What’s Behind Small Cap, Externally Advised REITs?

chart01.pngAmong the much-hyped apartments REITS, externally advised small caps have caught the attention of investors, thanks to their high yield and greater upside. For example, NexPoint Residential (NXRT) spiked by 29% last month, reaching a 51% year to date return. Independence Realty Trust (IRT), Bluerock Residential Growth REIT (BRG), and Preferred Apartment Communities (APTS) are averaging a 11% year to date return. However, if you are investing in these companies, you should be prepared for some distortions.

First, there is a reason that small caps are high risk, high return. The management is essentially fighting for survival or their place in the sun. Trading volume is thinner so stocks may not fluctuate in the smoothest manner. Moreover, they are often much less followed by the Street, meaning discussions over management moves and strategic planning tends to be little and less scrutinized by the market. Finally, they have fewer borrowing options and worse terms. Some strive for aggressive growth is an effort to be on better footing with bigger peers.

Second, externally managed REITs present a conflict of interest. Bluerock Residential went further and disclosed a long list of common situations where shareholders’ interest could be hurt when the REIT makes decisions. As a way to mitigate the conflicts, some external managers own a portion of the REIT. In Bluerock’s case, they own approximately 12% of the class A common stocks.

The following was extracted from their Risk Factors section in their last 10-k.

  • The external manager is under no obligation to dedicate specific personnel to the REIT. This means the REIT might not receive the same level of support it would if it were internally managed.
  • Some of the REIT’s officers work for the manager. This means that agreements between the REIT and the manager (for example, their management agreement) might not be favorable to the REIT and the REIT may choose not to enforce their rights.
  • As the result of conflicts of interests with their managers, the REIT could end up making decisions that are not in the best interest of their stockholders.
  • The incentive fee the REIT pays their manager may cause it to make riskier investments.
  • If they purchase properties from their manager, the price may be higher than it would have been had it been negotiated at arm’s length.
  • Regardless of the portfolio’s performance, the manager will receive a base management fee.

In a recent article, Hoya Real Estate questions the legality of Bluerock’s arrangements with external management and its private funds. Sounds like that this disclosure works as a blank check for the manager to do whatever they want without the fear of legal repercussions (click here). Nevertheless, other REITs also disclose potential conflicts of interest and whether they are disclosed or not, they are observable in all externally managed REITs. Bluerock simply had the courage to be thorough.

In conclusion, small caps were already high risk investments. The introduction of external management simply adds a new twist.

Source: Bluerock Residential Growth RE(AMEX:BRG), Preferred Apartment Communitie(NYSE:APTS),Independence Realty Trust, Inc(AMEX:IRT),NexPoint Residential Trust, In(NYSE:NXRT)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

Investing In Residential Real Estate Properties vs. REITs (Part 2/2)

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Click here if you haven’t read Part 1

Purchasing REIT stocks is a much less hands-on approach to real estate investment. Once the investor has decided which REIT stocks to buy, all that is required is to track the stock value, get paid regular dividends and decide when to sell. There is no financial responsibility once the initial purchase has been completed, unless the investor decides to buy additional shares. Liquidation is easy: You just pick up the phone or enter the necessary information on your PC, tablet or smartphone.

Among residential REITs, our due diligence has spotted certain highly-ranked stocks with regard to dividend-generation potential. Essex Property Trust (NYSE:ESS), which invests in apartment communities on the West Coast, has greatly exceeded our expectations. It has no sole leading indicator that outperforms its peers; however, all distributing-boost components stand out as above average. The downside is its heavy price-to-FFO — around 24× vs. the sector median of 19×.

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Note: As of 23 October of 2015

Mid-America Apartments (NYSE:MAA), currently trading at 16×, is a cheaper choice, with a dividend-generation potential somewhat above the sector median — not little for one of the best-performing REIT space sectors at the moment. Additionally, dividend yield is at par with peers’, unlike Essex’s, which has the lowest. Also unlike Essex, Mid-America invests in Southeastern and Southwestern markets — about ⅔ in large markets, the rest in secondary ones.

Mid-America released strong Q3 results on October 28. The highlight has been its 2015 FFO guidance, which, compared with 2014 FFO, increased from 7 to 9 percent.

NexPoint Residential Trust (NYSE:NXRT) and Post Properties (NYSE:PPS) are also highly-ranked and will be subject to analysis in coming posts.

Source: Fast Graphs, Essex Property Trust, Mid-America Apartments

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

Investing In Residential Real Estate Properties vs. REITs (Part 1/2)

real-estate-475875_1920Many people earn great returns on their investments by putting their money into residential real estate purchases. These types of properties include singe family homes, multi-family homes, individual condominiums, and townhouses. Although some investors purchase and then quickly sell the residential properties for profit, otherwise known as flipping, for the purpose of this article we will concentrate on holding the assets for long-term rental purposes.

We will also compare purchasing individual residential properties to investing in Real Estate Investment Trusts or REITs. Both options provide investors with an excellent opportunity to earn great returns on their money. However, they are quite the opposite of each other regarding the overall investment strategy.

Residential Real Estate Properties

Purchasing individual residential properties may very well be the best option for investors that are hands-on and enjoy having far greater control over the situation. That being said, investors certainly need to be aware of the various aspects involved before considering this type of commitment. It can take a considerable amount of effort and time in order to locate the correct single-family property.

If purchasing more than one property, investors need to multiply that effort and time by a significant amount. Some might not agree, but a good rule of thumb to go by is that two properties require three times the amount of work. Another hugely important factor is financing. Most people are not able to pay for the purchases in cash, and rely on obtaining mortgages. Regarding mortgages, some aspects to keep in mind are the down payments, monthly principal and interest payments.

Other factors to consider are the property taxes and insurance, maintenance fees, and management. If an investor decides to manage the property, s/he needs to be prepared to answer phone calls in the middle of the night from unhappy tenants. On the other hand, hiring property managers will add on yet another expense. The expenses need to be paid even if the properties are empty or the tenants are not paying their rent. Residential properties are often hard to sell, so it may take time to liquidate the assets. Investors are able to borrow against the asset, and build equity over time.

To be continued…