The latest ad from Dr. David Eifrig for his Income Intelligence service (published by Stansberry) makes it seem like there’s something secretive and amazing happening that will boost your portfolio… and it’s happening immediately and on a specific date (September 16).
So what is it?
Here’s the intro to the ad:
“Last year, two of the most powerful financial entities in the world quietly sent out a 4-page press release.
“It laid out a shocking change to the financial markets that will take effect on September 16, 2016.
“This document wasn’t an academic paper or a commentary about something that might happen. It was an official notice…
“It announced the creation of a new rule — Sector Code 60 — under something called the Global Industrty Classification Standard (GICS).”
He goes on to say that this shift, which I think actually takes place on August 31 but could have its biggest single-moment impact on September 16, is going to lead to a “wave of $100 billion in buying.”
So what’s he talking about?
This is all in reference to the creation of an 11th major sector by the GICS folks, who are the ones who try to keep global investing organized and categorized.
Today the ten sectors that are used by pretty much everyone, whether to classify their investments or ensure diversification or build investment products or whatever, are:
- Consumer Discretionary
- Consumer Staples
- Health Care
- Information Technology
- Telecommunication Services
And as of the end of this month, to be most notably evidenced when Standard & Poors does their annual rebalancing of funds and indexes on September 16, there will a change to these top-level sectors for the first time in decades… and we’ll go from ten sectors to 11:
- Consumer Discretionary
- Consumer Staples
- Health Care
- Information Technology
- Telecommunication Services
- Real Estate
Real Estate is being carved out of the Financials sector, where it has been hiding for decades, and the thinking is that this new upper-level focus on Real Estate — mostly equity REITs — will have a big impact on making REITs less volatile, more popular, and perhaps more valuable.
That’s not necessarily because REITs will make up a larger percentage of the broad market, or of the big indices, but for rather squishier reasons — like increased visibility, a larger number of investors asking their advisers about REITs, and a growing acceptance that REITs are not just an “alternative” asset for income seekers but are a major sector all their own and should be a core part of most portfolios.
This might not happen, or it might not happen with great speed — particularly since REITs have already risen pretty dramatically in popularity over the past couple years as low interest rates have sent investors hunting for yield… but the wind is at the backs of the real estate sector to at least some degree because of this shift that will impact lots of institutional money, ETFs, and, perhaps, REIT visibility and popularity.
I shouldn’t use “real estate sector” and “REITs” interchangeably — but for most intents and purposes, they will mean the same thing. Equity REITs will, according to estimates I’ve seen, make up roughly 95% of the new “real estate” sector (the rest will be publicly traded companies in real estate operations and management who have not chosen to be REITs).
And I should also explain what I mean by “equity REITs” — equity REITs are what probably most of you think of as REITs, they are the Real Estate Investment Trusts who primarily focus on buying real property and leasing it to tenants, whether that’s apartment buildings or malls or office buildings or hospitals or whatever. That’s what’s going to make up the bulk of the new real estate sector.
There’s also another class of REITs that some of you may have run across called Mortgage REITs, and those are staying in the financial sector (where they belong). Mortgage REITs are financiers, they mostly buy and trade mortgage bonds, they don’t own real property, and they are both more levered, on average, than equity REITs, and more specifically dependent on things like interest rate spreads.
So what will the impact really be? Lots of folks are expecting a significant impact over the long term, but the long term also started last year — the official rebalancing of S&P indexes happens in mid-September, but this change was announced in 2015 and it seems likely that there’s been some preparation for the expected switches, so it’s less of a “REITs will jump by x% on September 16” rationale than it is a “REITs will get more attention and seem likely to rise based on that attention.”
Which wouldn’t be shocking — REITs have beaten the broad market pretty handily over the past 20 years, and according to the REIT industry groups REITs have outperformed the S&P 500 for seven of the last ten years. So “REITs doing well” wouldn’t be a change.
But it might be enough to help REITs do better than they otherwise might during what is expected to be a challenging time IF we start to see steadily rising interest rates.
That’s a big “if” — the great fear for REITs is that rising rates will hurt their prices, just as they hurt the prices of bonds and other income investments. And sometimes that’s how the market works, at least in the short term (over the longer term, rising rates generally are signifiers of inflation, and inflationary times have generally been good for real estate values so REITs don’t necessarily become permanently impaired by a rate hike — REITs have generally done fine during and following longer periods rate increases).
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And REIT investors (myself included) have been fearing those rising interest rates for more than three years, going back at least to the “taper tantrum” in the Spring of 2013, when then Fed Chair Ben Bernanke talked about “tapering” the quantitative easing and that was enough to (briefly) crush REIT prices and bond prices and most other income investments.
Why is that? It’s largely because of the clear math of rising rates and what it does to bond valuations (and, theoretically, REIT equity prices) — if the standard “risk free” return you can get from a Treasury Note is 2%, then your bond that has a 2% coupon is priced right at par value — but if things change and you can suddenly get a 3% yield by buying a Treasury Note, then the existing notes in the market have to drop in value so that a buyer on the secondary market would be getting that 3% yield (otherwise no one would buy it).
That’s a big and well-understood mathematical impact on bonds, since they are bought because of safety, for their return of principal and their “guaranteed” nature, and that’s why so many folks are worrying (and have been worrying for several years) about a catastrophe for bond investors if rates rise.
The same impact hits other income investments, albeit sometimes to a lesser degree — so if you presume that investors buy REITs primarily because of their dividend yield (which is a reasonable assumption), and guess that “risk free” US Treasuries will yield 3% at some point (instead of 1.5% or whatever it is for the 10-year note now), then it’s likely that some of those investors would rather own a bond paying a 3% coupon with a guarantee than a REIT paying a 3.5% dividend with no real guarantee… so maybe they’ll decide they’re only willing to buy a big, relatively safe REIT if it yields 5%, not 3.5%. If we assume that the REIT is priced around $20 now with that 3.5% yield (that’s about the average REIT yield these days), that means that the stock price of that REIT, all else being equal, would drop from $20 to $14 to give it a 5% dividend yield.
It doesn’t work that purely or cleanly, and it sometimes takes a lot of time (as inflation or rate hikes bringing the 10-year Note from a 1.5% yield to a 3% yield would presumably take a long time, though no guarantees on that), and REITs typically a also raise their dividend payments over time and make deals and do financings and all kinds of other stuff that will impact their share price… but that’s the worry for REITs, laid bare.
And that worry may be lessened a little bit if REITs become not something that institutions treat as an “alternative” investment, but something that is perhaps more a core sector that they always need some exposure to.
Which, again, will not be a sudden or direct change, but the general sentiment is that big institutional investors are generally under-invested in REITs — and that could change and give more of a foundation to the sector.
REITs are not all that small, as a segment… but they are somewhat hidden, and it’s perhaps easier for a institutional manager to justify avoiding a sub-industry of the Financial Sector than it is to avoid a sector entirely. Right now equity REITs are about a $1 trillion industry within the Financial sector, so they’re roughly the same size and get the same presence in the indices, in stock market terms, as the insurance industry… so while I agree that more focus on REITs will probably be a positive, I’d hesitate to assume that the rosier numbers about immediate changes will be accurate (like that “$100 billion will be rushing into REITs by the end of the year because of this sector change” argument that you’ll see from many REIT industry folks).
I do have an above-average exposure to REITs in my personal portfolio, and I am not that worried about rising rates as long as the rise is relatively slow and gradual (though I’ve kept some powder dry and will buy more REITs if we get another interest rate “tantrum” trade that drives them down too sharply), but I expect Janet Yellen’s talk at Jackson Hole tomorrow morning and what that talk does to investor sentiment about future interest rates will have more of a near-term impact on REITs than the September 16 rebalancing.
So… with that all said, is Eifrig recommending anything specific other than just “buy REITs?” Here’s some more from the ad…
“Mutual funds… ETFs… insurance companies and massive pension funds will be essentially forced to buy billions of dollars of one specific type of asset.
“And those already holding shares could see huge gains as a bidding frenzy ensues for whatever’s available.
“Again… Huge investors like these HAVE to buy to meet their benchmarks… regardless of price.
“The amazing thing is: This asset is not some high-risk speculation like tiny gold miners or biotech stocks…
“Or some boring safe-haven that barely yields 1%… like Treasury bonds.
“It’s actually a group of investments that pays three times more than treasuries… around 4% in annual income (sometimes much more)… and has a history of producing huge capital gains over time on top of that steady yield….
“Just keep in mind — this big change will literally happen overnight, before the markets open on September 16. In fact, some of the most important changes happen even earlier — on September 1 — although I expect the biggest inflow of capital to happen after September 16.
“The point is: If you want the chance to make the biggest gains, you need to establish a position before that date. And do it soon….
“The great thing is: These are stocks and ETFs that I would recommend to anyone looking for a solid, low-risk yield in this zero-yield world…
“…even without the huge catalyst for a move higher coming on September 16.
“That catalyst is just a bonus.”
OK, so that’s still “REITs in general” … and I don’t know if I agree that you have to be positioned for an overnight change on September 15, but I would agree that the “catalyst is just a bonus.”
Eifrig does quote some sources in asserting that big institutional investors and funds are under-exposed to REITs:
“According to JPMorgan’s research, big funds only have about 2.3% of their holdings in real estate. But their benchmark is 4.4%.
“That means they’ll need to nearly double their real estate holdings, beginning on September 16.
“In some cases, the disparity is even more dramatic. Large-cap value funds currently hold just 0.9% in real estate. But their target is 4.9% — 5 times higher! ….
“I think REITs are one of the best opportunities in the market today.
“And according to JPMorgan Research, the index change that’s about to take place on September 16 could grow the entire U.S. REIT market by 12%.
“That’s an astronomical move for an $886 billion U.S. market.”
How about specific stocks? Well, Eifrig doesn’t get into a lot of detail about which REITs he likes, but he does drop a couple hints about some of the ones that are apparently featured in his “The $100 Billion Windfall” special report….
“One of them (currently yielding 3%) operates a type of business that could actually do much better if we see a major downturn in the economy.
“Another yields close to 5% and has a dominant position in an industry that could grow 10-fold in the next few decades. This stock has returned an average 16% a year since 1970 — and it still has plenty of room to grow.”
Can we name the stocks based on those clues? Well, not with any certainty — but we can have the Thinkolator come up with some options, and add a bit of guessing on top to get some possibilities.
I expect the best candidate is Public Storage (PSA) for that “business that could do much better in a downturn” candidate. PSA does yield about 3%, has been a hugely successful investment, and is the biggest player in its sub-sector of storage REITs. PSA has fallen close to 20% from its highs earlier in the year, but it’s a big company in a lucrative industry with a long history of rising dividends, and there is a widely-held belief that self-storage is at least a “recession resistant” industry, if not “recession proof,” partly because people who downsize homes, move in with their parents, or move for employment use storage spaces to handle their stuff. And stuff, as every American knows, is sacrosanct.
And for the “16% a year since 1970” and 5% yield our best match is Health Care REIT, which recently renamed itself Welltower (HCN), another very large REIT. Welltower, along with most of the other health care REITs, hah recovered nicely from its brief collapse back in February that was caused primarily by fears of Medicare fraud from one of the major tenants of Welltower competitor HCP (HCP).
I’m pretty sure HCN is the largest and oldest of the health care REITs, it has indeed been a strong performer for an extremely long time (it’s been listed since 1970). It has not raised its dividend every year like some have (including HCP, which was arguably getting a bit overpriced despite lagging performance because it had such a long and strong dividend growth history that made it the only REIT that was a “Dividend Aristocrat”), but it has raised the dividend nicely over time despite a few years of flat dividends.
I am a fan of the health care REIT space in general, since I think that whole sector is likely o continue to have tailwinds as demand for healthcare services increases (including hospitals, rehab hospitals, medical offices, skilled nursing and retirement communities). The biggest pressure on this group in general has been regulatory concern about skilled nursing facilities and Medicare/Medicaid reimbursement, which is what caused a collapse in HCP shares in February that brought down all the other healthcare REITs and provided a nice buying opportunity in several other names that didn’t have exposure to the same regulatory issue (or the same operator that was in hot water), but yes, the general tendency is for the health care REITs to more pretty similarly to REITs in general — and many of them, particularly those with a focus on skilled nursing or senior housing communities, have unusually high yields for REITs.
There’s a pretty good list of the players here if you’re curious to research them yourself, I personally think it’s important to diversify some in this sub-sector and currently own shares in Medical Properties Trust (MPW) for its hospital focus, Ventas (VTR) for its strength and stability, Omega Healthcare (OHI) for its high and “raise every quarter” dividend, though it is volatile because of its focus on the skilled nursing space, and Physicians Realty Trust (DOC) because it’s still an emerging growth name in medical office buildings.
And no, you do not have to pick individual REITs to enjoy exposure to the REIT sector — it’s not officially an S&P Sector yet, but there are plenty of ETFs for the REIT sector that provide instant diversification across shopping malls, apartments, office buildings, health care, etc… my favorite is Vanguard REIT Index (VNQ), but there are others… and you get a decent yield from the ETFs, VNQ is currently yielding almost 3.5% and offers far more diversification than any basket of REITs you could put together.
Of course, it also offers a lower yield — that’s because a lot of the largest and most popular REITs pay pretty paltry dividends. Simon Property Group (SPG) is the giant that owns shopping malls and has a 3% yield, Prologis owns warehouses and distribution infrastructure and pays 3%, the biggest data center REIT, recent conversion Equinix (EQIX) pays 1.9%, office giant Boston Properties (pays 1.8%), you get the idea — those are all massive $20+ billion large caps in the REIT sector, and that’s what drives average yields down a little bit.
I am personally a little bit wary of the lowest-yield REITs that pay well under 2.5%, and of enclosed shopping malls (SPG, GGP and others), but I would have said that last year as well and most of them have done quite well.
Eifrig does not, unfortunately, drop any other hints about his favorite REITs, so we’re left with our “best guess” that PSA and HCN are likely candidates for his current Income Intelligence ideas… and beyond that, I’d be delighted to hear about other REITs or similar investments you find attractive — either before Yellen talks on Friday, or before the sector rebalancing in mid-September.
And for those who are not familiar with REIT investing, it’s worth noting that REITs generally pay dividends that are NOT eligible for lower dividend tax rates — that’s because the REIT structure is a tax pass-through, so REITs don’t pay federal taxes at the corporate level as long as they pass along 90% of their income to their shareholders in the form of taxable dividends. Like bond coupon payments, REIT dividends are generally taxable as regular income. Which makes a Roth IRA or even a regular tax-deferred account (your 401(k), a regular IRA) a better place to hold these kinds of investments, in my opinion. (There’s some variation in this, of course, some REITs also pay out a “return of capital” as part of their dividend if the dividend exceeds what would have been their taxable income, or they may have taxable subsidiaries that put a bit of the dividend into the “qualified” category for better tax treatment — you can usually see on REIT websites what the tax treatment of their dividends has been in past years… but in general, REIT dividends are treated as regular income.)
I personally expect that income investing will remain important, given our growing population of retirees and the lack of available “safe” yields, and that a 3.5%+ yield that grows every year will continue to be meaningful for the foreseeable future even in a world where interest rates might rise gradually, so that’s where I’m coming from and what colors my personal investment decisions and my continued allocation to REITs. Your opinion, of course, may differ… please help your fellow investors by sharing it with a comment below.