August 3, 2021

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The Great 2021 Real Estate Reset and the Only Properties I’m Buying

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Not all property types are created equal in the great 2021 real estate reset

Hey Bow Tie Nation, Joseph Hogue here with the Let’s Talk Money channel and an update to one of my favorite investments, real estate and REIT stocks.

Nation, nobody could have seen 2020 coming but the mark of a great investor is being able to read the signs, being receptive to the clues in the market, and using that to be ahead of the next trend.

And while real estate largely seems to have escaped the pain we see in other sectors of the market, there are some early warning signs that a large-scale real estate reset is just getting started.

In this video, we’ll look at how the different property types have done this year and the trends pointing to how you should be investing in real estate for 2021. We’ll look at investing in real estate investment trusts, those REITs that trade like stocks, as well as the private market and real estate crowdfunding where frankly, I think you can get better deals and higher returns.

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How 2020 Broke Real Estate Investors

One of the biggest themes we’ve been talking about this year is the splitting of the real estate market; with some property types doing really well and others…not so much. This table by the national association of REITs does a great job of showing why you can’t just think of the real estate market as one investment, you really need to be thinking of which property types can do well.

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Real Estate Investing for 2021

I’ve highlighted the year-to-date returns in red and you see overall, the market for real estate has been hit hard with the equity REIT stocks in the NAREIT index, so those companies that own real estate, these have fallen by 17.5% through the third quarter.

But it’s a completely different picture looking at it by property type. Three of the types here; lodging, retail and offices space account for the majority of losses with stocks in the segments falling between thirty- and fifty-percent.

Of course, it’s not hard to see why. Business travel has all but died out and there are no more in-person conferences to fill the hotels. The massive shift to online shopping has meant empty malls and work-from-home means less office space is needed.

Look at a few of these other segments though and you realize there’s still money to be made here. You’ve got the self storage market eking out a 5.8% return. Industrial property is beating the overall stock market with a 9% return and data centers are booming for a 25% return on the year!

With these as well, it’s an intuitive story. Industrial property includes all the warehouses and logistics centers being used in the shift to ecommerce. Infrastructure REITs are those building out the cell towers for 5G and that’s not slowing down for a second. The data centers…all that internet traffic means more servers and more data centers.

Where will Real Estate Go in 2021?

But now, what are the trends heading into 2021 for real estate? Are the underperformers of this year dead money or is there a chance for a rebound?

So I want to look at three major trends, what it could mean for real estate investors and how to position ahead of the market. We’ll look at the trend to work-from-home and the shift to ex-urban office space. I’ll explain how the mortgage and foreclosure moratorium might mean selling isn’t over in the residential market, and then some disturbing clues to why you might not want to jump in for a rebound in retail.

REITs in the office space have fallen 30% this year as the shift to remote work boomed in the lockdown. Telecommuting was already on a multi-decade uptrend hitting 50% to begin the year from less than 10% in 1995 but it’s absolutely exploded this year with as much as 63% of the workforce reporting working from home during the quarantine.

That number has come down since April and as someone that has worked from home for seven years now, I can tell you that we will always need some office space. Even without coworkers or a boss, I rent a space at a local coworking site and some business, you just can’t get done when you’re totally remote.

Eliot Bencuya, co-founder of investing platform Streitwise, told Forbes in August, “There are disadvantages to a fully remote lifestyle. Teams and conversations are siloed to those invited to a call and knowledge transfer is limited. Personal relationships don’t happen and often advancement opportunities get missed.”

Bencuya sees the solution as a hybrid where some work remotely for parts of the week and in an office for one or two days. Workers will need to be close to the office for last-minute meetings and total leased space will be smaller because not everyone will need to be in the office at the same time.

That means office space is going to be needed where the workers live, outside the expensive urban centers and out into the suburban areas. We’re already seeing a boom in sublease inventory in the city centers as tenants try to fill their previously used space instead of breaking lease. Office space for sublease has jumped 20% in Los Angeles and as much as a quarter of Manhattan’s available space is sublease.

Check out the Streitwise Fund of high-quality office properties and a 10% dividend yield!

So as that shift in demand happens from the city centers into the suburbs, you’ll start seeing a split even within the office market. Vacancies could rise and rents fall in the urban centers as the secondary markets see better fundamentals.

Now since most office-focused REITs are concentrated in the urban markets or spread out across both, I’m mostly investing in the private market and crowdfunding REITs for office space. With projects like on Streitwise, you can follow a portfolio closer and make sure their investing strategy aligns with your outlook. For example, the Streitwise properties are located in the secondary non-gateway markets, just outside St Louis and Indianapolis, and have been able to keep high-quality tenants.

This next property type, residential, is really interesting because while home prices are up double-digits since last year REITs owning residential property are down 20% and this might actually be the next big shoe to drop.

The reason the REITs like Equity Residential and Camden Property are down so much is because of those rent moratorium programs, allowing some tenants to forego rent payments for as much as six months now.

And while the moratorium on evictions and foreclosures has been necessary during the lockdowns, the bill always comes due.

Granted, some kind of nationwide rent assistance might lessen it but according to the Eviction Defense Project, up to 20% of the nation’s 110 million renters are at risk of eviction and this isn’t even counting the millions of homeowners that have fallen behind under mortgage forebearance.

We can only kick the can so far down the road. Within the first months of 2021, we could see a wave of evictions and foreclosures as people decide it’s just not worth it to pay six months’ of back rent or payments.

Now housing prices have been really strong this year, with most markets up double-digits from 2019, but a lot of that is on historically low supply of homes for sale. Homeowners just aren’t putting their homes up for sale, which means higher demand and higher prices.

But you get those evictions and foreclosures hitting the market and you’ll start to see prices come down. Then, homeowners that have thought about moving are going to rush to list their homes before prices fall any further and you get a one-two punch that could cause the housing market to crash.

How to Invest in REITs 2021

I would avoid the residential REITs in favor of healthcare and industrial but if you’re going to be investing here, focus on those with most of their portfolio in the suburban markets outside the city centers.

Retail space, especially those shopping mall REITs like Simon Property and Macerich, have been hit hardest, down a whopping 39% this year.

And while we could see some recovery on a vaccine, I think the long-term here is still going to be very difficult for this market and doubly so for the malls.

The Federal Reserve shows ecommerce as a percentage of total retail sales and we see that long, steady climb over the past two decades. But look at the huge jump this year, from about 12.5% to 15% of total retail purchases.

And a bump of 2.5% might not seem like much but look at the profitability measures for retailer Kohls, ticker KSS, here. The operating margin, that’s the percentage of sales left over after paying suppliers and all operating costs, that’s just 1.4% profit and doesn’t include paying interest on debt or taxes.

The entire retail space is like this with razor-thin margins and no room to lose another 2.5% of purchases to online shopping.

This shift is only going to get worse now that millions have been forced to go online for groceries and shopping, seeing how easy it is.

Now, that’s the downside in retail but its even worse in the malls where owners have taken on tens of billions in debt to survive and are now converting a lot of their space into much less profitable industrial centers like Amazon fulfillment. In this market, you want to be in high quality properties, maybe like a Macerich instead of SPG. I still think you can own some shares of Realty Income since a lot of its property is in the convenience and consumer staple retail side of the market. But you need to be very cautious here long-term on retail real estate and REITs.

Next year could be a rude awakening for real estate investors, especially in specific property types. If you’re investing in real estate in 2021, you absolutely must know what’s coming for each property type and invest accordingly.

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