The Ground Floor: 2016 REIT Resolutions

The Ground Floor is a weekly column written by Brad Thomas on Forbes.com. In the commentary he provides readers with risk assessment concepts in order to assist and prepare investors for the time in which risk meets adversity. As Howard Marks wrote, “outstanding investors are distinguished at least as much for their ability to control risk as they are for generating return.”

Sir John Templeton was knighted by Queen Elizabeth in 1987, and he is deemed one of the greatest global stock pickers of the century (Money Magazine, Jan, 1999).

Sir John was a value investor, meaning he was great at picking unfavored stocks and holding onto them long-term for great returns. Like Warren Buffet, another investor in the next generation of value investors), Sir John was also great at ignoring the conventional wisdom as he famously said:

Search for bargains. You should try to buy that particular investment whose market price is lowest in relation to your estimate of its true value.

Like Ben Graham, Sir John also preferred to use fundamental analysis rather than technical analysis in his investment decisions. He is well-known for making investment decisions counter to what the herd was doing. For example, during the technology bubble of the late 1990s, he is said to have made $86 million shorting Nasdaq stocks before the market crashed in 2000.

Sir John, who lived to be 95 years old, was definitely a product of the Grahamian-era where he continually taught that "wise investors must recognize that success is a process of continually seeking answers to new questions." As a key advocate to managing portfolio risk, Sir John was broadly recognized as a supporter of diversification as he is often quoted as saying:

The only investors who shouldn't diversify are those who are right 100% of the time.

My 2016 REIT Resolutions

In 2015 I wrote well over 300 on-line articles and in most every article I recommend a BUY, HOLD, or SELL. According to TipRanks, my picks in 2015 were profitable 66% of the time and my overall stock picking skills proved to be solid with an average return of 9.7% (I was ranked #30 out of 4,756 bloggers).

It’s funny though, I view my track record in 2015 as more of a validation that Ben Graham and John Templeton were right.

While I did not have the Ivy League education of Graham (or his star student, Warren Buffett) I have the necessary skills to manage risk and perhaps the sage advice learned from the most gifted investors of all time. Graham famously said, “ the most durable education is self-education .”

Ivy or not, to be honest, I made some bad picks in 2015.

A few months back I recommended shares in the small-cap energy REIT, CorEnergy (CORR). I never suggested to go all-in, but I did see an obvious margin of safety in the oil and energy business model and the dividend yield was enticing. I cautioned the volatility and my recommendation was guarded in the high correlation to oil prices. CORR shares have been crushed – down over 50% in a year – and the current yield of 20% is screaming sucker yield.

Another 2015 loser – on paper – is New Senior Properties (SNR). Like CORR, I suggested that the senior housing REIT was exposed to elevated risks, primarily in the form of high leverage. I have also been preaching SNR’s ownership composition made up predominantly of hedge funds feeding off of daily trading activities. In short, SNR is another volatile security that isn’t really conducive to a value investor’s long-term ownership tactics. SNR has also been smacked down hard in 2015 with shares down over 40% in a year.

There are other losers in 2015, but let me tell you about a few winners.

My best pick was Extra Space (EXR), a leading self-storage REIT that continues to dominate in the highly fragmented business of storing stuff. Unlike CORR and SNR (small positions in my portfolio) I have an outsized stake in EXR and the 55% total return performance in 2015 was a big reason for my success.

Another top pick, and similarly driven by growing household income, is Preferred Apartment Communities (APTS). Like CORR and SNR, APTS is a small-cap REIT (under $300 million) but the volatility worked to my advantage this time. APTS shares are up over 43% in the last year and my only regret is that APTS is a small-cap and, as a rule, I never invest more than 1% in a company that has less than $1 billion in equity capitalization.

REITs provide excellent diversification by reducing risk without inhibiting returns. The more money you have to invest in REITs, the bigger your average position size should be, particularly if you are trying to achieve an optimally concentrated portfolio.

I generally recommend that one should own between 10% to 20% in REITs and in some cases, depending on risk tolerances of course, 25% to 30% may seem reasonable (I'm targeting 40% as my maximum concentration. But remember, I have a "circle of competence" that most of you don't).

Sir John believed that diversification is a risk-management tool that embodies the maxim " don't put all of your eggs in one basket ."

It's widely held within the investment world that company-specific risk can be reduced by holding somewhere between 15-50 stocks. Industry-specific risk can be reduced by holding stocks from varying industries, country-specific risks can be reduced by holding stocks from varying countries, and so on.

Today, there are 25 countries around the world that have adopted the REIT (or REIT-like) structure as a tax-efficient way for small investors to achieve the many benefits of owning an indirect interest in high-quality, well-located, and professionally-managed, income-producing real estate.

The REIT industry has grown from a backwater with less than a dozen public companies, to a mainstream asset class with over 200 publicly-traded REITs with an aggregate market cap of over $875 billion.

Sir John Templeton one said, “to buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest ultimate rewards.”

My REIT Resolution: By investing in cheap stocks and by employing diversification correctly, investors can reduce risk without sacrificing returns.  The best way to own a “Knight-Worthy” REIT portfolio is to hold more winners than losers, and as Sir John suggests, “nobody can ever be 100% correct.”

In the January edition of The Forbes Real Estate Investor I provide a list of 20 REIT ETFs and their performance over the last year. I also provide a basket of REITs in my Durable Income Portfolio.

The author owns shares in CORR, SNR, EXR, and APTS.

Brad Thomas is the Editor of the Forbes Real Estate Investor and writes for Forbes.com and Seeking Alpha. He is also a frequent guest on Fox Business and he is currently writing a book, The Trump Factor, about U.S. presidential candidate Donald J. Trump. Given the author’s in depth analysis of Trump, this book is certain to be a “game changer”.