Oxford Income’s “GREAT 2020 Real Estate Redo”

What are the "Three Favorite REITs" teased by Lichtenfeld's Oxford Income Letter?

By Travis Johnson, Stock Gumshoe, September 24, 2020

Today I’m looking into a teaser pitch from Marc Lichtenfeld that has been running for a few weeks, all about the “#1 way to play the real estate rally” … so let’s get right into it.

Lichtenfeld says that “this special type of real estate investment has “historically done much better than the broader stock market during most recessions” … so that’s intriguing, but it turns out that’s just a general reference to investing in REITs…

“With this real estate play, it takes just five minutes and a few hundred dollars to get your foot in the door and get started… rather than the unbearable load of time and money you’d spend flipping houses.

“You don’t have to manage properties… fix even a single leaky faucet… or chase down checks from flaky tenants.

“The money is directly deposited from the tenants… into this unique asset…

“And then into your brokerage account in the form of dividends.

“For just a few dollars per share, you can essentially become an owner in ultra-cheap real estate all over the country.

“If you have the guts and the smarts to put down just a small starting stake… you could collect MASSIVE income for years.

“I think there is a definite chance we will see gains of more than 1,000% on the best real estate plays in the year ahead… just like we did in 2009.”

And here’s how Lichtenfeld describes these investments…

“REITs are easier to buy and have bigger upside potential, and you can do very well if you buy them. And let me stress this: THEY ARE CHEAP.

“Billionaires like George Soros… Sam Zell… and even Donald Trump have made massive fortunes with this approach.

“… here is how real estate investment trusts work.

“In short, the trusts own hundreds of properties in highly sought-after areas all over the country.

“Through them, you can get paid on government buildings like FBI and Department of Defense offices…

“Luxurious hotels and resorts by the likes of Marriott, Wyndham Grand and Park Plaza…

“You can even collect rent on the Empire State Building!”

All that is true, though some of the REITs that lease to those brands or government agencies, or own those trophy assets, are “cheap” for good reasons… with hotels in “pray for survival” mode in most areas, and the Empire State Building and other urban office buildings probably having trouble leasing new space while companies keep their employees at home. By the way, the highest office floor in the Empire State Building, the 78th floor, with incomparable views and 20,000 square feet of space for your cubicle farm, is available for lease right now, should you be interested. I have no idea what they’re asking for rent.

And Lichtenfeld further points out the income appeal of REITs — which won’t surprise any of the experienced investors among you:

“Due to their special tax status, 90% of all real estate income from these assets MUST be paid to investors.

“So by being an investor in a real estate investment trust, you can get a piece of all these properties and the income they produce…

“Without doing one bit of work….

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“Prices are cheaper than ever. You can get in for pennies on the dollar.

“And when the economy does come roaring back, as it always does, the value of your investment could go much, MUCH higher.

“That’s why right now I’m pounding the table on these high-income-generating real estate stocks.”

That’s true, and Lichtenfeld admirably does not throw in the misleading “this income is legally guaranteed” balderdash that many REIT pitchmen use — REITs do have to distribute at least 90% of their real estate income as dividends to shareholders, but we should also recall that this is a really, really easy hurdle to leap over. Real estate comes with such massive depreciation charges, which count against income, that in reality almost all REITs pay out far more than is required. Lots of REITs have very low reported income because of depreciation and amortization, but very nice cash flow that they can use to pay out big dividends and keep their shareholders happy — almost all REIT shareholders are primarily dividend-motivated, and this is not a secret to REIT managers.

That’s why REITs in general use the “funds from operations” (FFO) cash flow term instead of “earnings” most of the time, and analysts tend to focus on FFO as well. The officially accepted definition of FFO is that they take net income, then exclude depreciation and amortization of the real estate, exclude gains or losses from the sale of real estate, and exclude write-downs or write-ups in the value of the underlying real estate. It’s meant to be a measure of the ongoing business income from the real estate operations.

In practice, this also means that REITs are capital sponges — they are always looking for more equity and will generally raise more equity anytime they want to expand by buying or improving properties. That’s because they don’t retain any cash from that “depreciation” or amortization of the properties. They raise money, they buy properties, and they pay out a large portion of the net rental cash flow out to shareholders.

Growth for these companies comes not from compounding their income by building the portfolio’s value on a per-share basis, since most of them don’t really do that, it comes from selling shares and levering that equity up by borrowing money to buy properties, hopefully therefore increasing the cash flow (FFO) from those properties on a per-share basis, or, if they don’t use much leverage or try to grow by selling shares and acquiring properties, they can sometimes thrive, on a smaller scale, by maintaining or improving properties so well that they can continue to increase rents and become gradually more efficient. That latter one is tough, though, since the overhead of a public company can be a drag on a REIT that isn’t really growing.

In general, when it comes to REITs, the total return that shareholders can expect comes primarily from the dividend — if the dividend is largely flat, that’s probably all you’re going to get unless you buy at a really opportune “beaten down” price and sentiment about the company improves… if the dividend is rising, over time the share price tends to rise with that dividend, giving you real compounding power if you reinvest your dividends each quarter (or month)… but if the dividend is cut, look out below.

I don’t know what will happen in the big picture, but over the last 30 years we’ve had the tailwind, most of the time, of falling interest rates — which both makes REIT dividends look more impressive relative to bonds, and decreases their borrowing costs… but we’ve also, at the same time, seen the value of real estate rise pretty dramatically, even faster than rents, so that means the cap rate for a lot of properties is substantially lower now than it would have been 20 years ago. I’d tend to agree that REITs which can pay solid and growing dividends are likely to appeal to investors for the next few years, if for no other reason than that older investors need income, and there aren’t many places to find it — REITs and other relatively high-yielding stocks are likely to be seen as an “income replacement”. Assuming, of course, that the stock market doesn’t crash and scare everyone out of all stocks — when people are in a panic and go into “sell everything” mode, that usually includes REITs. I’d think of such panics as a buying opportunity, given the long history of REITs performing quite well as an inflation-hedged asset, but, of course, there will be good and bad names in the sector.

The coronavirus shutdown did certainly put a damper on real estate, though some parts of the business bounced back almost immediately… here’s more from Lichtenfeld’s ad:

“… home sales in the Bay Area dropped 35%.

“If that sheer drop happened even in a red-hot market like the Bay Area… where almost half of the houses were selling for MORE than the asking price…

“Imagine the carnage around the rest of the country.

“Orlando, a few hours north of where I live in Palm Beach, was a ghost town.

“The theme parks were empty… all the rides were shut down…

“And all the surrounding businesses – hotels, tours and shops – were making ZILCH.

“This is what caused real estate prices to drop so quickly…

“But here’s what the media isn’t talking about right now.

“The recovery happens muc