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Beckley
Saturday, March 28, 2020 4:04pm

Real Asset Investing The ‘4M’ Way


As a real asset focused investor in a low interest rate world, I am constantly faced with the battle of balancing risk and reward. With interest rates now scraping the bottom of the barrel at under 1% across the spectrum of U.S. Treasuries, it is increasingly challenging to find high-quality REITs and other publicly-traded real asset companies that offer a satisfactory rate of return through dividend and growth potential

Granted there are some, but they are in troubled, higher-risk sectors that are plagued by negative market sentiment and larger challenges. For example, Simon Property Group (SPG) boasts world-class management, a broadly diversified and high-quality portfolio, an A-rated balance sheet, and a solid dividend growth track record, yet it trades at a mere 57% of its Net Asset Value. Another example is Enterprise Products Partners (EPD). It has arguably the best portfolio, balance sheet, and management team in the midstream MLP space along with a terrific distribution growth track record and is even beginning to repurchase its units, yet its unit price continues to flounder.

While both of these appeared to be slam dunk investments at the beginning of the year, an investor who had concentrated their portfolio in these two would have gotten absolutely smashed, even relative to the stock (SPY) and REIT (VNQ) markets’ overall dismal performance:

ChartData by YCharts

At the same time, however, both EPD and SPG have outperformed lower quality/higher levered peers in their respective sectors:

ChartData by YCharts
ChartData by YCharts

Granted, this is a short-term snapshot and, as a contributor at High Yield Landlord, I value the long-term investment perspective. However, I am simply using these charts to illustrate Warren Buffett’s rule #1 for investors:

Never lose money.

Put another way into more mathematical terms:

The secret to successful long term compounding is to always be multiplying your principal by greater than 1.

What does this mean? Well, simply it means that it is generally more important to always win than it is to win by a lot some of the time and lose some of the time.

If you take a Russian Roulette approach to investing (i.e., pursue a concentrated portfolio in high-risk high-reward ventures) and have a strong combination of skill and luck, you might win big five out of six times. However, eventually, your luck will run out and even the most brilliant analysis from a finite human being will eventually prove incorrect due to a black swan event. The end result will be massive setback that could lead to bankruptcy, an empty account balance, or at the very least massive losses.

If, on the other hand, rather than focusing on maximizing the margin of victories you focus on doing everything in your power to “always win” and keep your losses minimal by pursuing adequate diversification and focusing on quality, over the course of the full cycle you will almost always end up ahead.

The only way to win over the long term with the Russian Roulette approach is to be able to accurately and consistently predict macroeconomic behavior, which, to my knowledge, no one is able to do. However, there is one macroeconomic certainty that we do have: as long as government and central bank monetary policy involves manipulating the price and quantity of money, we will regularly experience economic distortion due to entrepreneurs engaging in economic miscalculation on a systemic scale. This, in turn, leads to the boom-bust cycle. While we cannot accurately time the market swings associated with the boom-bust cycle, we can structure our portfolio to provide adequately comfortable returns during the boom periods within the constraints of a foundation built to weather the busts, just like someone would design a structure in a hurricane or earthquake prone area. This is the only investment philosophy rooted in the reality needed to generate adequate returns today, tomorrow, and 50 years from now.

Of course, we also know from the mathematical laws of exponential compounding that even small increases in the rate of return can result in massive differences in total returns over the long run. As a result, it would be a mistake to focus excessively on quality and safety with total disregard for valuation, otherwise we should just invest entirely in bonds, raw land, and precious metals.

Where do we draw the line? Well, everyone has their own standards based on their age, goals, portfolio size, the current macroeconomic environment, and personality.

Generally, I have found that it is prudent to focus more on quality in sectors that are troubled in order to increase your chances of multiplying your principal by greater than 1 and avoid a total loss of capital.

It is also generally more advisable to sacrifice some quality and safety (while still insisting on above-average quality and balance sheet strength) in thriving sectors in order to ensure a satisfactory rate of return since the strong sectoral tailwinds already make the chance of total loss low and reduce the need for the company to play defense.

Financial, asset, and management strength tend to shine the most when times are tough whereas during good times it is often more difficult to discern strength from weakness.

To use a Warren Buffett analogy: when the tide is in, you can swim naked without anyone noticing, but when the tide goes out, clothing is at a premium. Since we don’t know the ways and whims of the broader economy, it is always necessary to insist on a certain degree of financial, management, and asset strength. However, the degree to which we emphasize this relative to value should be determined by the fundamentals in the sector.

This leads me to introduce the 4 “M” approach to investing:

  1. Moat – insist on assets that will retain their value through the cycle. Defensive cash flows or top tier cyclical assets are essential to successful long-term investing.
  2. Management – management must be aligned with investors and be responsible allocators of capital. The more proven experience they have with successfully navigating busts, the better.
  3. Money – does the business have a sound balance sheet that can support a downturn in the market? This is largely dependent on the type of assets and business model the balance sheet is supporting, but insisting on an investment-grade credit rating when provided is a good place to start.
  4. Market – is Mr. Market offering an attractive price? Looking at things like private market value (Net Asset Value), dividend yield plus growth prospects, and historical valuation multiples are all useful here in determining if investing at the current price is worthwhile.

Evaluating and comparing investments through each of these filters while also taking into consideration the conditions in the particular sector in weighing the first three Ms against the final M along with insisting on proper diversification. What does proper diversification look like? According to some research, 12-18 stocks diversified across industries is all you really need to get close to the diversification of the broader index/market:

Source

The benefit of only having 12-18 is that you can actually take the time needed to study each opportunity based on the aforementioned criteria and pick the best opportunity in each sector in the aim of outperforming the broader market/index.

Model “4M” Real Asset Portfolio

With the 4 Ms and a 15 stock portfolio in mind, here are my top picks in the real asset space – diversified across sectors – as of this writing, with a brief blurb of why I selected each security:

1. Enterprise Products Partners (EPD)

Wide moat rating thanks to its strong asset quality and diversification, proven world class management, sector leading BBB+ balance sheet, and unit price sitting at multi-year lows along with a near record high distribution yield that is well covered. While Energy Transfer (ET) and MPLX (MPLX) are cheaper by many metrics, given the troubled nature of this sector and the oil price crisis, I chose to err on the side of safety here, especially given that EPD is already offering investors an incredibly cheap discount to fair value right now. That being said, depending on how valuations fluctuate, more ambitious investors would probably do OK also adding some smaller positions in ET and MPLX given how cheap they are and the likelihood that they will also manage to survive the current environment.

2. Ventas (VTR)

This is one of the premier healthcare REITs given its asset diversification, proven track record, world-class management, and BBB+ balance sheet. Now, it is the only high-quality healthcare REIT trading at a steep discount to NAV, offering investors a golden opportunity to climb onboard a long-term compounder that should remain steady through busts.

3. Simon Property Group (SPG)

This has long been considered the gold standard of mall REITs given its world class management, broadly diversified and high-quality portfolio, and A-rated balance sheet. Now, it trades at nearly half of net asset value. While Macerich (MAC) is another high-quality REIT that should make it through current challenges OK and is trading for an even steeper discount, given the considerable challenges and uncertainty facing the mall space, I believe it is crucial to err on the side of caution, especially given the incredible value already found in SPG’s shares.

4. Regency Centers (REG)

While Federal Realty Trust (FRT) and Kimco Realty (KIM) seem to get most of the attention in the shopping center space due to FRT’s impressive Dividend King status and KIM’s higher dividend yield. However, REG’s balance sheet is actually arguably as good if not better than FRT’s and trades at a steeper discount to NAV and sports a higher dividend yield. While KIM (and many other shopping center REITs) is cheaper relative to NAV than REG, we believe that the ongoing challenges facing shopping center REITs warrant a focus on safety. As a result, we side with REG as it is a virtual twin to FRT on quality and safety but is clearly more attractive from a valuation standpoint.

5. Spirit Realty Capital (SRC)

If you haven’t seen SRC’s recent investor presentation, check it out here. They are making a compelling case to be seen as a direct peer for Realty Income (O), but trade at a far lower multiple. In fact, despite their solid investment-grade credit rating, quality diversified portfolio, and impressive management delivery on stated goals and objectives, they are a rare NNN REIT to be trading at a meaningful discount to NAV right now. In uncertain times, SRC is one of the best buys around.

6. EPR Properties (EPR)

A more specialized NNN REIT, EPR has an impressive management track record, well-diversified assets, a solid investment-grade balance sheet that fully supports is conservatively structured, and supported rental contracts, and most of all a mouthwatering valuation with deep discounts to NAV, a very high dividend yield, and solid forward growth prospects.

7. Monmouth REIT (MNR)/ STAG Industrial (STAG)

This one is a toss-up between MNR and STAG, and investors would not be wrong to hold both.

While not even close to the most conservatively financed industrial/logistics REIT, in a sector where growth and demand are strong, MNR’s balance sheet is plenty strong to guard against downside. Furthermore, its assets are some of the newest in the sector and enjoy long-term NNN leases to strong tenants like FedEx (FDX), Amazon (AMZN), and Coca-Cola (KO). Finally, management has a very strong long-term track record of outperformance, so we know our capital is in good hands in a good sector. In a sector where valuations are at a premium, MNR offers investors a significant discount to NAV and an attractive dividend yield. The main drawbacks to MNR are that it has outsized exposure to a single tenant (though that tenant is fairly strong in FDX) and it also has a sizable REIT portfolio that has underperformed in recent quarters, dragging down performance.

While STAG’s properties are older and its leases are probably not as robust, its growth prospects, valuation, and dividend yield are all superior. STAG is a more aggressive play on the industrial space, whereas MNR is more defensive.

8. Host Hotels (HST)

While the sector is deeply troubled by coronavirus fears, a late cycle economy, and growing competition, Host Hotels boasts strong experienced management, the only investment-grade credit rating in the space, a broadly diversified very high-quality portfolio of irreplaceable iconic assets, and a deep discount to NAV. It’s hard to see how an investor will lose over the long term with this one thanks to a balance sheet that is built to last.

9. Columbia Property Trust (CXP)

Boston Properties’ (BXP) younger brother of sorts, Columbia has quality management, a very strong balance sheet, good assets diversified across gateway markets, and is trading at a very compelling (near 50%) discount to net asset value. Similar to Host Hotels, if investors have the stomach for the current downturn, it is hard to imagine them losing over the long term. Office properties are cyclical, so the strong balance sheet is essential to investing in this space.

10. Camden Property Trust (CPT)

What is not to like here: strong fundamentals, industry-leading balance sheet, excellent management track record, high-quality assets, healthy diversification, and a discount to NAV. Take advantage of the market panic to buy an all-around excellent company at a good price.

11. Weyerhaeuser (WY)

Woodlands backed by a strong investment-grade balance sheet, shareholder-friendly management, and a deep discount to NAV. Wood will be in demand forever and will appreciate over time with inflation. At today’s price, money does grow on trees. That being said, with the cyclicality of commodity prices, it is important to insist on a strong balance sheet. Investors get that with WY.

12. Farmland Partners (FPI)

Agriculture is a troubled sector right now and FPI’s management is delivering unimpressive results. The balance sheet isn’t particularly strong either. That being said, farmland has been called “gold with a dividend” for a reason, so it doesn’t need brilliant management or a stellar balance sheet as long as there is diversification. FPI offers that along with a ridiculous 50% discount to NAV. Think about that for a moment: highly liquid and diversified farmland for half off. Doesn’t get much better than that for patient long-term investors. On top of that, management is creating value for shareholders by selling assets and buying back the heavily discounted stock. The dividend yield is about 4-5x the current 10-year treasury yield too. For enhanced yield and safety, it might be prudent to split this position between the common shares and the preferred (FPI.PB), now trading at a steep discount and ~7.5% yield.

13. Brookfield Infrastructure Partners (BIP)

The global infrastructure boom is fueling strong growth and impressive total returns at BIP. With a BBB+ balance sheet, a broadly diversified wide-moat business model, and world class management, the current pullback offers investors a great opportunity to get aboard this dividend juggernaut.

14. Brookfield Renewable Partners (BEP)

The sky is the limit (or in some cases, the source) for renewable energy. Brookfield’s operating capabilities, world-class management and deal sourcing, high quality hydro portfolio, and sector-leading BBB+ balance sheet make this a compelling buy on the pullback.

15. Brookfield Business Partners (BBU)

While this real asset-servicing private equity play appears highly leveraged at first glance, its corporate level debt is zero. With an increasing focus on defensive cash flows, a strong record of value creation by management, and a high threshold of unit price appreciation to meet before incentive fees kick in again, now is a great time to go long BBU as part of a diversified portfolio.

Investor Takeaway

While there is a lot more analysis needed to fully justify each of these opportunities, I hope this article spurred some thinking.

One final note for investors is that SPG, REG, and SRC combine to provide substantial exposure to bricks and mortar retail. While they are indeed different types of bricks and mortar retail, given the social distancing going on, investors may want to reduce risk by only holding one or two of these positions. Based on valuations at the time of writing, I would personally pick SPG and SRC over REG at this point.

In the coming weeks, I hope to dive in further on each of these opportunities and will provide updates to this list as time progresses and the market continues to gyrate unpredictably. Happy investing!

As always, members of High Yield Landlord will receive “TRADE ALERTS” and “MARKET UPDATES” in real-time as we put new capital to work.

High Yield Landlord is the largest community of real estate investors on Seeking Alpha with 1,500 members on board. We started a Limited Time Sale on Monday – offering 50 spots at our lowest-rate-ever offered.

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Disclosure: I am/we are long EPD, VTR, SPG, REG, SRC, EPR, MNR, HST, CXP, CPT, WY, FPI, BEP, BIP, BBU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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