In one sentence: A REIT lets you own real estate through a stock with a management team, liquidity and an unusual tax pass-through, and you judge it with the same four filters and a margin-of-safety price as any other business.
Key ideas
- Real estate is not very different from stocks. Think of a share as buying the whole company, and apply Munger's four filters to both. The "intrinsic characteristic" of real estate is location. [00:00–06:00]
- Most people speculate in real estate. With no margin of safety you can only hope prices rise. Cheap property usually has real problems (bad area, cracked foundation) that need expertise to fix. Phil passed on an old printing building for exactly that reason. [06:00–09:30]
- Managing property is a job. Phil would rather not fix toilets at 2am. Property managers only pay off with scale, which is the case for a REIT. [09:30–10:30]
- How a REIT differs. A REIT must hold real estate and pass most of its earnings (Phil says about 90%) through to owners without corporate tax. Phil's example is a regular company that earns $100, pays about $40 tax and sends $60 out, taxed again for you. The numbers are his illustration and he says he is not a tax lawyer. [13:00–17:00]
- Two returns: cash flow (rent less costs) and growth in NAV, the net asset value of the real estate. [17:00–19:30]
- Types. Office, industrial, retail, lodging, residential, timber, healthcare, self-storage, infrastructure (data centres, towers) and mixed. Phil says about 350 exist. [23:00–31:00]
- Legal structure unlocks value. Sears moving its land and buildings into a REIT showed value that sat on the books at old cost (land bought in 1940 recorded at the 1940 price). [23:30–25:30]
- Liquidity and entry size. You can own a REIT with $1,000 and sell it in days, which is impossible with a building. Public companies also disclose far more than a private seller will. [31:00–33:30]
- Apply the four filters. Understand it (Phil's example is student-housing REITs: will student demand be higher in 25 years?), moat (restricted market, university relationships), management, price. [32:00–40:00]
- Margin of safety = the cycle. REITs trade below the price paid for their properties when everyone hates real estate (early 1980s) and far above it when everyone loves it (2006). Shopping-centre cap rates went from about 8–10% to 3%. Buy at the bottom, not when you pay a premium to the real estate. [40:00–43:00]
- Yield on cost grows. Phil's worked example: a REIT bought at $10 yielding 6.5%, with the dividend growing about 10% a year, pays about $2 a year on the original $10 after 10 years. He discloses his family owns a large stake in the company and says it is not advice. [43:00–47:30]
- Why 20 years out. Phil wants a retirement portfolio that pays more at 90 than at 65 and needs no maintenance. [37:00–39:00]
How it maps to RuleOne
- REITs are stocks, so they appear on All stocks. The screen's earnings-based numbers do not suit REITs (earnings are distorted by depreciation, and Phil's own test is yield against what was paid).
- Yield on cost is the same idea as yield on adjusted basis in 026. The screen does not yet show a dividend growth rate.
- A reader question about Betterment and robo-advisors is parked for a later episode.
Buffett, Munger and Graham links
- Investment vs speculation: Graham's definition (The Intelligent Investor, ch. 1) is a thorough analysis, safety of principal and an adequate return. Phil's "no margin of safety means speculation" matches it.
- Munger's four filters again, as in 001.
- Buffett's NYC building and farm are in 033.
Words to know
- REIT: real estate investment trust, a public company that owns real estate and passes most income to owners without corporate tax.
- NAV: net asset value, assets less liabilities. For a REIT, roughly the equity in its properties.
- Yield on cost: current dividend divided by what you paid.
- Liquidity: how quickly you can sell at a fair price.
Try this
On All stocks find one REIT you could understand (for example one tied to something you use). Write down its dividend yield now and the yield a year ago. Then write one sentence on whether you would be buying at the "bottom of the cycle" or at a premium to its real estate.
Check yourself
- Why does Phil say most people speculate in real estate?
Answer
They buy without a margin of safety, so the result depends on prices going up. - What are the two parts of a REIT investor's return?
Answer
Cash flow (distributions) and growth in net asset value. - When is a REIT a margin-of-safety buy?
Answer
When the market hates real estate and the shares trade at a discount to what the company paid for its properties, with a high yield to match.
Short quotes
"Most people don't invest in real estate. Most people speculate in real estate, meaning that they have no margin of safety." (Phil, ~07:00, auto-transcribed)