J U N E 2 0 2 0 IS COVID-19 A BLACK SWAN EVENT? Like a lot of you, it’s been 11 weeks since my shelter-in-home confinement started due to the coronavirus. Of course, a lot of my time has been occupied with researching and analyzing REITs. I have also been working on the second edition of The Intelligent REIT Investor . There have been a lot of changes since I co-wrote the first book in 2016. The new copy will include a significant chapter that will share the name of the book EDITOR, BRAD THOMAS I’m reading now, The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb. His book analyzes “black swans”—extremely IN THIS ISSUE: unpredictable events that have massive impacts on human society. An example COMMENTARY .1 of a past black swan event is 9/11. PLAYING OFFENSE & DEFENSE . 3 Are we facing a black swan event now? Taleb, who wrote in his 2007 book COVID-19 IMPACT ON OFFICE REITS .9 10 HIGH-YIELDING REIT BUYS .12 that he sees the risk of an acute virus spreading throughout the planet, does not DIY PORTFOLIO GUIDE .13 consider the Covid-19 pandemic a black swan event because what is taking place HOTEL FOCUS: APPLE HOSPITALITY .16 NET LEASE REITS FOR THE LONG RUN .19 now was not a completely unforeseen occurrence. According to Taleb, a “white 3 PREFERRED PICKS .21 swan” event like the coronavirus was preventable. SMALL POWERFUL REIT .23 He told Bloomberg, “We issued our warning that, effectively, you should kill HOUSING RECOVERY ETFS .26 DURABLE INCOME PORTFOLIO .30 it in the egg” but that governments didn’t “want to spend pennies in January. SMALL-CAP PORTFOLIO .32 Now they are going to spend trillions.” CASH IS KING PORTFOLIO .34 DIY PORTFOLIO .36 Personally, I’m anxious to finish reading his book. The way I see it, Taleb’s PORTFOLIO COMPARISON .37 background as an options trader and his work in probability theory should INDEXES .38 FREI REIT SECTORS .39 inspire me to become a more thoughtful investor. Obviously, reading his book BUY LISTS .41 doesn’t mean I’ll be able to see what will happen in the future. And neither can PREFERRED STOCK & BOND TRACKER . 43 Taleb. That’s the whole thesis to his work: black swans, unlike white swans, are GLOSSARY .46 FREI TERMS .48 always unpredictable. They’re the “unknown unknowns” for which even our most comprehensive models can’t account. WWW.FORBESNEWSLETTERS.COM But we can try to prepare for the unknown as best as The most important we can. One way to do this is by simply committing to smart, quality investment strategies. So, in this issue I focus lesson here is to be on risk mitigation, recognizing that risk avoidance is the most essential part of the investing process. As the legendary prepared for adversity by investor Howard Marks framed it, “Outstanding investors, in my opinion, are distinguished at least as much for their investing in high-quality ability to control risk as they are for generating return.” Given the current state where many are working stocks and practice from home, avoiding social interaction and becoming financially stressed, it seems safe to say that risk is certainly sound diversification elevated. But as Marks also says, “Risk is inescapable.” As investors, our job is to seek out the best alternatives in order to “intelligently bear risk for profit.” Personally, I’m not going to quibble over whether REITs, in which we point out the risks and returns Covid-19 was predictable or not. The most important associated with this sector. Dividend yields on many lesson here is to be prepared for adversity by investing stocks have risen; we look at 10 from our Buy List (see in high-quality stocks—or what I call SWANs—and page 12) and we take a close look at the once-monthly practice sound diversification. dividend payer Apple Hospitality REIT (APLE) Portfolio returns have definitely been beaten down I should also mention that, on page 19, we provide a since early March. There’s no avoiding that fact. But we’ve net lease REIT update. Incidentally, we’ve recently taken advantage of market pullbacks by purchasing new deployed capital into names like Realty Income (O) and shares in some of the highest-quality stocks. Four Corners Property Trust (FCPT). We’re also Once again, quality is the key here; it’s the reason our introducing a new REIT to our coverage spectrum. It’s a risk-mitigation strategies have been so successful. To nano-cap by the name of Power REIT (PW). quote Marks one more time, “A skilled and sophisticated Finally, we close out the June edition with a investor can look at a portfolio in good times and decide commercial mortgage and ETF update, as well as three whether it’s low risk or high risk.” preferred stock picks. With that in mind, this month’s newsletter features All that should keep you busy thinking and acting smart an article on winning with offense and defense (see page during these unusual times. And, in honor of the summers 3), which is a risk-management piece focused on stress “official” opening, I want to wish all of you a prosperous testing. On page 9 you’ll find Covid-19 Impact On Office summer. Stay safe out there, and happy SWAN investing. 2| FORBES REAL ESTATE INVESTOR | JUNE 2020 OFFENSE WINS BALL GAMES, DEFENSE WINS CHAMPIONSHIPS The Covid-19 pandemic, also dubbed the “Great we’re expected to see the strongest economic growth in Lockdown” and the “Coronavirus Recession,” is history, at more than 20%. unprecedented. Never in history have countries However, in this article, I want to point out how representing more than 60% of the global population this unique white swan event has largely upended one essentially shut down, virtually overnight. of the most basic assumptions REIT investors have, The Congressional Budget Office estimates that especially about such treasured safe income names as second-quarter economic growth will be -40%. The Realty Income (O), Federal Realty Trust (FRT) and New York Fed and the St. Louis Fed estimates are more triple net lease REITs in general. dire, at -47% and -50%, respectively. But next quarter 3| FORBES REAL ESTATE INVESTOR | JUNE 2020 GREAT LOCK DOWN: WHEN DEFENSIVE NAMES Realty Income and Federal Realty, tend to have less BECAME SPECULATIVE AND SOME ECONOMICALLY recession sensitivity because most of their tenants are SENSITIVE NAMES BECAME DEFENSIVE either recession-resistant or much of their rent comes More than 180 companies have announced dividend from grocery-anchored shopping centers (and 11% cuts or suspensions so far, and plenty of economically from apartments). sensitive REITs are among them. In contrast, industrial REITs tend to have It’s no surprise that hotel REIT dividends haven’t economically sensitive cash flow (another REIT industry survived the recession. Even in typical recessions hotel with 75% or less AFFO payout ratio safety guidelines). REITs lack the long-term leases and stable cash flow of However, the lockdowns have turned these normal other equity REIT industries. That’s why I consider a defensive/cyclical relationships on their head. In April, safe AFFO (adjusted funds from operations) payout industrial REITs, many of which are leased to the likes ratio for hotel REITs 75% or less, rather than the 90% of FedEx or Amazon as online fulfillment centers, that’s safe for most REITs. You need a safety buffer collected virtually all their rent. People cooped up at when recession strikes and hotel occupancy falls. home are ordering record amounts of online goods and Similarly, low-quality mall and shopping center industrial REITs are thriving like never before. REITs with high leverage, like Whitestone Realty In contrast, the April Nareit rent survey found that (WSR), Macerich (MAC) and Washington Prime half of triple net lease rents (industry-wide) were not Group (WPG), have cut or suspended dividends, which collected. Over half of shopping center REIT rents were is something we warned income investors was likely to similarly deferred or under negotiations. This sent happen, even before the lockdowns. so-called “bond alternatives” like Realty Income But here’s what’s surprising: In a typical recession crashing from their overvalued bubble levels (a 39% triple net lease REITs and shopping centers, such as decline from October 2019 highs to March lows). 4| FORBES REAL ESTATE INVESTOR | JUNE 2020 We have always warned income investors that no I then stacked that cash flow hit on top of the dividend stock, not even highly defensive triple net already 5% or so reduced AFFO estimates analysts have lease REITs, with cash flows backed up by 15-year provided for most retail/triple net lease REITs in recent leases (when new) from thousands of properties, are months. I then looked at this conservative stress tested bond alternatives. This recession is teaching that AFFO payout ratio for all higher risk (pandemic timeless lesson to plenty of investors the hard way. exposure) REITs as well as applied the cash flow decline But there is an even more important risk to leverage and interest coverage ratios. management lesson we can learn from a recession Realty Income and Federal Realty had stress test AFFO unlike any before. payout ratios of 94% and 104%, respectively, thus earning temporary safety downgrades to 4/5 above-average safety. However, ultimately my stress test conclusions were SWAN STOCKS: HOW YOU AVOID LOSSES WHEN in-line with Brad’s triple net lease safety review, which THINGS GO WRONG (AND THINGS WILL ALWAYS showed Realty Income and National Retail Properties EVENTUALLY GO WRONG) (NNN) as the safest dividends in the industry, and I recently stressed tested all retail REITS, medical REITs unlikely to be cut.