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 much faster than people think….

“Wharton School of Business guru Jeremy Siegel says it’s the buying opportunity of a lifetime. He even added that the bottom is in and that 2021 could be a BOOM year.”

Well, we do at least know that the Federal Reserve has essentially committed to keeping interest rates near zero for the next few years, and that will serve to both send folks searching for income and will generally bring asset price inflation, just like we’ve been seeing for the past decade, so it’s hard to argue against REITs as a general idea… providing you can swallow the risks of any specific name in the space.

And which ones are they hinting at here? We finally get to the meat of the pitch:

“This is why I am recommending that my subscribers look very closely at real estate investment trusts.

“And in a moment, I’m going to give you details on my three favorite REITs.”

He gives some of his rules for picking REITs…

“Here are the criteria I use…

“The REIT must be trading at a big discount to previous highs so you can get as many shares as possible.

“The REIT must have a long history of INCREASING its payments as it acquires more properties and collects more rent.

“The REIT must operate in a booming sector. This will make it more likely that your shares themselves multiply in value.

“The REIT must be lesser-known, so you can get in at a good price before everyone else discovers it.”

So what, then, are those “top three” REITs being hinted at by Oxford Income? More from the ad, as the hints start to roll…

“These criteria brought me to the TOP THREE REITs on the market right now… and my favorite way to play the impending real estate rebound….

“The first is a technology REIT that rents out data centers to huge companies….

“Data centers are essential to new technologies like cloud computing, 5G and the Internet of Things. All that data processing has to happen somewhere…

“And this first REIT gets paid by clients like AT&T and IBM to house and operate their computing power.

“AT&T and IBM pay the rent (you can bet they never miss a payment), and then the REIT pays out 90% of the profits directly to investors.

“It’s paying out a total of $1.2 BILLION per year to shareholders.

“And right now, you can get shares at a big discount from their recent highs because of the crash.”

Who is it? Thinkolator sez that must be Digital Realty Trust (DLR), the second-largest of the data center REITs. It’s smaller than industry leader Equinix (EQIX), which converted to REIT status decades after DLR did, but pays a higher dividend (both per share and in total), so their trailing dividend payouts over the past twelve months have tallied up at about $1.17 billion.

And yes, it’s off its highs for the year… though I don’t know when Lichtenfeld pulled his data for this piece (the ad is dated August 2020, and the first version of the ad we saw was on August 28, when the shares were at about $155 and down about 8-10% from recent highs, though the shares are down another 9% or so from then at $142 today). The stock is still up on the year, like most of its competitors and near-peers — the “technology REITs,” into which category I’d put the data center REITs and the cell tower REITs, crashed along with everything else at the end of March… but didn’t fall nearly as far as most stocks, and bounced back very fast. I use the Pacer Benchmark Data & Infrastructure Real Estate ETF (SRVR) as my proxy for that whole group, it’s roughly half tower REITs and half data center REITs, with some oddballs thrown in, and this is how that ETF has done so far this year (in purple) compared to the average REIT (using the Vanguard Real Estate ETF, VNQ, in orange) or the S&P 500 (blue).

SRVR Total Return Level Chart

I do not currently own any data center REITs individually, though I do have money in that SRVR ETF. The group has been strong, and Digital Realty has been a great recovery and “growth resumption” story over the past five years. The dividend yield is about 3.2% right now, and the last few annual dividend increases have been 8.5%, 7%, and 3.5%. I’d expect the shares to track that dividend growth, and while this year was relatively tepid it looks like they should be capable of 5-10% dividend increases over the next couple years. Growth will probably be slower than it was for the past decade, but over those ten years the dividend has increased by 126% and the share price has increased by about 137%, and over the past three years that connection has been tight as well (20% dividend increase, 24% share price increase), so if you can buy on a bad day, or moderate your expectations to “this will go up as fast as the dividend increases,” you’ll probably do well… with a little boost if you reinvest those dividends as you go, and can ignore the stock price gyrations for long enough that the compounding of dividend reinvestment has a real impact. It won’t be dramatic, a 3% dividend and 7-8% growth is solid but not exciting, but it should work well over the long term.

Assuming, of course, that they don’t screw up something, get mired in a scandal, or cut the dividend. I think the risks to data centers are fairly low, given the very strong demand picture — more data, more processing in the cloud, more more more, every year — but it’s also an area that should be ripe for disruption, and the growing efficiency of technology should make the raw space for connected server racks and the massive power supply that data centers provide less valuable over time, but that hasn’t happened yet. Maybe it won’t.

What’s next?

“The second is an industrial REIT that rents out logistics real estate for e-commerce. Think warehouses and supply chain buildings.

“Its biggest tenant? Amazon.

“Amazon has warehouses all over the country so it can get you your package as fast as possible… and it’s adding more all the time.

“Imagine collecting income from all the shipping Amazon does….

“But get this – this REIT also collects rent from companies like UPS, FedEx, Target, Wayfair, Samsung and more.

“It’s paying out $214 million each year… and you get paid MONTHLY, just like collecting a real rent check.

“AND this REIT is trading for 25% off recent highs.

“To get the most bang for your buck, I personally recommend reinvesting the dividends you’ll get each month until you need the money.

“You’ll get more shares… and eventually see massive income streams.

“But if you need the money now, by all means, collect that monthly payment!”

That’s very likely to be Stag Industrial (STAG), the single-tenant industrial/warehouse REIT which, like the much-larger (and more frequently teased) industrial REIT ProLogis (PLD), counts Amazon as its largest tenant — though as of earlier this year, Amazon still accounted for only about 2% of STAG’s revenue, so we shouldn’t overstate that connection. Freight and logistics generally represents about 8.4% of STAG’s revenue, but “automotive” is the biggest sector at 11.6%.

Why is it a match? The dividend payout is quite close to what’s teased, this year the total dividend payout should be a little above $214 million, since the dividend tends to rise and the share count will also probably rise, but it’s very close right now (there are 149 million shares outstanding, the most recent quarter totaled 36 cents in dividends per share, that tallies up to $214 million if you annualize it at the current rate).

That “single tenant” business doesn’t mean that they have only one tenant, by the way, it just means that they have only one tenant per building — which increases the risk a bit, but is common in these kinds of REITs. Generally, properties like warehouses or logistics facilities have only one tenant, unlike an office building or a shopping mall, so having just one vacancy can mean a substantial drop in “occupancy rate,” and a purpose-built warehouse can be difficult to repurpose for a different client if your customer defaults. STAG has not been at a “25% off recent highs” price recently, it’s more like 10-15% off of the highs, but I suppose it was at that kind of a “discount” back in April or May. It’s fairly small, and volatile, and pays an above-average yield of almost 5% — and yes, it pays monthly, which generally attracts individual shareholders.

Dividend growth for STAG is paltry, averaging about 1% a year over the past four years, so unless you see a surprise surge in growth on that front it’s probably safest to assume that the dividend will be the entirety of your return. 5% isn’t bad, but it’s not great for a stagnant dividend… I do like STAG’s positioning, but I’d want to look into it in more detail to see if I can model up a vision for future dividend increases before investing.

I have looked into the industrial REITs several times in the past, thanks to relentless teases for ProLogis (which is far and away the industry leader, and one of the largest REITs in the world), so if you want to see that longer-form musing you can catch my update from last week here.

And one more…

“The third REIT in your special report is a play on LEGAL marijuana.

“You see, legal marijuana is set to be a $200 billion market in the next few years.

“But what’s the #1 resource this industry needs to reach that mark?


“And the third REIT in your report leases out land to medical marijuana growers… and rakes in the dough.”

OK, so longtime Gumshoe readers are certainly going to know that one…. but let’s see what other clues he drops:

“It’s paying out $78 million this year. But it’s been rapidly increasing payments as more and more states legalize marijuana.

“I fully expect the share price to go through the roof come November, when as many as 16 more states will vote on marijuana measures.

“But shares are still extremely discounted from the recent crash… about 30% off… so you can claim a share of the millions on the CHEAP.”

So that must mean Lichtenfeld was pulling his “extremely discounted” prices that went into this ad a few months ago, probably in May — the stock he’s hinting at is Innovative Industrial Properties (IIPR), which was indeed down sharply in March but has since bounced back to new highs for the year… albeit still 20% or so away from the all-time highs set in 2019.

Innovative Industrial Properties is indeed a REIT that leases space to marijuana growers — for the most part, that means advanced warehouse properties for indoor growing, leased primarily to “medical” marijuana companies in states where that is legalized. They have grown extraordinarily quickly, and the fact that marijuana companies are otherwise having a hard time finding access to capital without dilution (since most banks won’t lend to them) means that IIPR can charge very high rents for the sale/leaseback deals it does to offer financing to these marijuana growers. So their returns are high, and the risk is also quite high because these properties are essentially “build to suit” growhouses — if marijuana growing collapses as a business, it’s not like IIPR can slot in an Amazon distribution center in those properties and collect the same rent, the value of those properties for any other use would be dramatically lower.

The high returns from high rents plus the rapid growth in the portfolio, fueled by a ton of equity raises, means that IIPR has been able to raise the dividend extremely aggressively. That has fueled the rise in the share price, and the stock still has an above average forward yield of near 4%, so as long as those tenants continue to be able to pay their rent, IIPR remains a compelling buy… you just have to decide what kind of discount you might insist on given the above-average risk of the sector. For some folks, just the fact that IIPR has effectively no debt, unlike almost any other REIT, is discount enough.

Here’s what I wrote to the Irregulars last week, after IIPR raised its dividend again (I’ve owned this stock since January of 2018, though I did cut my position in half this year to reduce the risk levels in my portfolio):

“Speaking of dividend compounders, Innovative Industrial Properties (IIPR) raised its dividend again, a nice solid 10% lift after they raised it 6% last quarter (both sequential increases, the year-over-year growth is dramatically higher). So now the payout is $1.17 a quarter, which if they don’t do any more dividend increases in the coming year would mean we’re looking at a forward dividend yield of about 3.7%. Not the kind of valuation you’d necessarily want to chase, given the risk, but certainly it’s nice to see another dividend increase, which serves as both a nice boost to income and compounding power and a signal of strength and confidence from management.

“I was too cautious about the financial health of IIPR’s tenants earlier in the pandemic, and they’ve come through it very well so far… but tenant health is still the real overriding risk for IIPR — so I’ll repeat what I’ve said many times: if the tenants can keep paying their rent, a near-4% yield with 50% year-over-year dividend growth (down from 100%+ a year ago) is a no-brainer. I reduced my position because I decided the company is riskier than I had originally calculated, and wanted to lessen my exposure as a result, but the numbers say it’s an obvious buy.”

And actually, since we’re talking about dividends, I’ll close us out with a little more of an excerpt from last week’s Friday File on that general topic:

I shared some “rules of thumb” last November for when dividend-focused stocks like REITs look buyable, and what criteria to look for in dividend growers, here they are again in case you’re curious — the world has changed, rates have come down even further and will remain super low, but the average REIT dividend yield has now risen since then (from about 3.1% to 3.8%), creating a little better opportunity for investors (at least outside of the directly COVID-impacted assets, like some office buildings and shopping malls), and dividends will probably continue to be extremely important to most investors… so these broad “rules” still make sense to me:

“So these are the rules of thumb I’m trying to keep in mind these days when it comes to REITs and similar dividend-paying stocks. They are, of course, not perfect, and significant changes to interest rate expectations will matter a lot more to most REITs than any company-specific metrics, but hopefully it will help me to remember that dividend growth is the single most important factor when evaluating REIT stocks.

  • Average dividend (2-4%) and blah dividend growth of a few percent a year? Maybe will very slowly compound, but you can do better. That’s where most of the blue chips live.
  • Huge dividend (4-6%+) without dividend growth? Count on the dividend being all you receive, and make sure it’s sustainable — meaning free cash flow or FFO can cover the dividend with a little cushion.
  • Small dividend (1-2%) with dividend growth? Look at the underlying fundamentals, it’s not being valued based on the dividend yet, but if dividend growth stays very high, above 10% for multiple years, that’s a very good sign.
  • Average dividend (2-4%) with 5-10%+ dividend growth, or a large dividend (4-6%+ with dividend increase of at least 3-4%, above the rate of inflation), and a dividend that is easily covered by FFO or free cash flow? Just buy it (OK, after looking for skeletons in the closet)… it will probably work out really well.”

So there you have it… some income ideas hinted at by the Oxford Income Letter, and some of my general thoughts about investing in dividend-paying REITs. When it comes to your money, of course, you’ll need to rely on your own thoughts — and we’d love it if you’d share them… have a favorite REIT? Think the sector is generally appealing or unappealing right now? Sitting on a watchlist of REITs that you’d love to buy on a dip? Let us know with a comment below.

P.S. We always want to know what readers think of the newsletters they subscribe to, so if you’ve ever tried out Lichtenfeld’s Oxford Income Letter, please do click here to share your thoughts with your fellow investors. Thank you!

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