Every REIT manager faces the same question: grow the portfolio or optimize what you own? From 1995 to 2020, the average REIT's footprint expanded 5% annually—new acquisitions, new developments, new markets. Conventional wisdom suggests that scale creates value. But a recent study of U.S. equity REITs over that 25-year period found something unexpected: fast-growing REITs delivered no better stock performance than their slower-growing peers. Growth, it turns out, isn't accretive: REITs are “unable to create excess value by way of property acquisitions or expansion alone.”¹

Behind this finding is an oddity of the REIT universe: REITs are required to distribute to shareholders the vast majority of their income. Those distributions flow out as dividends every quarter, and that cash flow stream reflects the rents being earned at the underlying assets. In addition, investors expect their REIT stocks to drift higher over time as the underlying real estate appreciates. In fact, REITs were specifically designed to allow average investors to own securities that mimicked the income and appreciation return profiles of real estate since real estate would otherwise be too capital-intensive for these investors to own.

Every REIT provides some version of the value proposition mentioned above: consistent income in the form of dividends and the potential for the stock to rise. But every REIT takes a different approach to its real estate investment strategy and each one’s portfolio investment decisions impact the overall returns they provide. Surprisingly little research exists to explain how to identify REITs that are going to outperform, which is why this study about “empire-builders” that grow quickly is significant.

Why don’t fast growing REITs perform better? The answer ties back to the rules about REIT distributions. Most companies use a portion of their revenues to fund R&D, new product launches, M&A, stock buybacks and other forms of reinvestment in the firm. All of that organic reinvestment compounds over time. This is unavailable to REITs. Since they must distribute the vast majority of their income as dividends; any growth in the portfolio needs to be funded with freshly raised capital, either debt or equity.

The simple math is that if a REIT wants to buy a new asset for $100, it needs to borrow or raise $100, and at the firm level the result will be an increase in overall NOI but little change in NOI or FFO per share. Because all REITs need to access the same capital markets to grow, there’s a “homogenous environment” in which REIT managers raise money and then commit to investments. The cost of capital for REITs is similar at any given time.

And when a REIT buys or develops an asset, it’s easy to evaluate those returns. Any new property acquisition or development creates “direct, nearly immediate, and observable changes” in the portfolio. That’s in sharp contrast to R&D investments at traditional companies, the value of which may take years or decades to evolve.

Given this transparency and need to constantly access capital markets, you would think REITs would be very careful to only “invest in properties that generate positive net present value” at the firm level, and you’d expect the best managers to consistently outperform by being more selective.

But speed undermines discipline. Critically, fast-growing REITs’ NOI and FFO “increase at a slower rate compared with the rate of property growth.” Since expectations of NOI and FFO growth on a per-share basis are the fundamental driver of REIT stock performance, investors in slow-growth, especially careful REITs are rewarded with better outcomes.

The study suggested that fast-growing REITs, despite trading at higher valuations, apparently are unable to increase their operational efficiencies. In other words, efficient scaling is very hard to achieve and “simply growing the asset base is not value enhancing.”

The research reveals that what happens inside the portfolio matters most for investors. It is not how much you grow but how well you operate. Decisions about which locations to invest in, how well properties are operated, and how successfully tenants are attracted and retained ultimately drive stock performance. This affirms the primary importance of smart teams and good processes that drive value in the operations of the firm. The REITs that understand this—and focus on disciplined capital allocation and careful stewardship of their existing assets—are the ones most likely to deliver durable returns.

And the constraint is structural: because REITs must externally fund growth in a transparent, competitive market, they can't manufacture alpha through acquisition volume. The edge comes from doing more with what you already own.

Who: Kindred

What: A low-cost, home-swapping alternative to Airbnb: all members must host their own home to travel.

The Sparkle: “Everyone is verified” and “Everyone hosts” are the Kindred cornerstones. You earn “credits” when you host others and you spend them when you want to go somewhere. But you can’t buy credits, which feels un-American, but we like it. Kindred makes its money on the service fees it charges per trip, $20 to $45 per night. Apparently those fees are getting real, as Kindred just raised $125 million from a host of VCs and tech luminaries.

Are you a little weirded out when you see that a sports betting app in the “official betting app” of the NBA, the NFL, etc.? We remember when sports betting was banned everywhere but Vegas. After a supreme court ruling in 2018, states were newly allowed to legalize sports betting, and now 39 states have. They seemed to have gotten through the “weirded out” phase because sports betting brings in nearly $3 billion of state tax revenue a year. And have a look at what New York makes…

Link: https://usafacts.org/articles/how-much-revenue-does-sports-betting-generate/

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