You may have heard that more millionaires have been made through real estate than in any other way. While there are certainly some caveats to that statement -- particularly that many "real estate millionaires" are millionaires through their own home equity -- there is a lot of truth behind it as well.
Specifically, real estate can be an excellent total return investment over the long run. A combination of rental income, price appreciation, and responsible leverage can produce some big returns over time.
Real estate investment trusts (REITs) can allow individual investors to take advantage of the wealth-creating power of commercial real estate without directly owning or managing any properties. Thanks to recent interest rate increases, many REITs are trading at extremely attractive valuations. Here are two in particular that could be great long-term investments to make right now -- both of which I own in my personal stock portfolio.
Today's college students expect more than the dorms have to offer
Student housing has changed considerably in recent years, and American Campus Communities (ACC) can be a smart way to invest in it.
The company owns and operates multifamily housing properties that are "purpose-built" for college students. In addition to being more modern than traditional student housing, these properties feature student-focused amenities, more privacy than other student housing options, and other advantages that attract college students, and at a surprisingly comparable price point to the existing inferior student housing options.
As a result, American Campus Communities has done quite well over the years. In 13 years as a public company, the property portfolio has been 97.6% occupied each fall, on average, and net operating income has grown by an impressive 23% annualized rate thanks to a combination of same-store rent growth, acquisitions, and development of new properties.
On-campus residence halls (most of which are more than 50 years old) and off-campus housing options not designed for student living, such as rental homes and apartment complexes, make up 77% of the student housing market. Furthermore, the current trend favors properties within walking distance to campus, which only make up about 11% of the current student housing in the company's markets, so it's fair to say that there could still be lots of room to grow in the years ahead.
American Campus Communities trades for just 15.5 times next year's funds from operations (FFO). Not only does the stock have a 4.8% dividend yield, but its 52% FFO payout ratio is far below the industry's average, so there could be lots of room for future increases.
A "forever" business with temporary headwinds
Another top REIT is Public Storage (PSA -1.82%), by far the largest player in the self-storage industry. As of the end of 2017, Public Storage operated more than 2,700 properties, 88% of which were U.S. self-storage facilities. The company also has 222 self-storage properties in Europe, operated under the Shurgard brand name, as well as 98 business parks in the U.S.
Despite having the largest market share in the industry, there is still lots of room for Public Storage to grow, both by acquisitions and by development. The company is in 38 states, but the majority of its income is generated in just 10. And the self-storage industry is highly fragmented, with lots of room for consolidation.
One of the reasons I'm most excited about Public Storage now is that after decades of primarily growing through acquisitions, the company is starting to ramp up its ground-up development program. Without getting too deep into the math, development (when done well) can be a big driver of value creation. In fact, Public Storage estimates that every $1.00 it invests in new properties is worth about $1.80 in property value.
In addition to the rising interest rates that have affected the entire REIT sector, Public Storage has encountered some other headwinds that have held its stock price down. Specifically, some of the company's major markets have performed poorly recently, such as Houston, where the slowdown in the oil and gas industry has hurt Public Storage's business. Additionally, there are oversupply worries in certain markets, as the strong industry performance in the current decade has led to a boom in self-storage construction (including by Public Storage itself).
However, these are temporary issues, and as the market leader, Public Storage has advantages of scale and financial flexibility over its peers. Self-storage is a business that will always be needed, and Public Storage remains a great way to invest in it over the long run.
Thanks to the headwinds I mentioned, the stock is down by 25% since its 2016 peak. Now could be a smart time to add it to your portfolio and enjoy the 4% dividend yield, which is well-covered by the company's cash flow.
Can REITs like these really make you rich?
The short answer is "yes." While past performance isn't a guarantee of an investment's future results, a look at the track records of some of the leading REITs can help illustrate the long-term potential of compounded real estate returns. Just to name a few examples:
- A $10,000 investment in leading net-lease retail REIT Realty Income's 1994 NYSE listing would be worth about $295,000 today.
- Over the past 40 years, leading healthcare REIT Welltower would have turned an investment of $10,000 into well over $1 million.
- Finally, Public Storage, which I discussed here, has averaged 15.4% annualized total returns over the past 30 years. This would have grown a $10,000 investment to more than $760,000.
The bottom line is that while commercial real estate may seem like a boring investment, especially compared with some of today's popular tech stocks, the long-term potential is certainly not boring at all.