong. I’ll put that out there, but I would probably argue that it’s quite likely that interest rates will come down in the coming years. And if that’s the case, then perhaps cap rates won’t expand quite as much. Then another reason why cap rates haven’t expanded so much is because rent growth has been so strong in many of these property sectors, inflation was hot, and so rents were also rising. And so investors were willing to sacrifice on the cap rate to get this this growth because they could see the normalized forward cap rates being quite a bit higher once those rents are get get hiked in the future. Um but yes, I mean, would I buy an apartment community in in Dallas, Texas at a 4.5% cap rate today? I probably wouldn’t, but would I buy a REIT that specializes in Tex and apartment communities at an implied cap rate of six and a half percent or even seven percent, that’s much more attractive to me and this is because REITs are so heavily discounted today.
Speaker 1: That’s an awesome argument. Love that.
Speaker 1: Yes, I think you touched on something right there. You know, the behavior of these publicly traded REITs behaves a lot, the trading behavior, I’ll say, the trading behavior behaves a lot like a mutual fund or a stock as far as emotional upswings and down swings. And then when you advise people to invest in those sort of things, a lot of times dollar cost averaging is the simple, easy, lazy way to invest over the long term and a good way. And if you’re doing these publicly traded REITs, when you when you’re investing in a mutual fund like VTSAX, an index fund, you see a 30% drop in the market, what do you think if you’re a really good investor and you have a really good long-term time horizon and that’s your goal. This is this is a garage sale.
Guest: This is the strongest argument in favor of REITs specifically today. Um you know, if you go in the private market, you go buy a rental property, prices are pretty high, um you’re going to go to your bank, ask for a mortgage, interest rates also really high. But if you today go in the REIT market, there are plenty of REITs priced at huge discounts relative to the value of their private properties net of debt. Um in late 2022, the investment from Janus and Henderson came out with um with a study that showed that REITs were priced on average at a 28% discount to their net asset value. Since then, REIT share prices have come down a bit further even as their rents have kept on growing. And and so and that’s just the average. There are a lot of REITs that are priced at even lower valuations than this. And so let we can maybe take a an example here to illustrate my point. BSR read is is a small cap read that owns a portfolio of apartment communities within the Tex and triangle. So uh Dallas, Austin, and Houston, which would probably argue as some of the agree as some of the most, you know, attractive markets for long-term oriented investors because they’re attracting there a lot of growth happening in them, um rent to income ratios are still very low compared to other other major cities in the US. Um and and yet despite that and also well the REIT has a strong management team, they they own a lot of shares themselves, they are buying back shares today, they’re doing what’s right with shareholders. They have a strong balance sheet with an LTV of about 40%. And despite that, today they are priced at a huge discount to their net asset value. Um they the the their NAV is about $21 per share and they trade at about $12 per share today. So that’s a 40% discount. So you’re essentially buying a an interest in this portfolio of apartment communities at roughly, yeah, 60 cents on the dollar. And that’s very compelling to me. Um and then on top of that, you also get to buy an interest in these properties and then you assume the debt of this REIT, which is mostly fixed rate and has long maturities and so you you also get the benefit of these cheaper interest rates of the previous years which you wouldn’t get if you’re buying a property today in the private market.
Scott: I I think this is awesome. And what a fantastic thing to end on there as a potential example for folks to to go in and and take a look at. Um what what do you do all day, uh you see? What what is what is your profession right now and where can people find out more about you?
Guest: Um as you said in the intro, I run a small investment firm that specializes in REIT investing. It’s called Leonberg Capital. Um we we manage our own capital but we also offer some research services, um really three types. We have a newsletter called high yield landlord that’s hosted on Seeking Alpha. We also offer customized research services to larger REIT investors like family offices, small private equity firms, and then we also provide some consulting services to some REITs themselves to help them improve their investor communications. Uh so, so that’s really taking a big chunk of my time on a day-to-day basis. Uh investing is really my passion and business in general is my passion and so so I’m pretty much doing this the whole day.
Scott: So on Seeking Alpha as I said, we’re host we have our newsletter called High yield landlord. there is a a two week free trial if I can put a little plug in here in case you want to access my read portfolio. Um then on top of that, I recently created a YouTube channel. I I created it earlier this year so it’s still relatively small, but we are now approaching the 10,000 subscribers so if you can help us pass that, that will be really appreciated.
Scott: What’s it called?
Guest: If you type UC Escola in in the search bar, you’ll find me, but the the handle I think is ask Escolas, j s i. Uh it’s the same handle also on Twitter where I post some daily news on the REIT sector.
Scott: Everyone needs to go and check out uh UC Escola’s stuff. We’ll link to it all on the show notes here and you can go check out the YouTube channel and High yield landlord. That’s where I found you on seeking Alpha. um with a lot of the stuff you put you put out there. Uh thanks for all the value you add to the community and your very compelling arguments in favor of REITs today. It was a true privilege to learn from you and uh I think Kyle and I had a ton of fun. So I really appreciate it. Um really really, really respect your intelligence and the the approach you take to investing in this sector.
Guest: Thank you very much, Scott and uh, to end this, I also wanted to add that, you know, when I was still in high school, I was already uh reading, I think it was Bigger Pockets. I was uh and throughout my college as well later on, I’ve I’ve been a very actively following your YouTube channel or your the content you put out there on your website. So, so it’s been an inspiration for me and uh and so, so I really appreciate that.
Scott: All right, Kyle, that was UC Escola. What did you think of today’s show?
Speaker 1: Uh, it’s always good when you hear somebody and they make you want to change your whole investment philosophy. So, I mean, he just threw some great stuff out there that makes you really think through if you’re a real estate investor and you’re doing it on your own or very directly, the the incredible benefits of not doing that, of doing it more passively and letting more professionals do it in these larger funds. Uh he just has a depth of knowledge that we just totally took advantage of today and and it was great.
Scott: Oh yeah, I mean this I how how can how can you not help but leave today’s episode just totally into admiration of UC. You know, who who knows who’s going to be right in the long-term 30 years from now which is going to perform which other way, but what a really well-reasoned, well-crafted argument, what a clear level of depth and understanding and due diligence over years, maybe a decade plus um of just I would I would call it an obsession that I got from him in understanding every intricate detail of this market, the risks, puts and takes, opportunities within sub sectors, how managements compensated, understanding debt structures, all that kind of stuff. I mean, this is a true, true expert and and I I walked away admiring and and and really respecting his argument, even though I’m on the other side of it as a uh single family, you know, and small multi-family rental property investor personally. I probably will look into some rents and like or some rents to into some reads uh and and I like I told you, I follow his newsletter and and um really respect a lot of his analysis.
Speaker 1: Yeah, I think this is just a huge benefit to the listeners because this this fits a certain investor type. Everyone has a different goal, everyone has a different life stage, everyone has different circumstances as far as what they’re doing with their time. And REITs are a if you are really into real estate and you want that to be a big part of your investments, uh this is another great way to do it. And we touched about on it a little bit in the episode as far as like what your time is worth. Um and that and that really comes into play. I mean, I during the episode I was constantly thinking about terrible properties I’ve had where I’ve spent a lot of time where I shouldn’t have. I was just too nights at one of my short-term rentals, uh spending a lot of time there. I think it was worth it. We’re doing a big renovation, needed to be there, but I it just all these things are making me think and evaluate and an episode like this makes whether you continue to stay in your more direct investing in in real estate, that’s fine, but just make sure that you listen to an episode like this to give you another perspective to make sure you’re making the decision that you should be making.
Scott: And and I also thought he really handled my my challenge of, well hey, everything’s down 30%, like if that’s not a crash, what’s a crash uh in the sector. You know, I I think over long over the long run, you know, he’s brought a really good reasoned argument and in the short run, hey, there’s just a crash in the sector, maybe it’s something to go and look into and and do some research on um as a listener for for your own personal position. Maybe maybe there’s opportunity there and maybe now’s the time. Um if you can if that’s true and you can verify with your own due diligence, hey, there’s a four four and a half cap in Dallas, that’s pretty tough right now to believe in a lot of rent growth in the next couple of years, but if if a read is that owns a bunch of them is trading at six and a half and an implied six and a half cap rate, that’s a really compelling argument. Um obviously you gotta go do your own due diligence and um run all that stuff for yourself but um what a simple but powerful argument.
Speaker 1: Definitely. Yeah, it’s huge benefit to to knowing more about this way of investing.
Scott: Should we get out of here Kyle?
Speaker 1: Yeah, let’s do it.
Scott: All right. Uh from this episode of the Bigger Pockets Money podcast, he is Kyle Mast and I am Scott Trench saying won’t be long, little fon.
Speaker 2: If you enjoyed today’s episode, please give us a five star review on Spotify or Apple. And if you’re looking for even more money content, feel free to visit our YouTube channel at youtube.com/biggerpocketsmoney. Bigger Pockets money was created by Mendy Jensen and Scott Trench, produced by Kalyn Bennett, editing by Exodus Media, copywriting by Nate Winetraub. Lastly, a big thank you to the Bigger Pockets team for making this show possible.
