How to Make Real Estate Money WITHOUT Owning Rentals

Scott:
Welcome to the BiggerPockets Money podcast where we interview Jussi Askola 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.

Kyle:
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.

Kyle:
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. Jussi is just the perfect guest to talk about REITs, real estate investment trusts. A publicly traded, 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 BiggerPockets. And wow, is this guy pretty smart on this topic. This is a must listen episode.

Kyle:
100%. This is exciting. This guy knows his stuff and this is definitely a neglected topic in the real estate sector, so people are going to get a lot out of this episode. I’m excited for everyone to listen to this. It’s 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. You’ll earn more money, you’ll have more energy, you’ll spend less on healthcare, and you’ll be better looking. All things that contribute to financial success in the long run. So do you have a money tip for us? Email [email protected].
Jussi Askola is president of Leonberg Capital, a boutique advisory firm specializing in real estate investment trusts. Jussi 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. Jussi, it’s so great to have you here on the BiggerPockets Money podcast. Thank you so much for joining us.

Jussi:
Thank you very much for inviting me. As I was telling you before we started, this is my very first podcast ever, so I’m very excited.

Scott:
Awesome. Well, we’re honored you came on here first and really grateful. Would you mind starting off things by telling us a little bit about yourself and how you became interested in real estate and investing?

Jussi:
I come from Finland. I was born in a family of real estate professionals, so I’ve been going from one construction site to another already from a very early age. I decided to go into real estate quite early as well. Basically during high school 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, and so I bought my first REIT at about 15 years old. Already back then, I was very interested in real estate investing. I really loved this idea of being able to buy a property with the bank’s money, have your tenant reimburse it, and by the time 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 buy real estate just yet because the profits were not quite large enough, so I bought REITs instead. And so that was 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 to specialize quite early on already at the bachelor level, so that’s what I did. I also did 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 little while, but eventually I wanted to set up my own thing, and so that’s what I did.

Scott:
Awesome. And can you define REIT for the audience? What is a REIT and are there special rules or differences between a REIT and a public stock company, for example?

Jussi:
Yes. REIT stands for real estate investment trust. It’s essentially a company, a corporation that holds a lot of real estate for the purpose of generating rental income and 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 many other requirements, and if you fulfill those, then you don’t have to pay any corporate taxes. So that’s the main benefit really, of the REIT structure. They can be private. They can be public. In my case, I’m mostly interested in the publicly listed REITs. But yeah, so in short, that’s what a REIT is.

Scott:
Jussi, you are an expert at analyzing and evaluating the prospects and potential, the returns, whether REITs are going to perform well or not. How does one analyze the performance or expectations of a REIT? 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 the expertise in making these judgments about the potential of these opportunities?

Jussi:
That’s a good question. I think it’s important to start here by remembering that a REIT is a real estate investment. A lot of the things that you will look in a real estate property will also apply to REIT. 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 we’ll typically be interested in as a real estate investor. But then beyond that, because these are large corporations, you also need to analyze quite a bit their management. Is the management good? Is it well aligned with shareholders? What’s their track record? What’s the strategy that they’re following? Is it really creating value for shareholders or are they trying to extract value for themself in the form of fees or salaries? Then the balance sheet obviously is very important, especially today in today’s rising rate environment. So you look at a lot of different metrics. We can discuss those a bit later also if you want to in more detail, but things like debt to EBITDA, the long to value. So in short, you’re looking at the same things you’ll be looking in the private real estate investments, but then you’ll add some additional elements. These are large publicly listed companies.

Kyle:
Awesome. So what’s the difference between a REIT and a syndication investment?

Jussi:
A syndication will typically be a private vehicle, so you’re not going to have as much liquidity in most cases. They’re also typically going to be smaller in size, so much more concentrated. The management will typically be external, which leads to greater conflicts of interest and less economies of scale because the sponsor will typically charge a fee based on the assets under management as well as maybe a cut of the profits on the backend, 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 its scale. The management will typically be internalized, which means that the executives are working as employees for the REIT. They’re 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. So I think that those are really the main differences and also the reason why I prefer REITs versus syndications.

Kyle:
Well, that’s a good segue to the next question. We were just going to ask you, what’s the advantage of a REIT for someone who wants to get into real estate investing as opposed to maybe direct investment in real estate? And then maybe along with that, what’s a typical return? That’s hard to estimate, I know, but give an idea there and a time horizon for an investment like this too.

Jussi:
I could give you a really long answer to this question because I really enjoy this topic of REITs versus rental properties or syndications. 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’re also safer than private real estate in most cases. And on top of that, you also enjoy many other benefits here because it’s going to improve, I think, your lifestyle and also allow you to really focus on your career. So in short, better returns, lower risk, and it actually improves your lifestyle, which is not always the case with rental properties.

Scott:
Oh man, shots fired. Shots fired on the rental property one. Love it. So let me ask you this. Haven’t REITs had a pretty bad year and a half, two years here? And what would you say to the owner of maybe some single family rentals or duplexes out here in the states that haven’t seen their properties come down by that much at this point? How would you make that argument to somebody who’s in that position?

Jussi:
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 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 there are studies to back this up. There’s also a strong reasoning behind this argument, and we can go into this reasoning in more detail if you want to.

Scott:
Absolutely. Let’s do it. That sounds like a fun topic here.

Jussi:
Do you want me to give you the long answer or the shorter one for this? Because I can make it really long and comprehensive.

Scott:
We want you to make the strongest case you have and to nerd out to the best of your ability on the topic. That’s the fun thing, and that’s where everyone gets smarter.

Jussi:
So why REITs are more rewarding than rental properties in most cases. 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 will assume that REITs are less rewarding because you cannot buy REITs with a mortgage, but this reasoning is wrong because REITs 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 forms of capital to leverage 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 might get better terms than you could because these are large, diversified, publicly listed companies. Banks will be much happier to work with those than with a small rental property investor, which is typically a riskier profile.
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 large salaries, and so investors will assume that they can save those expenses by taking care of their properties themselves. And it’s true that REITs are paying millions to their top executives, but because they enjoy such a large scale, 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. Here we can take the example of Realty Income, which is one of the most popular rates in the world, maybe the most popular its management cost as a percentage of its total assets is just 30 basis points every year. 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 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 REITs 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. A big part of this is the non-cash depreciation, which allows you to defer a lot of the taxes far into the future, but REITs enjoy very similar benefits.
For one, REITs in most cases will retain about 30 to 40% of their cashflow within the company. Remember that the rule of 90% applies to taxable income, which is much lower than cashflow 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 portion of the dividend income that’s actually taxed is going to enjoy a 20% deductible, so that reduces your taxes even further. And then fourth and final here, REITs will typically invest in lower yielding, faster growing properties like e-commerce warehouses, data centers, cell towers, and so on. And so a larger portion of the 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 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. In some rare cases this may be the case, but in most cases I think that they’re simply miscalculating their returns. 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. The first and most important is that they are not accounting for the value of their own labor. They will spend countless hours finding the right deal, negotiating it, financing it, then renovating it, finding the tenant, managing the property and so on.
And 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. 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 a side hustle or anything else. 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, let’s say it’s 15%, 20%, the return on your typical year, but in real estate you have good years.
Let’s say you have five good years, and then on year 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 return is going to come down quite a bit. So now with these misconceptions out of the way, we can 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 wanted to say something, Scott?

Scott:
Because 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 you’ll find many of our investors do, hundreds of hours of self-education. Like the one that perhaps folks are consuming right now listening to this podcast, 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 on top of the time that you’ve just described there. 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. In those ranges. Because if you’re a doctor or lawyer, you’re probably not going to want to put in all those hours at 30, 40, $50 an hour depending on how you value that time at that point in time.
But it can be rewarding. More rewarding than many side hustles that are available to you if your dollar per hour time is less than that, for example. 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 nuance I think to your argument that I largely agree with, you see, around straight rental property investing. And then I want to give you one challenge and see how you react to it on this. One of the things that I enjoy, I think is an advantage as a real estate investor with a portfolio here in Denver over my competition or my alternative choice in investing in REITs is the ability to have used and to continue to use fixed 30 year low interest rate debt that reduces my risk and maybe amplifies my returns in a way that REITs are typically not able to access with the same low risk and low rates. Would you agree with that as a potential advantage for the little guy here?

Jussi:
Definitely. Those are two good counterpoints and I agree with you here. And 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.

Kyle:
This is awesome. We want the listeners to get a challenge and to think outside of the box, and you’re both touching on something here that everyone needs to realize what kind of investor they are. What’s your hourly wage normally? What do you desire to do with your time if you’re a professional? Publicly traded REITs are by magnitude more passive than anything you can do on your own in real estate. I mean that in itself … And we’ll get into these research studies you were referencing. I would love to hear about this next. But that in itself, even if someone were to prove I can do a lot better if I do it on my own in real estate, even with my hourly wage, even if they can make that case, in my opinion, you need to do quite a bit better. Because if you’re putting that much time and your resources into it and it’s only a little bit better, well man, that’s not worth it if you can be fairly passive with these publicly traded REITs.

Scott:
And to reinforce Jussi’s point here. Those high returns, 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 it only can be sustained if you’re consistently applying very high leverage to those deals. And that maybe is another advantage that the little guy enjoys over REITs where they can actually leverage much higher, up to 75% LTV, with this kind of fixed rate debt in the acquisition, 85 or even 95 to 100% if you’re an owner occupant in those first deals. So maybe that’s a part of that as well. And then one last thing I’ll also throw in there before we let you resume your wonderful thoughts here, Jussi, is the efficiency of the market. A listener might argue with you and say, “Well, REITs are already priced appropriately because smart guys like Jussi are constantly debating 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 work there to create some value on the upswing.”

Jussi:
Those are three very good counterpoints. I want to quickly address all three of them. The first one was on the hourly wage, and I completely agree with you that the more you value your time, 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 your hourly wage is relatively low, it makes more sense. But even then, if you really calculated all the amount of time you’re spending educating yourself and then finding the deals, doing all the work, even if you valued your time at 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, then it makes sense and a lot of people enjoy this type of work. But then to your second point, and this is probably 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. You can really use even more leverage. In some specific cases, I think it makes sense with some limits though. There are some limitations to it. But REITs, they typically don’t use quite as much leverage, but on the flip side, 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, convertibles, preferred equity. Typically, REITs 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. So you’re still getting a very good bump from all of that leverage as a common shareholder of a REIT, even if it’s not quite as much of that in the case of a private rental property perhaps. And then your third counterpoint, that was … What was it again? Can you remind me quickly?

Scott:
I wasn’t counting all the counterpoints. I wish I could remember too. I think it was the hourly rate of time can be worth it. And then the leverage.

Kyle:
The local neighborhood.

Jussi:
The local neighborhood, yes.

Scott:
Yeah. Efficient market.

Jussi:
Right. The efficiencies of the market. I agree that there are inefficiencies in the private market, but I would argue that this applies very much also to the public REIT market because when you think of REITs, they’re a bit of an odd category because they’re right in 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 mis-pricings happening in the REIT sector. 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, 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. Most investors in the REIT segment, they are generalist investment firms, generalist analysts looking at them with relatively little understanding about real estate.
And so not surprisingly, you have mis-pricings occur. I could point to several examples of REITs and we can discuss this later that are today priced at very large discounts to the value of their properties. So these are my three quick counterpoints to your counterpoints, which I think are valued and very good. There are a few research studies that have been made on this topic comparing the returns of both and the main conclusion here is that REITs typically outperform private real estate by about two 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. Let’s take the example of an apartment rate here that does a deal with a contractor in a specific city to change a hundred carpets each year.
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. But this applies to really every cost. They’re going to pay less brokerage fees. Even their property taxes. REITs are going to have legal team working for them full-time. They’re going to be able to fight the property tax hikes and so on. So they’re able to be much more cost efficient on every level. Then REITs 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 themself. REITs have better access to a wide variety of capital, which allows them to really take advantage of some distortion in the market. Sometimes they are priced at a 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 growth on a cashflow per share basis.
What else? REITs 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. REITs 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 REITs, 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 more rewarding in the past according to those studies, and in my opinion it makes sense.

Scott:
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 REIT space or is that more limited to this syndication or private fund market? The private REIT market?

Jussi:
Bankruptcies in the REIT sector, especially for public REITs, are extremely rare. And 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’re rare because most streets are conservatively financed. They are widely diversified. In most cases, they’re going to own class A properties, and so it’s quite hard to screw it up. There are some exceptions. The few bankruptcies have been mall REITs that were over leveraged, and so it can happen, but it’s really rare in the REIT sector. Considering the syndicators, it’s much more common because there are much greater conflicts of interest and they will typically use a lot more leverage and they will also be concentrated. So again, it’s quite normal that this happens. The operators, the sponsors also might not be quite as skilled. Perhaps they are skilled at raising capital, but not quite as skilled at actually investing that capital.
If you ask me, I would think that these syndications are actually the worst option of all, if you’re going to invest in real estate, especially those that have been promoted heavily by influencers who have questionable backgrounds in the real estate space. I think that it’s a much better option perhaps to 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. Just deploy the capital, whether the deal is good or not. They charge huge fees, which will really impact your bottom line, and then they will use way too much leverage and so then they end up in these situations that you just mentioned.

Kyle:
Yeah. I think you really highlighted on something there that we want to make sure we are painting a pretty, pretty picture of publicly traded REITs, which is very good. I mean, this is awesome for our listeners to hear this way of investing in a 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. But we also need to … Jussi, let us know some of the risks that are out there. I know from my CFP background, some of the products that exist, they’re not all publicly traded on exchanges. There are non-traded public REITs. You’re talking a little bit on high fee products. There’s some high commission products that are brokered through broker dealers. There’s other things out there. So if an investor is hearing a REIT to invest in, it doesn’t necessarily mean this publicly traded with a ticker symbol REIT, which it could be, and there could also be some risks there, but maybe just hit on the biggest risks you see. If someone’s like, “I need to go down this avenue of looking at real estate investment trusts,” what’s a red flag they need to watch out for?

Jussi:
Yeah, that’s a great point and perhaps I should have clarified this a bit earlier in the call that most of the time when I’m referring to REITs, I’m really referring to the publicly listed REITs, which are very different from the private non-traded REITs, which are, in my opinion … I mean 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. 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. 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 will also use too much leverage. There are commissions, as you mentioned, also quite often.

Kyle:
That’s a super awesome overview of the risks and I just want to highlight one of those risks a little bit deeper just because of me experiencing it. The firm that I first started at … 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 you’re paying them. And 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 listened to this podcast who has been offered one of these by a “financial advisor”. So if you’re hearing from someone who could potentially sell you a financial product, if you’re hearing about a REIT, you need to ask a lot of questions because sometimes these … They’re called non-traded public REITs. 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” that’s selling it to you often gets a seven to 10% commission for selling you this product. And basically they’ll give you a timeframe 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 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. But this is what Jussi has talked about. Some of these, they over-leveraged, 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 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. What Jussi is talking about are publicly traded REITs 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, the liquidity of a publicly traded REIT. 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.

Jussi:
Yeah. No, you’re correct. If you’re buying a publicly listed REIT, it’s just like any other publicly listed company. It’s quite easy to buy the shares. It’s quite easy to get out of it as well. If you’re individual investor, you probably don’t going to run into liquidity issues with a public listed company. But then there are these public non-traded REITs and with those, it’s quite different. The biggest one in the world is one run by Blackstone. It’s quite a good public non-traded REIT actually. It may be one of the best. So by the way, there are some exceptions. Some of them can be decently good, even though I still probably wouldn’t invest in them.
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 REIT 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 experienced recently. But liquidity with publicly listed REIT in my opinion, is a major advantage. I feel like a lot of real estate investors 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 dive into … All right, we’ve defined all the other alternatives to the word REIT. When you’re using the word REIT, Jussi, 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 thoroughly dissected the alternatives in the landscape here. Where are we at from a overall status in the market? We talked about it being down. And where should people be looking? Where are you looking for good and bad in the space at this point?

Jussi:
Yeah. It’s a very vast and versatile sector. There are over 200 publicly listed REITs in the US alone. There are also 30 additional countries in the world that now have 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. There are a lot of REITs that I will stay away from. Some that are publicly listed still suffer management issues, despite most of them being well aligned with shareholders. Good example from the top of my head is a REIT called Global Net List, ticker symbol GNL. It has attractive properties, but over the long run it has done very poorly for its shareholders because the management has really looked out for its own interest in my opinion.
Then there are also some property sectors that you probably want to stay away from. Well, the most obvious one that probably comes to the mind of most people are offices. And myself, staying away from offices. The valuations may seem cheap today because they’ve come down quite a bit, but if you now account for all the cap ex, the leverage and so on, perhaps the valuations aren’t that cheap. So that’s one sector to stay away from. There are some others as well that I’m not quite as bullish. I don’t like hotels quite as much. I don’t like data centers. So there are many sectors that I don’t like. There are also some countries that I’m not as bullish on as others. There are some exceptions of REITs that are also way over leveraged. Today, the average loan to value in the REIT sector is only about 40%.
It’s even a bit less than that. So that’s very conservative, but some REITs have decided to take on more risk and today they are paying the consequences following the surge in interest rates. So the bad stuff to look for really is the wrong property sector at the wrong time. Then some over-leveraged balance sheet. There are some exception of REITs that are poorly managed. And then finally, one point that you want to also consider is that while REITs valuation have come down a lot, there’s still some REITs that are priced quite aggressively when you account for the higher interest rates today. And so while I’m bullish on the sector, it’s still one in which you need to be very selective.

Scott:
What do you make of the fact that in a lot of commercial and multifamily real estate sectors, cap rates, the amount of cashflow a property, the percentage of cashflow a property will generate as relative to its purchase price, are lower than interest rates in a lot of cases? Do you think that there’s a lot of room for these prices to come down in a lot of these sectors, or should we be afraid of REITs for the near time or is it a buying opportunity because it’s already down 30%?

Jussi:
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 the reason why interest rates were hiked so much is because we’re dealing with high inflation. I still buy into the idea that 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. If you add just for real-time shelter, I think it’s already backed at the target rate of the Fed of 2%, and so do we need these high interest rates for much longer?
Anyone who makes predictions about interest rates 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 growth because they could see the normalized forward cap rates being quite a bit higher once those rents get hiked in the future. But yes, would I buy an apartment community in Dallas, Texas at a 4.5% cap rate today? I probably wouldn’t. But would I buy a REIT that specializes in tax and apartment communities at an implied cap rate of 6.5% or even 7%? That’s much more attractive to me, and this is because REITs are so heavily discounted today.

Scott:
That’s an awesome argument. Love that.

Kyle:
Yes. I think you touched on something right there. 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 downswings. 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’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 are a really good investor and you have a really good long-term time horizon and that’s your goal, this is a garage sale.

Jussi:
This is the strongest argument in favor of REITs, specifically today. If you go in the private market, you go buy your rental property, prices are pretty high. You’re going to go to your bank, ask for a mortgage. Interest rates are 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 the private properties net of debt. In late 2022, the investment firm Janus and Henderson came out with a study that showed that REITs were priced on average at a 28% discount to the net asset value. Since then, REIT share prices have come down a bit further, even as their rents have kept on growing. And that’s just the average. There are a lot of REITs that are priced at even lower valuations than this. So we can maybe take an example here to illustrate my point.
BSR REIT is a small cap REIT that owns a portfolio of apartment communities within the Texan triangle, so Dallas, Austin, and Houston, which you’ll probably agree has some of the most attractive markets for long-term oriented investors because there are a lot of growth happening in them. Rent to income ratios are still very low compared to other major cities in the US. And yet despite that … And also, well, the REIT has a strong management team. They own a lot of shares themself. 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’re priced at huge discount to the net asset value.
The NAV is about $21 per share. They trade at about $12 per share today, so that’s a 40% discount. So you’re essentially buying an interest in this portfolio of apartment communities at roughly … We have 60 cents on the dollar. And that’s very compelling to me. 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 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 think this is awesome. What a fantastic thing to end on there as a potential example for folks to go in and take a look at. What do you do all day, Jussi? What is your profession right now and where can people find out more about you?

Jussi:
As you said in the intro, I run a small investment firm that specializes in REIT investing. It’s called Leonberg Capital. We manage our own capital, but we also offer some research services. 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 the investor communications. So that’s really taking a big chunk of my time on a day-to-day basis. Investing is really my passion and business in general is my passion, and so I’m pretty much doing this the whole day. So on Seeking Alpha, as I said, we have our newsletter called High-Yield Landlord. There is a two week free trial if I can put a little plug in here in case you want to access my REIT portfolio. Then on top of that, I recently created a YouTube channel. 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 appreciative.

Scott:
What’s it called?

Jussi:
If you type Jussi Askola in the search bar, you’ll find me, but the handle I think is askaskola. A-S-K-J-U-S-S-I. It’s the same handle also on Twitter, where I’ll post some daily news on the REIT sector.

Scott:
Everyone needs to go and check out Jussi Askola’s stuff. We’ll link to it all in the show notes here and you can go check out the YouTube channel and High-Yield Landlord. That’s where I found you is on Seeking Alpha with a lot of the stuff you put out there. 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 I think Kyle and I had a ton of fun. So really appreciate it. Really, really respect your intelligence and the approach you take to investing in this sector.

Jussi:
Thank you very much, Scott. And to end this, I also wanted to add that when I was still in high school, I was already reading … I think it was BiggerPockets. And throughout my college as well later on, I’ve been very actively following your YouTube channel, all the content you put out there and your website. So it’s been an inspiration for me and so I really appreciate that.

Scott:
All right, Kyle, that was Jussi Askola. What’d you think of today’s show?

Kyle:
It’s always good when you hear somebody and they make you want to change your whole investment philosophy. 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 incredible benefits of not doing that, of doing it more passively and letting more professionals do it in these larger funds. He just has a depth of knowledge that we just totally took advantage of today and it was great.

Scott:
Oh yeah. How can you not help but leave today’s episode just in total admiration of Jussi. Who knows who’s going to be right in the longterm 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 of just, I would call it an obsession that I got from him in understanding every intricate detail of this market. The risks, the puts and takes, opportunities within sub-sectors, how management’s compensated, understanding debt structures, all that kind of stuff. I mean, this is a true, true expert and I walked away admiring and really respecting his argument even though I’m on the other side of it as a single family and small multifamily rental property investor, personally. I probably will look into some rents … Or some rents. Into some REITs and like I told you, I follow his newsletter and really respect a lot of his analysis.

Kyle:
Yeah. I think this is just a huge benefit to the listeners because 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 … If you are really into real estate and you want that to be a big part of your investments, this is another great way to do it. And we touched on it a little bit in the episode as far as what your time is worth, and that really comes into play. I mean, 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 two nights at one of my short-term rentals, spending a lot of time there. I think it was worth it. We’re doing a big renovation. Needed to be there. But 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 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 I also thought he really handled my challenge of, well, hey, if everything’s down 30%, if that’s not a crash, what’s a crash in the sector? I think over only the long run, he’s got a very 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 do some research on as a listener for your own personal position. Maybe there’s opportunity there and maybe now’s the time. If that’s true, and you can verify it with your own due diligence, hey, there’s a 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 a REIT that owns a bunch of them is trading at an applied six and a half cap rate, that’s a really compelling argument. Obviously you got to go do your own due diligence and run all that stuff for yourself, but what a simple but powerful-

Kyle:
Definitely. Yeah. Huge benefit to knowing more about this way of investing.

Scott:
Well, should we get out of here, Kyle?

Kyle:
Yeah. Let’s do it.

Scott:
All right. From this episode of the BiggerPockets Money podcast, he is Kyle Mast, and I am Scott Trench saying won’t be long little fawn. 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.

Speaker 4:
BiggerPockets Money was created by Mindy Jensen and Scott Trench. Produced by Kaylin Bennett. Editing by Exodus Media. Copywriting by Nate Weintraub. Lastly, a big thank you to the BiggerPockets team for making this show possible.