Since the spread of Covid-19, I’ve frequently referred to Warren Buffet’s quote “Only when the tide goes out do you discover who’s been swimming naked”. Based on my experience working with the largest US pension funds during my tenure as CFO at RREEF, I believe that there are so many unsound real estate offerings being promoted that I imagine seeing the following headline:
Pandemic Exposes Teams Swimming Naked Relays
How should you invest in real estate? Either directly. Own the property outright and manage it yourself, which involves rolling up your sleeves and doing the work yourself or putting your kids to work, finding your tenants, collecting the rents, hiring the contractors, the handyman, the gardener. This is the common formula followed by those I know who have made a success from owning real estate. Or buy shares of REITS. If you don’t have this kind of interest in bricks and mortar, then buy shares of REITs or, to effectively diversify, index funds that own REITs. *
* Disclosure: I recently advised my clients to exclude real estate from their investment portfolios because the current valuations are based on unsustainable assumptions: that rents continuing to grow faster than inflation and future buyers assume the same.
Taking this a step further, shelter in place orders caused by Covid-19 have sucked the water down like a tsunami. As a result, an unusually large number of swimmers were caught swimming naked.
Until recently, many real estate investments seemed like secure ways to generate higher cash returns than bonds. A great example were properties leased to national chains, commonly referred to as NNN or triple net, where the tenant is responsible for all the care of the property, often including paying property taxes. When the tsunami hit, owners of properties leased NNN to some national chains have received letters demanding a break in rent. In some cases, the letters have notified the owners that the chain is filing for bankruptcy and has closed the location.
Other types of real estate investments include Private REITs, Delaware Statuary Trusts, and Limited Partnerships. They all involve giving control to someone else without a robust, liquid secondary market. So, once your money is invested, you are stuck with little, if any, recourse. And, often, you won’t realize the returns associated with real estate because of the fees and share of the profits that the promoters charge. Bankers refer to this as “there’s no such thing as a bad pro-forma.”
When I was a teenager, after someone would pitch these types of “opportunities” to my dad, he would ask me rhetorically, “if it’s such a good deal, why are they offering it to me (a stranger)?” While at RREEF, I learned how we identified and steered our clients away from those “opportunities” and that my dad was right. They aren’t “such a good deal.” And these lessons have been reinforced many times since.
If I were to advise you on what type of real estate to buy, I would recommend residential: multi-unit or single-family property close enough to where you live so you can manage it yourself. As you evaluate the revenue projections, consider the prospect of rent control and the impact it might have.
Avoid other types of real estate unless you will use it for your own business. Retail has been going through a transition which has been made worse by COVID-19. Office is too risky until we learn how business adapts to work from home.
If you’re not into bricks and mortar, then buy shares of a REIT (real estate investment trust). Being a proponent of broad diversification, I recommend an index fund that owns REITs such as Vanguard’s Real Estate Index Fund (VGSIX) or ETF (VNQ) or DFA’s Real Estate Securities Portfolio (DFREX) or International Real Estate Securities Portfolio (DFITX) or Global Real Estate Securities Portfolio (DFGEX)
I hope you find this article helpful and welcome the opportunity to discuss how we might make it a little easier for you to live the life you want with the money you have.
As always, please share this information with someone who might want to hear a grounded voice of reason provide a 2nd opinion about their financial situation and let them know that I will be happy to meet with them at no cost or obligation.
Stay safe, stay healthy, and keep washing your hands,