REITs Are A Deep Value Opportunity – Hoya Capital

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Hoya Capital’s David Auerbach explains why retail investors should have REITs in their portfolios (0:35). Why Hoya created its own REIT ETFs (5:08). Dividend income streams and interest rate sensitivity (9:05). Dividend safety – who’s at the top? (12:50) Navigating the wall of debt (13:50). How to evaluate REITs (18:30).

Transcript

Rena Sherbill: David Auerbach from Hoya Capital. Very excited to talk to you again. We just got finished with a live talk at the Investing Summit, where we talked about REITs and categorized them.

And let’s have a continuing conversation with our Investing Experts audience. What would you say is the best reason for a retail investor to get into REITs?

David Auerbach: It’s a great question. Wow. You could do a whole hour just on that one question alone. I think to start out, I’ll answer your question with a question, what percentage of your portfolio should be allocated to crypto? I don’t know. What percentage of your portfolio should be invested in ESG or DEI initiatives? I don’t know.

Well, go talk to any advisor, what percentage of the portfolio should be allocated to REITs in real estate? And every single advisor has an answer, 5%, 8%, 10%. It’s always part of that diversified model that REITs are in that portfolio.

So I think for that retail investor, if you want to have a growth focus, as some guys are here promoting, there are growth-ier REITs that are out there that could satisfy that 5% to 15% allocation. You’re a deep value guy. There’s a boatload of REITs that can satisfy that deep value portion of the portfolio.

You have an international skew. There’s REITs that have an international focus, whether you go outside our borders, or there are U.S. REITs that have international exposure, you could play that card as well. And so basically, the long and the short is that as income-producing vehicles, there is a REIT sector or a REIT story or a company that will fit in every single portfolio out there.

RS: Is that why it’s such a specific part of every recommendation?

DA: I don’t know if it’s necessarily a specific part of it, but I think the fact that it’s also now its own S&P sector, you got your financials, your commodities, your utilities and REITs and real estate it’s its own standalone sector.

Now it hasn’t led to the birth of a whole bunch of new real estate funds, I missed that one, I was wrong many years ago, I thought it would. But, again, you have your NVIDIAs (NVDA), you’ve got your Microsofts (MSFT), you’ve got your crypto, you’ve got your cannabis, you’ve got all these income sectors that are out there. Utilities, commodities, MLPs, REITs, they all kind of go hand in hand as far as the income side of the portfolio.

And so looking at Investing Summit 2025, there’s going to be an MLP focus. There is going to be commodities. There is going to be utilities. There is going to be the cryptos. Again, you’re focusing on all of those different segments of income that are available that what resonates with this person may not resonate with this person, but the same end goal is that income preservation, and income preservation through dividend income growth or strength.

So yes, I think it’s something that’s going to continue to evolve. And I think REITs are – again, because REITs are still just a very small part of the industry that we may only be in the third or fourth inning when it comes to REITs, the goal is to figure out what’s the next story, what’s the next REIT sector that’s out there.

I guess 10 years ago, there was no such thing as cannabis REITs. Now we have several of them. Well, what’s the next sexy story? Is there going to be an AI REIT? I don’t know. Is there going to be a solar REIT or something, which I could see that happening? But I don’t know when.

So it’s our job to basically figure out of the 10-plus shopping center REITs that are out there, what makes the most sense in our portfolio or in your portfolio and let’s talk about why InvenTrust (IVT) is a better fit for you than a Brixmor (BRX) than a Kimco (KIM).

RS: Why do you think that the funds didn’t explode the way that you thought they might?

DA: Wow, that’s a good question. I don’t know. To be honest, I don’t know why. I have a couple of different thoughts on that. I think that there was an investor demand. You didn’t see a bunch of new fund issuers coming to market saying, oh, REITs are now its own standalone sector, let’s launch this new REIT fund.

When they looked at what a (VNQ) or an (IYR) or some of the existing REIT ETFs that are out there compared to like a (SPY), a (QQQ), or some of the other more well-known tickers that are out there, I think if they went and revisited today from back then, you might see some more new funds.

But if anything – the breakout did lead to kind of the birth of more thematic REIT ETFs that are out there, like the industrial REIT ETF, there’s a couple of data center ETFs that are out there, there’s a NETLease ETF, (NETL), our funds. There’s a couple of other ones that are out there.

So I think instead of it just being typical bread and butter, large cap, market cap focused ETFs, it did lead to a proliferation of 50-plus new real estate ETFs to the market.

RS: Why did you guys create – why did Hoya Capital create your ETFs?

DA: It’s all because of you guys. It was because of the Seeking Alpha research platform and the subscribers that led to the birth of (NYSEARCA:HOMZ), the Hoya Housing 100 ETF. And through the growth of HOMZ, our clients were asking us to bring a higher yielding product to market.

So we responded to our subscribers, and that’s what led to the birth of (NYSEARCA:RIET), which as of this date, middle of June of 2024, and we’re hovering around $65 million under our RIET ETF and about a $115 million on the whole complex, and it’s all because of our Seeking Alpha research platform.

RS: That’s so awesome. I love that story. I love a collaborative origin story That’s fun because you’re really filling a need. Literally, people are asking for it.

DA: We responded to what our clients wanted. Absolutely.

RS: Do you have plans for more?

DA: Yes. But I’d like to get our existing funds to $1 billion before I start thinking about it. The goal is obviously generate AUM, generate fees off of the AUM that basically make the business sustainable and that the fees are generated could then launch the birth of the next ETF versus me having to come out of pocket to launch a new fund.

Because really with the ETF, as I mentioned in the previous conversation, it’s kind of like throwing darts at a wall. You don’t know what’s going to hit, you don’t know what’s going to resonate, what’s in today is out tomorrow, what’s out today is in tomorrow. It’s all about timing.

For an ETF guy, it’s harder for an ETF to go from $0 million to $25 million under management than from $25 million to $1 billion. And it’s because of the stars lining up, the right model, the right platform, the right advisor, the right social media post, the right algo on LinkedIn or whatever it is to capture the right audience, to get your message that’s out there.

We have ideas, but I’ve also been taught do one thing and do it good. Don’t just do it good, do it darn good, got to watch my language. And when you do that one thing darn good, then branch out to the second thing and do the second thing good. Don’t have 10 balls in the air and hope that you’re able to keep them all together. Why don’t I just juggle two balls and do it really good and then when it takes off, okay, now let’s do number three.

RS: The smartest people I know in business always say something like that. You got to perfect what you’re doing first before you expand.

DA: Keep it simple, stupid, don’t reinvent the wheel. If it ain’t broke, don’t fix it. I feel like a broken record, but it’s so true.

RS: Yeah, yeah. So how do you decide what goes into the ETF? How do you navigate that?

DA: That’s a great question. It’s rules-driven. We take all the REITs, the 180 REITs that are out there, we break it in terms of market cap, large, small, mid. We break it out in terms of sector, geography, we cap the weightings on terms of sectors, geographies, market cap weightings, preferreds.

The goal is to basically produce 100 stocks in the portfolio where the largest weighting is no more than 1.5%. But the goal is to really bring a truly diversified portfolio that should constituent #6 cut its dividend your max exposure really is 1%, 1.5% and you’re covered on 98.5%.

But because it’s a rules-driven process, it’s our job to, like I said, try to find the best stories, the highest dividend-paying REITs, the lowest leverage stories, the stories of the sectors that are resonating across whether it’s homebuilders, resi, or in data centers or industrial.

But to find those dividend champions, frankly, that again, it doesn’t matter what the market cap size is or what the sector focus is, but that dividend income stream kind of carries itself, again, that we could sleep well at night knowing that Simon’s not going to cut their dividend tomorrow, public storage or whatever.

RS: And how should retail investors be thinking about dividends in the REIT space?

DA: REITs are two things, interest rate sensitive and dividend income streams. So I think it’s important when you look at don’t look at a REIT stock price and think about, oh, like, what’s the total return been? Like how much is the stock up or down this year? Because I think you’re going to be sorely disappointed if you just buy a REIT for the stock price appreciation. You buy a REIT for the dividend income stream.

As an example that I used with the gentleman earlier, the stock’s trading at $25, but it’s paid out $10 of dividends over five years. The stock’s really at $35, but you don’t think about that because all you see is $25 on your screen, and not the fact that you’ve earned $10 in income from these guys, especially if it’s a monthly dividend payer.

Also, if you start the clock, if you just have a child or a grandchild and they’re one day old and you go out and buy a monthly dividend paying stock, a REIT that you can dividend roll DRIP the dividends, the difference between buying REITs for that child today versus waiting until they’re 40, you’re talking potentially millions, multiple millions of dollars of income that you could start for your beneficiaries today just by buying 1 share of Realty Income (O) and Agree – now I’m not saying that 1 share of Realty Income and 1 share of Agree Realty (ADC) is going to make you seven figures over the course of 65 years, but you’re going to make a nice boatload of money again through a dividend appreciation just rolling it into itself.

That by the time that child turns 18, they’ll have accumulated what, 25 shares of stock. You’re starting them on the road towards retirement. And I think that’s any advice. It doesn’t matter if you’re one years old, 10 years old, or 100 years old, maybe it’s just because of how I was raised. I think it’s always important to start thinking about your retirement for tomorrow.

We all can’t grow up as a Walton. We all can’t grow up as an Ackman or a Bill Gross or pick your favorite celebrity multi, multi-billionaire. We got to do it the hard way and REITs are pretty much the easiest way to help you go down that road to becoming the next Bill Ackman or fill in the blank of your favorite investor.

RS: How difficult is it to navigate? Like we’ve had these conversations about the rate cuts and how many are coming or how many aren’t coming and maybe there’s one more to be had. How much is that going to affect the REIT space and in which ways is it going to affect the REIT space?

DA: Oh, I mean, REITs respond to the good and they respond to the bad. And so when the Fed raises interest rates, REITs sell off. And when the Fed cuts interest rates, the REITs rally.

And I think the problem, as we discussed earlier, the problem is that when the Fed makes an announcement at 2:00 PM Eastern on whatever date that the Fed cuts interest rates, at 2 o’clock and 1 second, the REITs are going to go up, they’re going to rally as a whole, and at 2 o’clock and 2 seconds, the advisor’s going to call their client saying, hey, the Fed cut interest rates, it’s time to buy REITs.

That ship has already sailed, they’ve missed out on the rally. And so the key is to now find your favorite story, your favorite sector, your favorite play to position today for what’s eventually coming down the road tomorrow.

Right now, REITs are a deep value opportunity.

And if I can get the best of the best stocks at, frankly, $0.01 on the $1 because they’re trading at discounts to their net asset value, if I can buy the Empire State building for $7 a share as a whole for the entire portfolio and the Fed cut interest rates and the stock goes to $9, you’re going to be a happy camper.

Now wait, the key is what’s your cost basis? When did you buy that Empire State Realty Trust (ESRT)? Did you buy it in 2023 when nobody was traveling in New York or did you buy it in 2019 when things were rosy? So it kind of depends on your cost basis when you look at the story, but from the fundamental level, all you care about is, are my dividends going up?

RS: In terms of the safety of the dividends, who are your favorites?

DA: That’s a good question. Obviously, the guys that are in the S&P 500 are a very easy place to start because you don’t just get in the S&P 500. You have to put it up or shut up and those guys that put up. So I think that’s a great – if you’re a first time REIT investor, what’s the easiest way to play it? Go buy the REITs in the S&P 500.

If you really want to start going under the surface, again, our ETF, RIET, the High Dividend Yield REIT ETF Index, tries to find the REITs that pay the highest dividends with the lowest leverage ratios.

So if you’re concerned about this wall of debt that’s coming due or a company being over-levered, we kick it out. It fails our rule, so it wouldn’t be part of our portfolio. It’s our goal to find basically the dividend champions across large-cap REITs, mid-caps, small caps, mortgages, and preferreds to build the best portfolio that maximizes the dividend income in investors’ pockets.

RS: Speaking to that wall of debt that you were mentioning, and we talked about this in the talk, how should investors be navigating that debt?

DA: I’ll have to watch my language because I wasn’t so good in the presentation earlier with that. REITs are just a small blip on the radar in the world of commercial real estate. They get kind of lumped in as a whole. So you have media publications like a CNBC or Bloomberg that talk about this wall of debt that’s coming to rising interest rates going to sink the ship, et cetera.

And I think it’s important to peel back the onion because if you go and ask the actual REIT companies themselves because of how transparent they are with their quarterly earnings releases and supplements that they publish, they’ll tell you, here’s how much debt we have coming due this year, next year, five years from now, 10 years from now.

And by and large, these companies are telling you, we’re not concerned about rising interest rates or where the interest rate market is. We know what’s coming due. It’s our CFO’s job to figure out when to pull the trigger on that. They’re watching these markets like a hawk every single day, just like any other portfolio manager is.

RS: Do you think the shareholders’ interests are aligned with the REIT managers’ interest when it comes to navigating for interest rates?

DA: I think the answer is it depends. Case in point, let’s use the Blackstone (BX), Starwood REIT (STWD) example. Advisors are recommending that product to tens of thousands of investors across the globe. But what you don’t know is how much the advisor is being paid by Blackstone and Starwood to sell that product to investors, right?

So typically, an advisor is going to sell the product that puts the most amount of smash or commission in his pocket. So I kind of question your question because what’s the advisor’s motive? Is the advisor the steward to his end customer or is the advisor trying to figure out which of these investments potentially puts, and I’m not saying this happens across all, everybody, but it is a problem in our industry that there’s a bias towards certain investment recommendations because of the fee stream that advisors been making.

I think it’s important, again, going back to that peel back the onion thing, where, look at a fee structure of a Blackstone or a Starwood REIT. Look at the fee structure of a REIT – publicly-traded REIT. Do you know what the fees are buying a publicly-traded REIT? The commission that it costs you to execute the trade. Do you know what the ongoing charges are to own that REIT? Nothing. You don’t pay a fee to own Easterly Government Properties (DEA). The cost is what it costs me to go into that trade.

So, it’s a tough question to answer because obviously, you want your financial advisor to be the steward of your capital to make sure that you’re bringing the most, he’s bringing the most, or he or she are bringing the most bang for their buck to making sure they’re looking out for your interest, but the problem is that you’re a completely different investor than I am.

I don’t know what’s in your portfolio, you don’t know what’s in my portfolio, but if we had the same advisor, and I know there’s no such thing as a guarantee. But I guarantee if we have the same advisor, you and I are going to have some overlap in positions because the advisor has certain favorites that he likes, maybe because of ulterior motives, maybe because he knows something that you and I don’t know, right?

I mean, what do I know about MLP investing? If I have an MLP question, I call my buddies across the street here at Infrastructure Capital because they run MLP ETFs. They know the sector better than I do. Do they know it better than my financial advisor does? I’d like to think the answer is both yes and maybe no.

So I think it’s a very tough question to answer. But that’s why I think at the end of the day, because Dan Ives tells you to buy NVIDIA, you shouldn’t buy NVIDIA. Because Tim Seymour tells you to buy Innovative Industrial Properties (IIPR), you shouldn’t buy Innovative Industrial Properties.

I don’t care if you’re two years old or a 100 years old, you need to do your own due diligence. You need to do your own research and figure out what’s important to you as the investor. The REITs aren’t going to answer that question for you, right? They’re putting the information out there, which you’ve got to go through and figure out what matters to me as an investor.

Do I care that they’re DEI focused? Okay, check off that box. Do I care that their earnings are going up? Okay, now this looks like a more value compelling opportunity versus what’s the earnings stream look like?

What have they done during COVID? How did they respond to COVID from like a political situation? Oh, you mean they kicked tenants out? I can’t be affiliated with something like that, and I’m going to sell that name. They kicked tenants out. I like that they kicked the tenants out, which means they only wanted to bring in income-producing guys. I’m going to buy this name. No two people are alike.

RS: What are the things that you look at first when you’re looking at REITs?

DA: Me personally, so do I know the company? Do I have a relationship with the company in my years in this industry? How shareholder-friendly are they? Do they respond to shareholder investor requests? You saw my buddy that was here earlier who’s investor relations for one of these companies and she’s handing out her business card asking, hey, you got questions about our company? Call me. I’m happy to answer your questions.

So how much do they want to engage with their investors? What’s their focus? Where is their focus? Where’s the puck going? Are they going to where the puck is going? When I think about REITs, I think about not what’s happening today, but what does this look like 10 years from today, 25 years from today?

Remember, REITs are long-term investment vehicles. So therefore, what’s the long-term vision of this company? Tell me your one-year vision, your five-year vision, your 10-year vision, your 50-year vision. They may not have the answer for that. But if you’re not thinking about what this is going to like 10 years down the road, we got a problem here.

RS: Do you think that there’s something inherently wrong with a REIT that doesn’t want to share with investors?

DA: Every REIT will share something to an extent. They don’t want to reveal the sweet sauce. They would say it’s an ongoing conversation, we’re always figuring out, like it’s why I’m launching a REIT jobs board.

I mean, it’s something we didn’t talk about, but it’s trying to find that next generation of REIT talent because I’ve heard from multiple companies at this hotel two weeks ago at the NAREIT Conference that they can’t find good candidates and good talent and they’re farming out these REIT positions to India and to Mexico at a fraction of the cost and they want to pay graduates here, but they haven’t found that talent pool. That’s concerning to me because people helped you when I get to where we’re at in this industry.

I’m sure you have mentors and colleagues and people that you admire in this business that helped you get to the position that you’re sitting in today. Same with me. Who are we helping to take these seats from us 10, 20 years from now? And the answer is there really isn’t anybody that’s trying to do that. So I’m trying to think about this industry 10, 20-plus years down the road.

RS: Is that specific to REITs?

DA: Oh, I mean, it’s – the answer is no, but I’m making it specific to REITs because that’s my baby and what I care about. Nice trick question there.

RS: No, I mean I didn’t even ask it as a trick question, but I kind of knew that that was happening…

DA: But okay, what is NVIDIA doing to figure out what its talent base is going to look like 20 years from now? How do you tell this kid that’s in elementary school who doesn’t care, but what is the company doing today to focus on that kid 20 years from today?

And I think it’s an epidemic across all of Wall Street and all of business, but I don’t know if people are necessarily focused on that. And I’m – money’s important, don’t get me wrong, got to pay the bills, but there’s more important things in life than how much money can I put in the bank?

For me, it’s when do I go see my next Phish show? That’s a separate conversation, but seriously, what’s my legacy? What do you want your legacy to be? Don’t answer the question, but what do you want your legacy to be?

And for me, because of how connected I am in this industry, I want to use that as a platform to help this next generation find that investor relations job to become that next REIT CEO, you know? Would I love to be a REIT CEO with 30 years of an S&P 500 company? You’re darn right I’d love to, but it comes at a cost. And I know what my calling is, it’s education.

RS: Wow, really beautifully put. That is just a really lovely point to make. Yeah. I kind of want to end it there, but I want to ask you if you want to share anything else with investors that you think they should be aware of.

DA: Can I give my contact information?

RS: Yeah, of course.

DA: If anybody wants to learn about our Hoya Capital ETFs, you can reach out to me at [email protected] I’m always available to chat, 214-492-3777. Learn about us at Hoya Capital. We are a Seeking Alpha research platform.

We also have Hoya ETFs. We manage the High Dividend Yield REIT ETF, ticker (RIET); and the Hoya Housing 100 ETF, ticker (HOMZ). But to end it, it’s not a question of are REITs the right investment? The answer is yes. The question is which REIT is the right investment? And we want to help you try to figure out what the best fund, mutual fund, ETF, single stock, whatever it is that resonates with your portfolio.