3 reasons why private REITs are strategic hedges against volatility

Despite the wild ride investors of all kinds have been on this year, their portfolios were almost certainly hit with volatility.

Change is afoot; uncertainty about the future lingers. 

Long-standing investment wisdom holds that markets do not like uncertainty.

The best we can do to manage risk under murky conditions is minimize the variables that contribute to volatility. 

Real estate and REITs are attractive, incoming-generating options.

But after an IPO, publicly traded REITs become subject to numerous irrelevant or amplifying market dynamics that do just the opposite. Many of those dynamics have little to do with the performance of the REIT’s portfolio value or management.

Here are three reasons why private REITs are an attractive alternative investment to hedge your portfolio against volatility.

They aren’t grouped in ETFs

A well-run, private REIT’s share price is a truer reflection of value than many publicly traded investments.

Consider this: According to Statista, the number of publicly traded ETFs has gone up more than seventeen-fold since 2005. 

At the same time, the number of companies listed on the stock market has been on the decline.

 

 

The result? The stock price of publicly traded securities is becoming increasingly tied with the performance of the overall U.S. economy and less directly correlated to the performance of the underlying asset itself.

The value of the investment asset is now intrinsically tied to the performance of all the companies in the fund. That may include competitors or even completely unrelated industries. 

There are 20 publicly traded ETFs that are composed solely of various REITs.

If one asset in the ETF dives, the value of all assets are impacted. The more ETF exposure, the more amplified the influence of groupings becomes.

You know what they say: The company you keep. 

By contrast, a private REIT’s share value is primarily a function of real estate appreciation and property management performance. 

That has proven to be a blessing for HappyNest’s portfolio. 

The tides of the last 12–18 months have hit various real estate sectors asymmetrically. 

Some sectors thrived: The demand for industrial properties, such as HappyNest’s shipping fulfillment center in Fremont, IN, grew substantially as major retailers dialed up their ecommerce capacity.

Meanwhile, large sections of the workforce were sent to work from home. Skyscrapers and office buildings across the country became ghost towns

How quickly the demand for office space and other hard hit sectors  rebounds remains to be seen.

Had HappyNest been grouped with an office space REIT in an ETF, its share value would have been impacted by office sector decline. That is despite the fact that HappyNest has no office space real estate in its portfolio. 

They aren’t shortable

Speaking of market forces that distort true value: Recent activity in GameStop’s stock price revealed that many players in the publicly traded markets aren’t always gunning for share value to grow. 

GameStop got lucky – they were given a second wind by retail investors. 

But hundreds, if not thousands of other publicly traded, struggling businesses have not (and will not) be rescued in the same way.

When hard times hit, the last thing any organization needs is numerous parties vested in their failure. 

Last year, as retailers across the country were forced to shut down, retail REITs faced many challenges. Vacancies mounted, decreasing revenue.  Property values themselves also took a hit as shutdown uncertainty cooled demand.

To make things harder, short interest in retail REITs skyrocketed. Tanger Factory Outlets for example, has over 30% short interest as of February 12th. That only adds anvils to already-heavy challenges.  

Now, this is speculative but, Tanger Factory Outlets probably wishes they were a private REIT. If they were, they would be insulated from the downward market pressure of shorts simply because, well,  their shares aren’t shortable. Simple as that. 

They aren’t day traded

One publicly traded share can be, and often is, traded numerous times a day. Day traders and algorithms are the arbitragers of investing.

They have little to no interest in the long-term success of an underlying company. For them, it’s not really an investment – it’s a trade. 

In fact, short-term traders are generally quite agnostic about what they’re investing in (especially the algorithms). 

Their strategy is to capitalize on short-term price action. That’s it. 

They jump in for a few hours, maybe a few days, and are gone as quickly as they came.

This ebb and flow of day trader capital in an investment pretty much only brings volatility to the share price, blurring the true value of an asset. 

The rise of commission-free and independent traders has increased the ranks of these kinds of traders substantially.

This type of activity is for the most part curtailed in private REITs. 

When investors buy shares in private REITs, they generally intend to hodl it for the long term. 

Shorting, ETF groupings, and day trading are all volatility variables that are neutralized when investing in private REITs. 

The result is a steady investment foundation on which to determine the best possible strategy to optimize shareholder return without fear of unexpected liquidity issues.   

HappyNest’s portfolio is poised for steady growth

While some real estate sectors have hit rough times, others have experienced tremendous growth. HappyNest’s portfolio been on the right side of that like, and has a bullish outlook.

All of HappyNest’s portfolio properties have active, 8-10 year rental agreements with major organizations such as FedEx, AutoZone, and CVS.

Given the balance sheet of these organizations, we expect our revenue flow (i.e.: rent) to remain steady as well as the value of our properties to continue to appreciate.

Everyone has to decide their own investing strategy risk tolerance. 

But no matter your investing style, having a steady and reliable investment in these volatile times not only brings ROI (and passive income), but also peace of mind.

And it’s hard to put a price on that. 

Inflation is coming – how will it impact the real estate market?

There’s little doubt inflation is coming. By some measurements, it’s already here. The question is: How do you proactively hedge your portfolio against this value crusher?

If history is any guide, private real estate is the heavyweight champion of inflation hedging compared to alternative investments

To better understand what lies ahead, we need to understand how we got here, and why real estate tends to perform well during periods of high inflation.

What is inflation?

Nobel prize-winning economist Milton Friedman once said: “Inflation is taxation without representation.”  

That’s because inflation is primarily a function of federal policy on things like interest rates and price controls. These things have the ability to erode your purchasing power significantly, and the decision makers are appointed, not elected. 

Inflation is often the product of increasing the supply of currency without a corresponding increase in economic output. 

It’s important to understand that the value of anything is dynamic and relative. Economists assess the value of a currency against things like other currencies, the cost of goods, and asset pricing over time.

As costs increase – particularly on fundamental commodities like oil, timber, or metals – purchasing power decreases. Inflation is afoot.  

How is inflation measured?

Economists have created several models to calculate the rate of inflation. 

The federal government has two ways of measuring inflation. There’s:

Inflation rate: Poorly labeled, what is often referred to as the ‘inflation rate’ is actually an index that measures the rate of change in inflation compared to the previous period (year over year, for example).

Consumer price index (CPI): CPI is a calculation based on the prices of consumer goods across various sectors, such as the cost of energy, groceries, housing, etc.

CPI is the metric that impacts the average American directly, as it is based on recurring household expenses.  As the cost of these goods rises, Americans feel the pinch.

In April 2021, Federal Reserve Chair Jerome Powell announced that the consumer price index had clocked in at 4.2% for the month. 

consumer-price-index-for

That’s the highest monthly rate of increase since 2008 – and we all remember what happened in 2008.

Inflation on Wall Street

This increase was expected. The Federal Reserve printed trillions of dollars in order to address the economic fallout due to shutdowns ordered in response to COVID-19. 

It’s hard to be economically productive in lockdown. As a result, the output of the United States (GDP) went down by 2.3%.  Not bad, all things considered.

Yet, the S&P 500 – an index that reflects the 500 biggest companies in the U.S. – gained over 16% during the same period.

Peel back another layer of this onion and things get even more eye-watering. 

Price-to-earnings ratios (PEs) are used to assess how expensive a stock is relative to the underlying company’s earnings. The higher the PE ratio, the more expensive the stock is. 

Between January 1, 2020 and January 1st 2021, the S&P 500’s overall PE ratio jumped from 24.88 to 40.3. That’s just shy of a 40% increase. 

S&P 500's PE ratio (2010-2020) (1)
Data source: multpl

Clearly, gains were not based on the improvement in performance of the S&P 500 companies, but on an influx of capital into the markets.

 

The logical explanation for this disparity is that a considerable portion of the newly minted greenbacks found their way into the stock market. 

Stocks simply got more expensive. Investors need more capital to buy the same amount of shares they did in 2019 without the fundamentals of the companies backing that price hike. This discrepancy reflects inflation. 

Inflation on Main Street

As asset and commodity prices increase, the purchasing power of the dollar declines. 

It’s a sneaky force that debases the value of your savings account. 

The cohort that ends up paying the heftiest price for inflation are wage and salaried workers – particularly if they don’t own assets that appreciate in value. Wages haven’t historically kept pace with inflation, let alone during years of elevated levels.

Put it this way: If you had $10,000 sitting in a savings account in April 2020, you’d need to have $10,420 in there now to buy the same amount of goods this year. 

And that’s only if you trust the numbers reported by the Federal Reserve. 

Other economists, including famed contrarian investor Michael Burry – who foresaw the 2008 Financial Crisis – believe the real rate of inflation is significantly higher than the numbers reported by the fed.

Michael Burry Twitter
Michael Burry Twitter

Real estate as an inflation benchmark 

In addition to the S&P 500, the real estate market serves as a reliable benchmark for inflation indexing. That’s because the need for housing remains fairly consistent, and the supply grows slowly.

According to a report by Zillow, the housing market gained 7.4% in value during 2020. Furthermore, Zillow projects this trend will not only continue, but accelerate throughout  2021.

If you own property, that’s good news. Your net worth just grew by however much your real estate asset(s) appreciated. 

If you don’t…you slipped 7.4% further behind on your journey to homeownership. That figure could well be 15% by the end of the year against the 2019 level. 

Time to ask the boss for a big raise.

Considering the real estate market gained 7.4%, and the S&P 500 gained 16% in 2020, perhaps Burry is right to raise an eyebrow at the Federal Reserve’s reported CPI of 1.4% for 2020.

Inflation on the global stage

A hallmark of inflation is that the prices of commodities start to rise, particularly in assets where production of the supply has bottlenecks or lead times, and therefore grows slowly.

To understand this better, it can be helpful to think of the dollar itself as an asset. 

After all, the global community certainly does. That is why many foreign governments hold large reserves of U.S. dollars. 

Relative to other countries, the U.S. has enjoyed decades of growth and stability. Subsequently, the U.S. dollar has proven to be  a reliable store of value, particularly relative to other volatile currencies.

However, the DYX –a measurement of the dollar’s value compared to a handful of other foreign currencies – has been melting like an ice cream cone on a hot summer day.  

dxy_cur

Because the U.S. dollar is the global reserve currency, a big slide in the DXY could prove especially catastrophic if foreign governments were to liquidate their holdings.

We don’t know, J.Pow, but those inflation numbers just aren’t checking out. 

Why real estate thrives during periods of inflation

When it comes to inflation and real estate value, it’s a classic case of ‘a rising tide raises all boats.’

From an investment standpoint, an asset with a fixed or slow-growing supply, but steady or increasing demand, will gain value over time.

Building a house requires permits, materials, construction time, and financing. The growth in supply tends to be slow. 

Constricting supply growth either further, the price of building materials for new homes have skyrocketed over the last year. 

The cost of lumber, for example, exploded 130% to historic highs in 2020 alone. Steel and concrete are also experiencing sharp price increases.

That adds additional challenges to expanding supply. Meanwhile, thanks to the work-from-home and ecommerce revolutions, demand in several real estate sectors has skyrocketed.

Money printer go ‘BRRR’

Now, let’s sprinkle in that extra three trillion dollars that got injected into the economy in stimulus measures. That alone would have led to significant gains in the real estate market. 

Let’s say we have a total economy worth $1,000,000, and a total of 10 houses in the real estate market worth $10,000 each. 

If the same economy then prints another $1,000,000 – without a corresponding increase in economic output – the total economy is now worth $2,000,000. Those same houses are now worth $20,000. 

Good if you owned one of those houses. Less than optimal if you didn’t, particularly if your bosses didn’t give you a 100% raise during the same time. 

The U.S. did not double the amount of dollars in circulation like in the example above. But it illustrates the point that real estate appreciates in tandem with inflation.

Interest rates, the accelerant

Despite shutdowns and high levels of unemployment, the real estate market gained more value in 2020 than it had in any other year since 2005. 

Part of that is that the borrowing costs of money have been historically low. Borrowing money is easy and cheap, enticing more potential buyers into the market. 

Institutional investors take advantage of these low rates by borrowing at 0% and investing that money into assets that yield 5% or more – like the real estate market, because hell, why not? 

Real estate is an attractive investment to whales, because it can generates income in the form of rent from the jump. Rent prices increase with the value of the leased real estate. (Brace yourselves, renters). 

By setting up REITs, institutional players can optimize yields through corporate tax exemptions

Given that the  Central Bank recently said they wouldn’t hike interest rates in the near term, the real estate market’s value appreciation is slated to continue as interest-free investment capital flows in.

This adds more weight to the demand side of the equation.

Get your slice

You may have caught on already, but there are winners and losers when it comes to inflation. 

The winners own assets and investments that appreciate substantially without any extra effort on their part. 

Unfortunately, waged and salaried workers whose pay doesn’t keep pace with rising commodity prices get pinched. Their purchasing power is increasingly eroded. The average 2–3% annual raise fails to reconcile the decline of the dollar’s purchasing power.

With indicators of inflation already flashing code red and graphs moving into exponential inclines, investing in real estate can protect your net worth against erosion in value.

Even if you’re not in a position to buy property, you can enjoy the market’s gains by investing in REITs like HappyNest, for as little as $10. From there, it’s entirely up to you how much you want to invest, every dollar of which carves out your stake in the real estate market and its future gains.

Getting on the right side of inflation

HappyNest generated 5%+ returns every quarter – for a total of over 20%  compounded annualized return – for its shareholders in 2020.

Our shareholder ROI outpaced both the S&P 500 and the overall real estate market’s gains, even accounting for the influx of capital and inflation. 

As HappyNest’s portfolio of properties appreciates in value, so will your investment. While investing always comes with risk, HappyNest’s properties currently have reliable tenants like FedEx and CVS on 8- to 10-year lease agreements. We don’t anticipate any interruption of dividend payments. We expect to have ample time to react in the event of an unexpected vacancy. 

Learn more about the properties in our portfolio.