Real Estate Investment Trusts: An alternative to direct property investment

Over the past few months I have gone through the pros and cons of investing in real estate and how to go about buying your own investment property and then all the things you need to know about to effectively own an investment property.

In this post I will outline an alternative to direct investment property - the Real Estate Investment Trust (commonly referred to as a REIT).    I will not cover every aspect to REITs in this post however I hope o cover some of the salient features with a few to providing more detail in future posts.

What is a REIT?

Broadly speaking, a REIT is a vehicle where several investors pool funds to invest in property.  It is essentially a managed fund which invests exclusively in real estate.

Below are some of the points which commonly define REITs (although they are not necessary for something to be classified as a REIT):

1. There are several investors (large, or listed REITS can have thousands of investors)
2. There is usually more than one property in the REIT
3. They are usually structured around specific types of property (e.g. office, industrial, residential, retail etc)
4. There is a manager who takes a management fee

Beyond these general characteristics, REITs can take on so many different forms that you can basically search for and invest in exactly the type of product you are looking for - there are listed and unlisted REITs, some of which are open ended and some of which are closed.  There are also REITs focused on growth and those focused on income and heaps of other features as well.

If you are thinking about investing in a REIT - make sure you understand exactly what you are investing in because it is not as standardised as many other financial products.

Benefits of investing in a REIT

There are several benefits associated with investing in a REIT (relative to direct property investment).  These include

• The entry costs are much lower
• Investing in direct property costs a lot of money up front.  This includes the amount for a deposit, taxes and a certain amount to cover the interest until the property is rented out
• REITs do not have these costs - you generally invest a minimum amount (which can be as low as $1,000) and you get the same proportionate return as everyone else
• Your risk is spread over several assets
• Single asset investing is inherently risky - all your eggs are essentially tied up in one basket
• Investing in a REIT gives you exposure to the property sector but spreads your risk among several properties - see my post on diversification
• It requires very little effort
• Once you decide to invest, other than keeping track of the performance of the manager and whether they are doing anything particularly dumb - you do not need to do anything

Downsides to investing in a REIT

Investing in a REIT is not the golden solution to property investing (although during times when the property market is on an upswing people assume it is).  There are several risks and downsides to investing in a REIT including

• You have to pay a management fee
• This fee can vary quite a lot but generally you are paying 1% - 2% of the totally amount you have invested each year for the manager to manage the portfolio - this can really add up over the long run
• You have no control over the asset or what assets are invested in
• When you invest in property directly you have a lot of control to make sure that the property is being looked after the way you want and that you get the property you want
• If you let someone else do this you are hoping that they will do it right
• You do not take as great an interest in the fundamentals of the investment as you would if you were managing the asset
• When you have an investment property you know absolutely everything there is to know about that property - the tenants, the upcoming expenditure requirements - everything
• Although you should keep track of your REIT investments the fact is that most people trust the manager to do it right and only look at it once a year (if at all)
• It is quite hard to know if and when things are going wrong until it is too late

Overall

I think that REITs have a place in every investor's portfolio.  They offer access to investments that would be out of the reach for normal investors (e.g. office buildings) and at various points in the cycles can be great value.

I hold both direct property and REITs.  I use REITs to hold those property forms that I am not comfortable investing on my own - that is development properties, commercial properties and retail investments.

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Finding holiday accommodation - advertising websites are not always your best bet

A post today for all those who like to do weekends away (i.e. not major holidays) but always find that accommodation is the hardest thing to organise.  This post was inspired by my own experience trying to find a place to stay for a weekend away.

It is amazing how easy it is to find travel recommendations when you are going to major cities, whether you are looking to do the 5 star route or the back packer option - there are always places with reviews and comments.  It is often much harder to find recommendations for accommodation closer to home - where you live in the city and you are travelling down to a beach or holiday location or perhaps wine country for a relaxing weekend away.

I found that what I ended up doing (and taking a straw poll amongst some of my friends this is what they do too) is that they go to a dedicated vacation website, look at the options and try to get a sense of whether the location and amenities are really what you are looking for.   If you really are in a rush these websites are the best thing going around because it takes very little time to easily see what is available.

However using these websites often means that you miss many better (and cheaper) options

When I was booking a weekend trip away I thought I had looked at almost every single house that was available to rent in the location I was looking at for the dates I was interested in.  However one of my work colleagues sent to a site, that admittedly looked like it had been built using one of those auto-website builders, for a single cottage accommodation that had a better location, better amenities and a lower price than anything I had seen advertised - AND it was available.

I could not understand it until I realised that it actually was not advertised on all of those aggregation websites.  When I called to book, I asked the lady who was renting it why she didn't advertise it on those sites - surely she would get more enquiries that way.  She said that a bit risk with holiday accommodation is that you cannot check things like references and they prefer to get people through word of mouth.

So what is a better option?

I think there are several things you can do before you commit to a place advertised on one of the aggregation type websites (assuming you have time):

1. Ask friends:  Friends and colleagues often have great recommendations of places that you would not be able to find ordinarily.  If you come with a reference people are much more willing to open their property to you
2. Spend some time on Google:  If you are not able to find a friend who has a recommendation - a lot of these places have very basic websites on google and you can find a lot just by looking.  I did this when testing my hypothesis and a LOT of places that are much cheaper and often better suited to couples or small groups are just not advertised on the aggregation websites

Hopefully you come up with some better results that save you some money and get you a better location.  If you do I'd love to hear about it so please comment below.

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Too Big to Fail by Andrew Ross Sorkin

Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System is an in depth look at the credit crunch from the time that Bear Sterns was bought by JP Morgan (it does not cover this in any great detail) to the introduction of the bail outs for the major US Banks.

This book is the most in depth look at the near collapse of the financial system in America (although it briefly touches on the impacts on the international financial system) and is the most in depth look at a financial crises since the 1990's classic Barbarians at the Gate which dealt with the takeover of RJR Nabisco.  It is written in a similar fashion as well - it looks at the crises from each individual bank CEO and senior management as well as regulators and investors. 

What Sorkin has attempted to do in this book, and does so amazingly effectively, is look at the financial crisis from every viewpoint so that we the reader understand what was going through the minds of decision makers when important decisions were being made (whether they were the right or wrong ones at the time).  It was a mammoth task and one that few books previously have emulated.

The necessary trade off for the amount of detail required is that this book takes a seriously long time to read if you are following all the detail.  I like to think that I am a rather quick reader however this book took me a very very long time to finish.  I enjoyed every moment of it. 

The beauty in a book like this is that most of us know the highlights - Lehman's fails, Morgan Stanley and Goldman Sachs become bank holding companies, AIG, Fannie Mae and Freddie Mac are effectively nationalised, the banks are bailed out etc etc.  Therefore we are not reading to see what happens but rather HOW it happens.  In this way the detail is not too much - we are reading for the detail, for the thought processes and for the insights that this book gives us into the way that CEO's, regulators and law makers think.

Because this book is not pushing one point of view or another, but rather going through a series of events, and these are from the view of the professionals involved in it it may seem like it is very much pro business and does not tackle the underlying flaws in the system.  But this book is not meant to preach - it is giving insights into what actually happened - not what should have happened.

Pros

• The level of information that author has been able to get from interviews etc is truly amazing - if you want the detail behind the effort to save Wall Street then this is the book for you
• It is not biased at all - you actually

What is diversification and how does it work?

In a recent post I sad that understanding the concept of risk was fundamental to understanding much of the assumptions that we make about other concepts in finance.  Today I will be discussing diversification - understanding what risk means in a financial theory perspective is important to this so I would read the old post first and come back to this post.

Overview

Intuitively most of us understand diversification - at the simplest of levels it is spreading your bets so that no one adverse event can negatively affect your outcomes.  Intuition, however, only takes us so far.  Using the definition I just gave of diversification it would suggest that this necessarily means that your potential gain from your bet is lower.

However in a financial sense this is not completely true of diversification.  In an investment sense diversification is defined as:

A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.

The above definition is one given on Investopedia, and whilst I have posted before on how you can never completely trust what Investopedia says - in this case they had the most concise, correct definition of diversification that I could find.

What are the key parts in that definition?

1. Diversification will result in a higher yield AND lower risk than any individual investment in the portfolio
2. This is only true if the returns are not perfectly correlated

Why is the definition of risk so important to understanding diversification?

If you read the above definition without truly understanding risk, in a financial sense, diversification sounds like the best thing since sliced bread.  You get higher returns and lower risk - what could anyone else possible ask for?

However if you read my post on risk you will have noticed that the problem with the financial definition of risk is that it defines risk as a deviation from the expected outcome.  This means that an investment is risky even in the unlikely scenario that all the risk is on the upside.  In this case we are not separating positive risk and negative risk.

Once we think about that we see that while diversification reduces risk, it is also reducing the positive risk in a portfolio.  That is, it is reducing the risk that your portfolio will significantly outperform what is expected.

Does this mean that the definition of diversification is wrong or bad?

No - diversification is still an important downside risk management tool.  If you go back to the intuitive definition of diversification which is that of spreading your bets so that any one adverse event doesn't overly impact your outcome then we see that diversification does this however it is not the holy grail that many make it out to be.

The intuitive definition actually falls squarely within the second important component of diversification - around that of non perfect correlation.  Most assets are not perfectly correlated (i.e. move together either upwards and downwards) however many are influenced by the same factors.  For example

• All property valuations in a certain location will be impacted by certain events such as interest rates, availability of debt even though the individual investment propositions may be quite different
• All airline stocks will be impacted by terrorist attacks or diseases or civil unrest overseas even though the

You do not need the stocks to be uncorrelated (i.e. not move with each other at all) or negatively correlated (i.e. one goes up when the other goes down) for your risk to be mitigated.  All that you require is that they do not move together perfectly and you get the 'spreading the bets' benefit I have described above.

Final comments

Many who are reading this who understand finance and diversification more intimately may want to point out that I have missed several points and nuances in this post.  I do not intend this to be a complete dissertation or critique on diversification - I just want those readers who hear the concepts to know what it means and some ways in which it is flawed (and also where they are correct).

If you feel I am fundamentally wrong though in any way (or would like more information) please feel free to comment below

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Things to consider when investing outside your home state

To date my series of posts on investing in real estate have been centred on the assumption that when you buy your first investment property you will be buying close to home.  This is because you tend to know the areas better, know the demographics and have a sense for the rules and regulations. 

When investors start thinking about their next investment property, or one further down the track they often start thinking about investing outside their home state.  There are several reasons that you may want to consider doing this but be aware that it comes with significant draw backs and you cannot assume that because you have an effective, functioning relationship in your current property / properties that this will translate to another state.

Pros of investing outside your home state

There are several pros to investing outside your home state and most of these centre around the benefits that come from having a diversified portfolio.  I have outlined some of the benefits below:

1. If your state is relatively expensive for property at the moment you can sometimes buy in 'slower' states which you think will recover
• Property markets are not homogeneous and while some are growing very fast, others are slowing down or are often in slumps
• If you are looking to buy a property you may not find value in your own state but there may be many great deals in other states
2. It allows you to diversify state specific downturns / high rental vacancies
• If you have multiple investment properties in one state the fact is that all of them will be affected by the same factors at the same time
• Having properties across multiple states allows you to diversify some of this risk away, especially when the other states are driven by different sort of impacts than your own home state

Cons of investing outside your home state

There are some very clear downsides to investing outside your home state and you should think about these very carefully before investing.  Only if you are totally comfortable should you go ahead and take the plunge.  Some of the downsides and risks include:

1. You have to start from scratch and do all your research again
• Although the asset class is the same, fundamental things like rules, regulations, rights and obligations are often very different between states
• Do not go into an investment in another state thinking the same rules apply!
2.  You do not have the insights that you do in your own state
• We all have significant insights into our own state that we don't have in other states
• We know which areas are better and worse and which ones are desired or have the potential to be desired in the future
• Although you can do your research in another state you just do not have that same level of inherent knowledge
3. Searching is a time intensive process - there is a risk that you make a hasty choice because you have limited time when you travel
• As you would know from your

Cinema Membership Cards: they really do make sense

Just a quick Weekend Warrior post from me this Friday about membership cards for cinemas.  This post is mainly aimed at Australian consumers however I have no doubt that such cards and deals exist in other countries as well.

For years teenagers manning the ticket booths and candy store at cinemas had been asking me if I wanted to sign up for either the Village Movie Card or Hoyts Rewards Card.  I always used to think these were at best a pointless addition to the already overflowing number of cards that I had in my wallet.  However I must admit that recently I have really discovered how good value they really are.

Why do I think it is really worth having at least one of these cards?

I will use the Hoyts Rewards Card as an example.  It costs $10 to purchase the card and with this you get one free adult movie ticket.  Given that most adult movies are $17 - $21 depending on the movie and whether it is 3-D this is like buying a discount card which is what convinced me to buy the card in the first place.  So straight away you are getting value.

Then for every dollar you spend either on buying movie tickets or at the candy store on popcorn and drinks you accumulate more points (note that I have not worked out how the points accumulation thing works).  When you have enough points you can redeem it for a free movie.  I admit that I was very sceptical of ever being able to get a free movie out of these cards however it didn't take too long for the pimply teenager behind the counter to let me know that I had a free ticket available on my card.  This is a benefit that you really do receive.

One of the best things though, and one benefit I had no idea about when I signed up for the card, was that they have these 'movie of the week' and pre-screenings available for members only.  The movie of the week takes one movie each week and makes it $10 a ticket for members.  Again given the price of most full price tickets - this is a STEAL.  The pre-screenings are also great because you can see blockbuster movies in advance of the general release date.  This is one of the best (not often advertised) feature of the card.

Do I need to go to the movies often to make these cards worthwhile?

Not really - while I like going to the cinema to what films I am not a huge movie buff.  I may see a movie once every 3 - 4 weeks and I still find that I get great value out of the card.  If you go and see films more often then this can save you some serious money.

How do I get best value out of the cards

I found the best way to get value from the cards is to sign up for the email notifications of when the discount movies are and to book your movies through the online booking system - you can then see what rewards you are eligible for and whether it is worth seeing a different movie that week (as well as not having to wait in the line)

I also recommend having only one membership card and going to one chain of cinemas.  This is not always possible however you really do get the best value if you accumulate points only on one card.  I chose Hoyts because it is the cinema closest to me.

Do you have any other ways you save money when going out to the cinemas?  If so please post below.

Usual disclaimer: I get nothing for promoting these products - I just think they are great value

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What is the difference between bottom-up and top-down investing?

There are so many investment strategies out there that sometimes it is hard to know exactly what all of them mean, whether they can be applied in your actual personal investment portfolio or whether they should be left to the professionals.  In this post I will be covering the difference between bottom-up and top-down investing.

Defining bottom up and top down investing

The difference between these two types of investing unsurprisingly relates to what point in the investment universe you start looking.  Do you start at the bottom looking at individual stocks or so you start at the top thinking about industries and macro considerations?

Bottom up investing starts wit the hunt for cheap companies and then overlays other considerations such as the macro environment on top later.  The most important consideration to these investors is the company and stock that they are investing in which then gets context applied to it.  Most traditional value investors fall within this category.

Conversely for top down investors the context is the most important part of the equation.  They try and spot or think of the big macro trends and structural factors which will affect valuations.  Once they have researched this theory they then search for the best companies conforming to that theory.  A lot of macro and hedge fund investors use this approach - for example think about those funds that bet against housing during the GFC . they were thinking about industry considerations not about individual stocks

Why does it make a difference?

It makes a difference because it fundamentally affects how you are thinking about your investment proposition and the framing of the investment question.  The fact is that each person is different and the way they tackle this question will be highly dependent on their individual investment experiences as well as the way they think about the world.

Both approaches have their upsides and downsides (and their limitations):

• With top down investing you are constantly going through a 'narrowing' process
• You find a 'big picture' that you want to trade on and you keep narrowing down the options until you get to a stock and company that you like
• This has the benefit of understanding structural reasons before you get enamoured with any stock in particular
• The disadvantage however is that you potentially miss good deals in sectors which are not doing a lot but where a stock may be very mis-priced
• With bottom up investing the approach is much less limiting
• Although most people specialise in some sectors or understand some sectors better than others the fact is that bottom up investing is a lot less limiting - you are free to look for good deals everywhere
• The disadvantage though is that you can miss potentially important structural factors which can affect the value of the stock you are investing in regardless of how good the value appears to be

Are they mutually exclusive?

While all professional money managers have a view and a style which takes primacy in their investment approach, I think that all apply both techniques in some form.  A bottom up value investor will always look at the macro considerations to see whether there is a structural reason that the stock they are looking at is so cheap while a top down macro investor will always start with their hypothesis and then look for the stock with the best value proposition which conforms to the macro idea.

These two investment approaches are not mutually exclusive however one will normally come first in an investors thinking and it really has to do with the investment approach that each individual takes.

What should you do?

So now that you know what the difference is - do I think one way is netter than another?  In all honesty I think that while it is important for professional money managers to define their thinking around these ideas, I think that the average person investing on their own behalf has only limited time each day to think of investment ideas.  

If you have an idea which gets you going you should pursue it regardless of whether you see yourself as a 'bottom up' or 'top down' investor - the fact is that your investment mentality will probably drive you to one point or the other.  The research process that you go through should automatically incorporate both concepts as I explained above.

Be aware that almost every investment book you read will push one method over the other and make it sound like the only 'correct' idea.  the reality is much more subtle than this and keeping this in mind will allow you to think about what you are reading much more critically.

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