Are REITs a Better Investment Than Bonds at 5% Interest Rates?

During their recent episode of the Acquirers Podcast, Travis and Carlisle discussed Are REITs a Better Investment Than Bonds at 5% Interest Rates? Here’s an excerpt from the episode:

[Tobias] Why buy a REIT with a 5% yield?

[Tim] Well, because when you have a shorter-term treasury, like let’s say the 5-year at 5%, your upside is limited, right? Because it’s not a super long-duration bond. So you don’t have that convexity that you have on the longer-duration-type bonds.

What’s convexity, just for folks who aren’t deep in the market? It’s kind of the impact of interest rates. I’m not a mathematician, but it’s the impact of interest rates.

[Tobias] How much it moves, right?

[Tim] Relative to the movement. Exactly. And so with a lot of the real estate investment trust, for instance, you’re buying them right now at like…

I mean, like Vichy Properties, for instance, has a yield of 7.5%, a starting dividend yield of that. And then the actual cash flow yield is substantially higher than that. It’s around double digits, close to that.

And then you also have CPI escalators on their leases. And this is the case for most REITs, CPI, contractual. So those yields are going to keep going up.

And then you also have more inflation protection, Toby, because real estate tends to go up in value over time. And the cost to build something like the Bellagio now, can you even imagine? I mean, can you imagine what it would cost to build the Bellagio?

The Venetian, Caesar’s Palace right now, relative to when they were built. So there’s a few tailwinds there. It doesn’t mean that you shouldn’t own bonds.

I think that if you’re a buyer of bonds, there’s probably more opportunities now than there has been in quite some time. But that’s kind of why. It’s not an apples to apples comparison.

There’s much more growth potential. Because a lot of that real estate, commercial real estate, or even residential, is more long duration in nature. I mean, they have 30-year leases for Vechey, for instance.

If REITs do move down, I think it’s very likely you see a huge run in some of these names. I mean, I saw that realty incomes trading at a really, really low level, one of the lowest valuations that’s been at a long time, which is probably the biggest name in the real estate space. So I think that you could be like, if you’re buying now, Toby, into the face of a very significant adversity with the headlines that you referenced, you might be setting the stage for a 10, 15-year cycle for some of these REITs, like you saw in the early 2000s, for instance, where, yeah, you’re going to have some volatility, especially when you get the financial crisis, but the returns were quite good.

Value Options Letter combines value investing with conservative Buffett-style options strategies. Follow the strategy from cash-secured puts through assignment and covered calls, with ongoing trade recommendations focused on businesses they believe are worth owning.

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