Why Real Assets Will Soar in the Recovery

September 16, 2020

Your asset allocation decision will have a major impact on your performance in the recovery.

We believe that this low growth, low interest rate environment favors resilient, high cash flowing real asset investments.

Finally, we present two real asset investments that we currently hold in our Core Portfolio.

Looking for a portfolio of ideas like this one? Members of High Yield Landlord get exclusive access to our model portfolio.

Most investors invest the majority of their capital into regular stocks and bonds.

I prefer to invest most of my capital into real assets investments, which include REITs, MLPs, YieldCos, and other Infrastructure companies.

And in this article, I will outline why I expect real assets to soar in the recovery and outperform regular stocks and bonds.

Without further ado, here are the 5 main reasons why you should consider a large allocation to real assets today:

Reason #1 – Defensive Cash Flow for a Slow Recovery
It appears increasingly likely to us that the economic recovery will be long and slow. As we explain in a recent Market Update at High Yield Landlord:

Three issues will prevent a quick snapback in the economy and will instead cause the recovery to be slow and halting for a long time to come:

The coronavirus itself, which is killing people (i.e. workers and consumers), reducing (or reducing the efficiency of) work hours, and diverting resources away from productive purposes.
Government responses to the coronavirus pandemic, which, whether beneficial on net or not, have undoubtedly had a dampening effect on the economy by restricting business operations.
The major increase in national debt incurred because of the crisis.
The Fed itself does not expect a full recovery for quite some time and this is also why interest rates are expected to stay at near 0% for years to come.

You just cannot have it all: a full recovery and strong covid safety measures. It is one or the other:

With the economic recovery taking much longer than previously thought, investors should position their portfolio for slower growth by focusing on investments that enjoy:

Long contractual cash flow
An essential nature
A high cash flow yield
And that’s exactly what real asset investments will provide you.

Class B apartment communities are a great example because they are essential to our society, generate contractual income, and earn a high yield to their landlords:

People need shelter regardless of how the economy is doing and it is not in their best-interest to stop paying rent. All it would do is ruin your credit and result in a eviction a few months from now. Once you have ruined your credit and been evicted once, it becomes much harder to find a new home as other landlords refuse to do business with you.

REITs that own such properties have enjoyed near 100% rent collection rates through this entire crisis. Moreover, as residents of more expensive Class A communities downgrade to cheaper Class B communities, their landlords enjoy growing demand.

Independence Realty Trust (IRT), a Class B apartment REIT, recently noted that its leasing is today even stronger than in 2019.

An investment in IRT enjoys a near 8% cash flow yield and as such, you really do not need much growth to achieve attractive total returns. Moreover, it is estimated to trade at a 20% discount to the underlying value of its properties. Before the crisis, it traded at a 20% premium and as fears dissipate, we expect it to return where it was, unlocking ~40% upside to investors who buy it today.

That’s quite attractive coming from a defensive, high cash flowing real asset investment that is essential to our society.

Reason #2 – Inflation Protection and Durable Values
The central bank printing presses are going wild all around the world. Will this eventually lead to more inflation?

The Central Bank Bubble: It Will Be Ugly – Gold Telegraph

Moreover, the Fed recently shifted away from its previous policy to instead encourage faster inflation.

“Many find it counter-intuitive that the Fed would want to push up inflation. However, inflation that is persistently too low can pose serious risks to the economy.” Jay Powell

And there isn’t much better than real assets to fight inflation.

Real assets are “real” and tangible. They represent essential infrastructure that is absolutely needed to the well-being of our society:

Shelter: apartments, single family homes, manufactured housing.
Food: farmland, grocery stores, distribution centers.
Energy: pipelines, rigs, windmills, solar farms.
Transportation: railroads, airports, highways.

Real assets impact all facets of our daily lives and their values cannot be inflated away. They have remained valuable through centuries of different monetary policies and in today’s times of uncertainty, we like to know that in case inflation runs out of control, real assets won’t suddenly disappear and become worthless.

Reason #3 – 0% Interest Rate Policy Tailwind
The 10-year treasury currently yields 0.7% – a clear sign that the market expects very low interest rates for many years to come.

This is very bullish for real assets because of three reasons:

Lower interest expenses: REITs and other real asset companies are able to refinance their current debt at lower interest rates, which results in higher cash flow available for shareholders.
Faster external growth: They are also able to earn higher spreads on their new investments. As an example, Realty Income (O) recently raised some debt at a 2.34% effective rate, and it is able to reinvest it at 6-7% initial cap rates. That’s the biggest spread in 10 years for Realty Income.
Higher valuations: Generally, real assets trade at a yield spread relative to interest rates because they are considered to be bond-proxies. Therefore, lower interest rates make them more valuable and as we put this crisis behind us, we expect a repricing at much higher valuations.

All three factors combined together will lead to higher returns that are less dependent on the economic recovery.

Reason #4 – Deeply Discounted Valuations Offer Upside
Following the covid crisis, interest rates hit 0% all while dividend yields of major real asset sectors rose significantly. As a result, the valuations based on yield spreads are at the lowest they have been in over 10 years:

As an example, REITs commonly yield 150 basis points more than the 10-year treasury. However, right now, REITs are priced at 2-3x higher spreads, which we have only seen previously during the great financial crisis.

Of course investing during the great financial crisis proved to be a fantastic decision. REITs (VNQ) nearly tripled in the following two years:

Interestingly, many real asset investments are today even cheaper today than they were back then, and we expect similar results in the recovery.

Reason #5 – Yield-Starved Investors in a Yield-Less World
Right now, real assets are the last remaining investments of scale that offer high and sustainable yield in a 0% interest rate world.

A lot of investors absolutely need income. Think about pension funds, banks, insurance companies, endowment funds, and retirees.

As the covid fears dissipate and interest rates remain at near 0%, what are these investors going to do to earn their income?

We believe that the answer is real assets. REITs, MLPs, and other infrastructure companies offer high yield in a yield-less world, and as yield-starved investors eventually return, they will bid up prices, which will then cause yields to compress to more reasonable levels.

Brookfield (BAM), a major private equity firm, expects asset allocations to change very drastically over the coming decade. They estimate that real assets could reach 60% of investor’s portfolio, up from just around 25% today:

Over 60% sounds like a lot, but the reality is that income investors really don’t have many options. When your other alternatives are 0.7% yielding treasuries and volatile non-income paying stocks like Tesla (TSLA), it may seem like a no-brainer to buy resilient, high cash flowing apartment REITs that pay a growing ~4% dividend yield.

Profit from the Rush to Real Assets – Our Portfolio
At High Yield Landlord, we currently own 24 real asset investments in our Core Portfolio. They are mostly publicly traded REITs or REIT-like entities that are deeply undervalued and expected to richly reward investors in the recovery.

We believe that these 24 companies are the best opportunities of the entire real asset space, which represents over 250 publicly listed companies:

Below we shortly outline two of these opportunities:

National Retail Properties (NNN) is a blue-chip net lease REIT that just recently hiked its dividend, marking its 31st consecutive year of dividend growth.

Net lease properties are unique in that they enjoy >10 year long leases with pre-agreed rent increases and high rent coverage ratios. Therefore, even if we go into a prolonged recession in the aftermath of this crisis, NNN will still earn highly consistent and predictable cash flow for years to come. Moreover, NNN has a strong BBB+ rated balance sheet (just shy of an A-credit rating) and has enormous liquidity to deploy in new acquisitions in the coming years.

The market thinks that it is deeply troubled because rent collection rates temporarily dipped during lockdowns, but NNN now has near 100% of its rents collected or under a definitive deferral agreement. The fact that it was able to again hike its dividend is a clear sign that things are headed towards the right direction.

Yet, the dividend yield is nearly 6%, which is quite spectacular for a BBB+ rated blued-chip with a 31 year track record of dividend growth in a yield-less world. As it returns to its 52-week highs, the company has 60% upside potential.

Healthcare Trust of America (HTA) is an investment grade rated medical office REIT, which is exactly the type of resilient business that you want to own in this environment. HTA enjoys >5 year leases with high-credit tenants that have kept paying near-100% of rents in full and on time.

Medical office buildings are essential to fight the pandemic in the short run, and as the population keeps getting older, HTA enjoys a strong tailwind in the long run. It is expected that the age group over 80 years old will be 50% larger within 10 years.

Yet, HTA has dropped along with other REITs and become discounted. It currently offers a near 5% dividend yield and has 30% upside potential as it returns to recent highs. For a highly defensive REIT, this is quite attractive.

NNN and HTA are just two examples among many others. At High Yield Landlord, we target this type of defensive, yet undervalued real asset opportunities as we attempt to maximize returns in the recovery.

This real asset portfolio is expected to generate over $9,000 in dividends per year from a $150,000 investment:

Our Portfolio is priced at just 7.5x cash flow and an estimated 48% discount to NAV on average. As such, it enjoys strong margin of safety and significant appreciation potential relative to regular stocks and bonds.

And the catalyst for upside is clear: we are in a low growth, low rate world with a lot of yield-starved investors who will need to reposition their portfolios in the coming years to include more real asset investments.

By positioning yourself ahead of the crowd, you have the chance to lock-in high yields and profit from the rush to real asset:

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Are you Positioned to Profit from the Rush to Real Assets by Yield-starved Investors?
At High Yield Landlord, we have positioned our portfolio to thrive in today’s rapidly evolving environment. We are the #1 Ranked Service for Real Asset Investors on Seeking Alpha with over 2,000 members on board.

We spend 1000s of hours and well over $50,000 per year researching the Real Asset market for the most profitable investment opportunities and share the results with you at a tiny fraction of the cost.

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