What I Wish I Knew Before Investing in REITs

Summary

In this video, a seasoned real estate investor shares valuable lessons from over a decade of experience. The speaker highlights three key mistakes: underestimating capital expenditures (capex), over-leveraging investments, and neglecting foreign real estate markets. By focusing on conservatively financed REITs with lower leverage and diversifying across international markets, the speaker has learned to optimize risk-adjusted returns. The video emphasizes the importance of capex, a more cautious approach to leverage, and the benefits of exploring foreign REIT opportunities. It offers insights into avoiding common pitfalls and creating long-term investment success.

Takeaways

• 😀 Focus on CapEx: Real estate investors must account for capital expenditures (CapEx) as they are essential for maintaining property value and productivity. Ignoring or underestimating CapEx can lead to misjudgments about cash flow and property risk.
• 😀 The Mistake of Overestimating Cash Flow: Many investors overlook CapEx because it's not deducted from Funds from Operations (FFO), leading to overestimations of cash flow and potentially underestimating risks and leverage.
• 😀 The Importance of Conservatively Managing Leverage: High leverage can create greater short-term returns, but over the long term, conservative leverage often yields better outcomes due to lower risk and the ability to weather down cycles.
• 😀 Real Estate Is Cyclical: The real estate market is cyclical, and higher leverage can result in significant losses during downturns. More conservatively financed REITs have historically performed better over entire market cycles.
• 😀 The Financial Crisis Example: The 2008 financial crisis demonstrated that highly leveraged investors suffered significant losses, whereas those with conservative leverage were able to capitalize on market dislocations, buying assets at lower prices.
• 😀 Foreign REIT Markets Offer Opportunity: Investing in international real estate markets can be more rewarding than focusing exclusively on the U.S. due to less competition, higher cap rates, and better demographics in many countries.
• 😀 Diversification Beyond the U.S.: International diversification is key to optimizing risk-adjusted returns. The speaker's portfolio includes real estate from multiple countries, including Canada, Europe, and beyond, rather than being solely U.S.-focused.
• 😀 Underestimating Foreign REITs: Early in his career, the speaker neglected foreign REITs, but now emphasizes them due to their higher growth potential, lower valuations, and less competitive environments.
• 😀 Higher Risk in Foreign REIT Markets: While foreign REITs offer advantages, they also carry higher risks due to a lack of research and less developed markets. It’s essential to be selective when investing in these markets.
• 😀 Low Valuations in Foreign Markets: Many foreign REITs trade at lower valuations than their U.S. counterparts, offering potential for greater returns. For example, the speaker highlights Storage Vault, a leading Canadian REIT with a 10x return over the past decade.

Q & A

What is the biggest mistake the speaker made early in their RE investing career?

The biggest mistake the speaker made was underestimating CapEx (capital expenditures). They failed to recognize the cost of maintaining and improving properties, which impacted cash flow and led to poor investment decisions.

What does the term 'CapEx' refer to in real estate investing?

CapEx refers to capital expenditures, which are the costs required to maintain or improve a property. These are real expenses that should be deducted from cash flow, unlike the commonly reported Funds from Operations (FFO), which often ignores these costs.

How can ignoring CapEx impact real estate investments?

Ignoring CapEx can lead to overestimating a property's cash flow, which might cause an investor to believe the investment is cheaper or less risky than it actually is. This can result in costly surprises down the line when necessary repairs or improvements are needed.

Why is CapEx particularly challenging for office REITs in today's market?

In today's market, office REITs are facing oversupply issues, leading to higher vacancies. To stay competitive, landlords must invest in property improvements, draining cash flow. This CapEx, if not accounted for, can make valuations seem cheaper than they actually are.

What is the second biggest mistake the speaker made as a real estate investor?

The second mistake was believing that higher leverage would automatically lead to higher returns. The speaker, coming from a private equity background, initially thought that higher leverage would yield better returns, but realized that it often leads to more risk and lower long-term returns.

How does leverage affect real estate returns during economic cycles?

Higher leverage can boost returns during good years but also amplifies losses during down cycles. Over-leveraged investors may face liquidity issues in downturns, resulting in forced asset sales or equity raises at unfavorable valuations, leading to poor returns over a full cycle.

Can higher leverage ever be beneficial in real estate investing?

While higher leverage can offer strong returns during good economic times, over-leveraging typically results in significant losses during downturns. More conservatively leveraged investments, with lower loan-to-value (LTV) ratios, tend to perform better in the long run.

What did the speaker learn from the Great Financial Crisis regarding leverage?

The speaker observed that many real estate investors who were over-leveraged during the Great Financial Crisis suffered severe losses. Those with more conservative leverage were better positioned to capitalize on opportunities by purchasing properties at low valuations during the crisis.

What was the third big mistake the speaker made in their investing career?

The third mistake was overlooking foreign REIT markets. The speaker initially focused on American REITs because of the wealth of research available, but later realized that foreign markets often offer more rewarding opportunities due to factors like higher cap rates and lower competition.

Why might foreign REITs offer better investment opportunities than American REITs?

Foreign REITs often provide higher returns because they tend to have higher cap rates, lower competition, and fewer building permits, which can lead to less supply. Additionally, they may operate in markets with lower interest rates, providing more attractive investment conditions.

Can investing in foreign REITs present risks?

Yes, foreign REITs come with their own set of risks, such as less available research and potentially less stable markets. It's important to be selective when investing in foreign REITs, even though they can offer significant advantages over American REITs in some cases.

How is the speaker's investment strategy evolving based on these mistakes?

The speaker now focuses on investing in conservatively financed REITs with lower leverage (LTVs in the 30-50% range), gives more attention to CapEx by prioritizing AFFO (adjusted FFO) over FFO, and has diversified geographically to include REITs from various countries beyond the U.S.