JPMorgan Predicts REIT Dividends Should Now Be Stable

JP Morgan

When an investment really doesn’t grow much and you are down to dividends to make money, your dividends better be good. REITs have been cutting them, but the bleeding may have stopped.

People love to invest in real estate, and naturally prefer investing that is easy over more difficult and complicated means like actually buying real estate yourself for investment purposes and having to manage all the headaches that can come with it.

You also need the means to borrow to buy properties including the ability to make the higher down payments that buying investment properties require, and have to deal with things like renting the properties, dealing with periods of vacancy, maintaining your properties, and especially having a good enough head for business to ensure that you are getting into the right investments and managing them properly.

There’s also a lot more risk in going it on your own, where you can lose everything you put into it and more if your investments don’t work well enough. You’re staking your investments not on cash flow but on property appreciation, where the goal usually is to have the renters pay the mortgage on the property with little left once your costs are deducted, so if property values decline instead of appreciate, this can leave you with a sizable loss.

On the other hand, you do get to invest someone else’s money and get a return on that, and that’s the big gorilla in the room that looks to even the score between investing your own money in real estate stocks and going through all the hassle of doing it yourself.

When you invest in a property and borrow 80% of the money, you end up leveraging your investment by a factor of 5. This isn’t quite the 20 to 1 leverage you can get by putting 5% down when buying your own residence, but you can only have 1 residence while you can work your way up to several rental properties as you grow your business over the years.

If we’re considering investing in real estate in any form, we need to start out by realizing that these investments do not pay that much as far as returns, and without this added leverage, don’t expect much from real estate trusts, or REITs.

We might think that the REITs themselves provide the leverage here, and expect that investing in them should replicate doing this on your own, with your having to do nothing but sit back and collect. When you buy properties yourself, you are shooting for capital appreciation over time, when you sell the properties, with the income you earn along the way paying down your debt, but REITs are structured as income investments, paying this out to shareholders through dividends and not using much of the proceeds at all to grow the enterprise.

Income investments are characterized by their not accumulating in value very much and also by their low returns compared to investments like stocks that do appreciate a lot over time and deliver their returns mostly that way.

Most people tend to view income investments in isolation, not really considering how they may measure up with other types of investments or even how their returns measure up on a nominal basis. Instead, they focus on the “income” they generate as if it was the only thing about them that means anything.

When we hear things like the dividend yield of REITs being higher than yields from treasuries, where we’re not looking at the total return of either, this gives us a good idea of how isolated the perspective of investors who find that a meaningful comparison is. Sure, dividends and interest payments, the part that is considered the income, do contribute to returns, but are only one variable and can never be viewed alone.

Doing this is just like operating a business and just looking at revenue to measure your success. It would be hard to find someone who runs their business this way though as they would not be very mentally competent, and wouldn’t be in business for long either, ignoring both the costs of running the business and the net profit after this is deducted from revenues.

We’d probably want to see these people institutionalized, not just from this but from the utter lack of sensibility overall that this is indicative of, as this mistake is that bad. However, when we do the same things with our investments, that’s considered perfectly normal although it is no less insane.

If we’re looking to invest in REITs, we want to make sure we stay on the right side of sanity and actually view our investments from the perspective of profit and not this particular form of revenue that looks so shiny to people and mesmerizes them into just keeping their eye on that. They may even go into the hole and still happily stay in these income investments because they think that they are still getting paid.

We Should Not Have to Point Out If You Seek Profit, Profits Matter

This is not a reason in itself to avoid REITs or other income investments, but we do need to measure their comparative value, and using anything else but total returns, the profit or loss that occurs, is just incredibly stupid. Whatever mental disorder that could cause such a thing is rampant though, and is far from limited to REITs, as anything paying a dividend or interest is prone to this mistake.

Bonds are particularly abused this way, and once again, this doesn’t mean that bonds do not have their place, but we’ll surely never have any idea about what we are doing if we are seeking profit but refuse to measure the investment in those terms.

Given that we have a choice about what to invest in, we also need to avoid the grievous mistake of refusing to compare how different investments stack up in terms of profitability. We need to choose to understand our investments in terms of how well they serve our goals with them, their profitability, and then see which ones would serve our goals the best.

If investing were a school, this would be taught in grade 1, as this is the most basic principle of investing. This is so simple that we should not even have to teach this, as even the kids in kindergarten should be smart enough to know that if making money is the goal, how much you make actually does bear considering and you also should want to see if you can make even more.

The concept of better results being better is a simple one of course, and this is even a tautology. We don’t even know how far back we need to go to get to an age where this degree of thinking may not be present, as even babies know that if you cry, you will get attention, and if you cry harder, you will get more.

What is actually absent here is proper stimulus-response recognition, where our baby will at least normally direct their behavior toward more desired responses and seek to avoid undesirable ones. You have to have your eyes open to see what the response actually is, and if we’re not even looking at the profitability response with what we hold, let alone how our profit compares with alternatives.

It is only when we do these two things, measuring the progress of what we are in and comparing this with what else we could be doing that we can have any sense of what is going on. This applies to REITs and everything else. People can get tricked more easily with income investments like REITs though so we have to pay particular attention to comparative value as the dividends do blind most who hold them.

Investing in REITs are as easy as buying and selling stocks, so this provides the maximum of convenience where you can do absolutely nothing and think of absolutely nothing until you want to sell them.

We don’t want to go too crazy with this idea, as while it’s understandable that easy is so appealing, but this cannot be seen as a good excuse for not using your head at all with these investments or any investment.

With this said, we can now have a look at how REITs are doing and how desirable they may be right now.

We don’t even look at the dividends themselves, because they really don’t matter by themselves and we only care about how much we can make on this sort of thing. If we see that it returns 5% over a certain period, we don’t care how they got this, because it doesn’t make any difference other than potential tax implications of the type of distributions we earn.

We are then going to need to compare this with other investments, and as always, we’re going to need to look at both their returns and their risk. While returns in themselves can manage risk, we still need to look at what it needs to manage to get the whole picture.

The very idea of a REIT right now should send shivers down your spine given the hit they have taken from the current economic crisis. REITs may not go up much but they sure can drop when trouble comes, and they sure did this year.

JP Morgan Is Playing This Dividend Charade as Well

J.P. Morgan himself was no fool, and you don’t get to make such an impact upon the financial world as he did by being one, where you are still a household name over a century after your death. Whether or not the people at his namesake company get this or not, they do sell investments and won’t sell more REITs right now by being too honest about them. Dividends may be a ruse, but when the ruse works so well and you benefit when it does, that’s enough for you to want to play along.

It’s not just the price that REITs dropped lately, as their dividends took a particular bashing, with widespread cuts. The average dividend for REITs is down to 3.5% now, and JP Morgan is now stepping up and calling a bottom here. They said on Thursday that “the current 3.5% dividend yield for the REIT group should be sustainable at this point.”

This predicted bottom doesn’t refer to the value of REITs, as JP Morgan is just talking about dividends, as they are as infatuated with them as their investors are, or at least are pretending to be. It wouldn’t be much of a stretch to assume these advisors are just as clueless though as not being so in this instance would be a stark departure from just about everything else that they believe.

This might not be a low market for anything, even though REITs have come back a little. The benchmark iShares U.S. Real Estate ETF may be up 14% over the last 3 months, but it’s still down 15% for 2020 once the excess sell-off that everything went through earlier in the year was corrected.

This is not an investment that is set up very well to grow back their losses, as REITs are required to pay out at least 90% of what they make to shareholders. Dividends stunt growth, high dividends stunt them highly, and 90% or more is very high indeed.

This only leaves 10% left to grow the value of the asset, and does leave you with nice dividends but little else. REITs are also anything but tame investments, and bears particularly show no mercy on them.

It’s not even how much you go down, as how long it takes you to get your share price back matters even more. This REIT fund didn’t wait until 2008 to crash as it began its decent in early 2007, and by the time it bottomed in 2009, it had given up 78%. It took 13 years to gain this back, in mid-February of this year, just to plunge toward the ground again and now sits off that point by 22%.

It’s back to the drawing board to get back to January 2007’s highs and these things take real time at the best of times. These are far from the best of times for REITs as real estate leasing and rentals face a tough road ahead, not only from all the money that they are failing to collect, but from the shrinkage of the market itself from all this economic damage that is still accumulating.

It’s never a good idea to just keep your eyes fixed on dividends to the exclusion of what may be going on with the price of an asset, but trying to do that when your asset is embroiled in such a crisis is particularly foolish. Income investors may not care if the price of their assets rise, but no one can escape caring when these prices go down, as hard as we may wish to.

REITs can rise in price at times though, when they are running on all cylinders, like in 2019 when this fund gained 24% plus dividends. When we add the 3.8% that it earned in dividends that year, we’re now up to almost 28% and pretty close to what the S&P 500 gained that year.

It doesn’t hang with the S&P 500 all that much though, and had averaged 5.85% over the last 5 years prior to 2020, where this year’s performance has cut this 5-year average more than in half, gaining 29% over this time and then abruptly dropping this over 15%.

The Nasdaq 100, viewed from the QQQ ETF that you trade it through, averaged 20% over the last 5 years and have already earned their 20% for this year. We do need to be comparing here, unless you are happy with your paltry dividends and your 14% over 5 years instead of more than doubling your money over this time.

While it’s true that the performance of the Nasdaq beats just about everything out there and humbles many of its competitors, we should never be content to see our investments embarrassed this much. They are paying out 90% of what they make to us, and instead of seeing that as such a benefit, and people definitely do, we need to instead see this as part of the problem, and a good portion of it.

Someone would have to be especially confused to be up for buying it at such a terrible time, and this is nothing like stocks in the travel industry who can look forward to getting close to normal in the near future, the damage that has been done to REITs will take a lot longer to heal.

REITs aren’t particularly good investments to start with, and when we realize that the way back will involve their getting their income back up to where it was before the pandemic, with their revenue dealt a serious blow and the demand for the renting that they do on such a slow path to recovery at best, especially with so many people working from home now, we need to leave this to those who remain confused about income investing, as we’d rather make good money for real than just pretend.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.

Contact Monica: monica@marketreview.com

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