1 High Yielder the Pros Love

No one knows real estate investment trusts better than Ralph Block. He's been investing in this underfollowed asset class for 40 years and is the author of the definitive book on the subject, Investing in REITs, which just came out in its fourth edition. I asked Ralph to join us for a discussion of his latest thinking on the industry and some ideas he's hot on. Read Part 1 of the interview here!

Joe Magyer: You've mentioned before that you're a fan of Retail Opportunity Investments (NAS: ROIC) , which also happens to be a recommendation at Inside Value. Care to wash me in confirmation bias?

Ralph Block: Consider yourself washed! I still really like ROIC, and it continues to fly below the radar screens of many institutional investors. The key thing to understand about ROIC is that the management team is led by Stuart Tanz, who had a very successful track record as CEO of Pan Pacific Properties before it was sold to Kimco Realty (NYS: KIM) near the top of the market a number of years ago. And, although the bargains that investors hoped that ROIC would snap up in the aftermath of the Great Recession haven't been spectacular (due to the flood of capital that began to flow into commercial real estate in 2009), the current environment plays to Tanz's strengths. ROIC is buying assets in good, stable markets, sometimes by purchasing the underlying debt, and refurbishing these properties (and sometimes redeveloping them). And they rarely buy these properties via auction at market prices; instead they take advantage of long-standing relationships in the property markets.

Magyer: Another company you steered investors toward earlier this year, Nationwide Health Properties, was promptly scooped up two weeks later by Ventas (NYS: VTR) . Any other ideas on REITs that might get bought out in the next two weeks?

Block: That was a stroke of luck, wasn't it? Merger and acquisitions activity is problematical in REIT-dom. The stocks tend to move together, so when a potential acquiree's stock is cheap, the potential acquirer's cost of capital is usually high -- and most REITs today are loath to finance acquisitions with debt. Also, there aren't many synergies that can be obtained via acquisitions, as few REITs have bloated overhead, and the acquirer won't save much more than the prospective acquiree on property operations and maintenance.

Magyer: Kidding aside, what are the traits in a REIT that might make it a logical takeout candidate?

Block: Don't get me wrong -- there will always be acquisition and merger activity in our world. We've recently seen the merger of AMB Property and Prologis (NYS: PLD) , as well as the Nationwide Property-Ventas deal you noted. I believe acquisitions will happen when a REIT is trading well below net asset value -- perhaps due to management miscues or a broken balance sheet -- but the assets are solid. Sometimes we also see M&A activity when a REIT has a platform or specific expertise that is desirable to an acquirer, as when Prologis bought Catellus Development, a very good development-oriented REIT, in 2005. Also, a REIT may be an acquisition candidate when it owns a concentration of properties in focused markets that another REIT desires; Equity Office Properties bought Spieker Properties several years ago for this reason. Also, when external growth opportunities are abundant (as happens at times in some sectors), and becoming larger can reduce a REIT's cost of capital, we may see acquisitions of even large REITs; I believe Ventas bought Nationwide Health primarily for this reason (as well as to take advantage of many tenant relationships that Nationwide enjoyed).

Magyer: Thanks again for joining us, Ralph. Any parting shots?

Block: I would just like to remind everyone that today's REIT world is larger and REITs are more solid than at any time in the past, but their stocks have become a lot more volatile. This may be due to many nontraditional REIT investors now playing in our sandbox, or it could be due to the rise of ETFs. And perhaps investors' commitments to equities are just not very deep these days. But what this means is that most investors should decide on an appropriate allocation to this asset class, whether 10%, 25%, or whatever, and stick to it, perhaps rebalancing from time to time. The long-term returns available on REIT shares will be captured over many years, not in a few weeks or months.

At the time thisarticle was published Joe Magyeris the advisor ofMotley Fool Inside Value. You can test drive his servicefree for 30 days. Both Joe and The Motley Fool own shares of Retail Opportunity Investments, which has been recommended by Motley Fool newsletters. The Motley Fool'sdisclosure policyis the strong and silent type.

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