Nick’s Note: It’s not very often that we see PBRG guru Teeka Tiwari recommend real estate. But that’s what he did in this month’s issue of The Palm Beach Letter. I called Teeka and asked what’s got him so excited about the sector…

Nick: T, in this month’s Palm Beach Letter, you recommended buying a real estate investment trust [REIT]. Why are you interested in real estate now?

Teeka: REITs haven’t been this cheap since the 2008 recession. Right now, they’re trading 16% below the value of their assets. That means we’re getting this real estate for 84 cents on the dollar.

If these companies sold all their assets tomorrow and mailed out checks, shareholders would make an immediate 19%.

Of course, they’re not going to do that. But this shows us how undervalued the whole REIT market is.

The market is valuing REITs as if we were in the middle of a recession. Yet, we have a booming real estate market in a booming economy.

Does that seem rational to you?

Nick: Not at all. Before we go any further, can you explain what a REIT is?

Teeka: REITs are companies that own, operate, or finance income-producing real estate. They trade on exchanges like regular stocks.

By law, REITs have to pay out 90% of their income to shareholders. That’s one reason we like them.

Nick: Thanks for the explanation. So why are REITs trading at such a huge discount?

Teeka: Wall Street is concerned that higher interest rates will cause a recession.

REITs have to borrow money to buy real estate. The cost of borrowing money (interest rates) has been rising sharply.

Today, the rate on the 10-year Treasury is 2.9%. That’s up from 1.38% in 2016… That may look like small change—but it’s a 110% increase.

The market fears that these higher rates will eat into profit margins and force REITs to cut their dividends. I call this Income Extermination.

Income Extermination is when certain income investments get “exterminated” by rising interest rates. That’s because as interest rates rise… commonly held income investments like bonds drop in value. When interest rates rise rapidly—as they’re doing now—bond prices drop a lot.

Bonds aren’t the only securities that Income Extermination will devastate. Income Extermination could also wipe out high-yielding stocks that hold lots of debt… like certain REITs.

So Wall Street isn’t completely wrong about being leery of REITs. Some REITs hold massive amounts of debt and will get “exterminated.”

But REITs without a lot of debt will do fine.

Nick: Why do you think REITs will go up now?

Teeka: Every now and then, the REIT market gets irrational. But it only gets so irrational before it comes back to its senses.

Right now, REITs are trading at a discount that will interest the market again… When that happens, we’ll see REIT prices shoot up.

I’ve seen this happen before…

In 2011, when the U.S. lost its triple-A credit rating, the market was convinced the economy would go into recession. Real estate suffered. At its low, the average REIT traded 15% below the value of the properties on its books.

Then, the entire sector roared back so much, the average REIT traded at a 14% premium to the value of the real estate held on its books.

In 2015, the same pattern played out again.

This time, Wall Street blamed China’s currency devaluation. The Street was terrified that U.S. goods would become too expensive for the Chinese market, so we’d see trade collapse, and a recession would ensue.

Again, the entire REIT sector traded at a 15% discount to its assets. And again, when no recession happened, the entire sector sprang back to life.

The entire REIT sector rose, trading at a 12% premium to its assets.

Today, Wall Street fears rising interest rates will cause a recession. But here’s the catch… There is no recession in sight.

This is just another case of the market seeing “monsters in the closet” that just aren’t there.

Nick: What evidence do you see that the real estate market is booming?

Teeka: I’ll give you three examples…

First, global real estate transaction volumes are strong. The fourth quarter of 2017 saw volumes surpass the previous quarterly peak set in 2014.

Second, global office leasing volume finished 2017 at its highest level in a decade.

And third… vacancy rates for apartment, office, retail, and industrial properties are at, or near, their lowest levels in the past 15 years.

That makes real estate an attractive investment opportunity, as it offers above-average yields and growth potential that exceeds inflation.

And we’re not the only ones interested in owning real estate.

While Wall Street’s running scared, some of the biggest pools of private money are snapping up real estate like mad.

Private equity firms like The Carlyle Group, KKR, and Warburg Pincus poured $71 billion into real estate last year.

According to PricewaterhouseCoopers, private equity firms now hold $1.2 trillion in real estate.

Nick: How can readers play this?

Teeka: In The Palm Beach Letter, we’re using a closed-end fund [CEF] that gives us access to investments that cover every aspect of the real estate business. From commercial and residential real estate, to hotels and data centers—this idea covers it all.

CEFs are an investment structure with shares traded on the open market. They’re like exchange-traded funds [ETFs], with one main difference: CEFs don’t issue shares daily.

That means CEFs can trade on the market at prices different from their net asset values or NAV. NAV measures the value of a fund’s assets, minus its liabilities.

When a CEF trades for less than its NAV, you can buy it at a discount. This means you could buy a dollar’s worth of assets for just 90 cents.

Nick: What do you look for in a CEF?

Teeka: We usually have three rules for selecting CEFs:

First, we only buy CEFs that trade at a discount.

Second, we only buy CEFs that offer above-average yields.

And third, we only buy CEFs with below-average fees.

But when it comes to real estate CEFs, we need to add another rule… you want to choose a CEF that doesn’t use a lot of leverage to generate returns.

Nick: Thanks for sharing this investment advice with us.

Teeka: You’re welcome.

Nick’s Note: In the June issue of The Palm Beach Letter, Teeka and his team had an idea that will pay us a 9.5% yield. On top of that, it trades at a 9% discount to the real estate investments on its books. If all it does is trade back to its NAV, we’ll make 9.9%. If it behaves like the industry normally does after getting this cheap, it could trade to at least a 10% premium. That’s a 20.9% return from here. PBL subscribers can read the issue right here.

If you’re not a PBL subscriber, you can learn how to get a copy of Teeka’s blueprint to survive and thrive during Income Extermination right here…

MAILBAG

An eagle-eyed reader spots a mistake in Tuesday’s Daily…

From Dan B.: Hi Nick. I enjoyed your article on short squeezes. (“How to Profit From a Short Squeeze.”) I love reading your essays. They’re informative, clear, and useful. But I think you made a mistake here… You wrote, “A short squeeze is when short sellers start closing out their positions to avoid massive losses. As they sell, they create upward pressure on the stock price.”

I think you meant “As they buy, they create upward pressure…”

Thanks again for some great articles.

Nick’s Reply: Thank you for the sharp eyes, Dan. We’ve fixed the error. And we’ll continue to crank out informative, clear, and useful essays for our readers… Hopefully, sans the mistakes.

And responses to Teeka’s essay about the smear campaign against bitcoin continue to fill our inbox…

From David A.: The way I deal with this misinformation about bitcoin is to watch how it scares others out of the market… and allows me to invest more at a lower price!  

From Douglas V.: I deal with misinformation by remaining aware of the inevitable triumph of logic and cold facts… but also with sensitivity. Bitcoin will be like a giant weed whacker going through the financial system. Blockchain technology will be an enormous benefit for humanity, even if it causes millions to lose their jobs.

From Jeremy H.: I try not to take the mainstream media seriously when it comes to bitcoin. The large institutions give bad press about an industry… only to turn around and buy at a discount when the price drops. Then they claim they’ve had a revelation and the product now is the best thing since sliced bread. Teeka, thank you for your information. Don’t be discouraged by short-sighted and unaccountable people.

From Oscar C.: Teeka asked “how do subscribers deal with the negative information about bitcoin?” The answer to the question is relatively simple for me. I listen to as many sides as possible. I make my best judgment knowing nothing in life is promised. 

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