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Not to scare you or anything, but there are risks involved in absolutely any kind of investing. If individual and world histories have taught us anything, it should be that.
There’s a risk to investing in financials and housing, as evidenced by the financials-fueled housing bubble burst of 2008.
There’s a risk to investing in giant staple-based companies like Enron and General Electric, as evidenced by the first’s fraudulent business behavior and the second’s over-expansive business behavior.
It’s also worth noting how, earlier this year, northern California’s PG&E – the largest U.S. utility – had to file for bankruptcy. It wasn’t for lack of customers or cooking its books either. As it turns out, there was much more literal cooking going on there.
Investigators found that PG&E was responsible for at least 18 of California’s worst wildfires over the last two years. And it may have been responsible for more, including the one last year that burned up about 200 square miles and killed over 85 people.
According to an online Slate article, PG&E now has over $50 billion in liabilities to account for.
There’s even a risk in investing in stodgy and staid hedge funds. Thank you, Bernie Madoff.
And that’s just recent history, not to mention the kind that was big enough to make the news. We all have our own personal failures and disappointments we’ve had to face throughout the years.
Some of them were big. Some of them were small. But all of them should have taught us the value of diversification… of never putting all our eggs into one basket.
We know not to “stock up” too heavily in tech or commodities or any other single sector. We know to at least dip our toes into international investing through ADRs, ETFs and the like. We even know to diversify within our diversification.
We’ve learned our lesson in that regard. That’s we say; and that’s what we mean.
Which is wonderful and all. But it does beg a question. If we’re so comfortable diversifying across business types and locations, then why are we so scared of investing across business sizes?
What’s our hang-up with small caps?
Size Doesn’t Determine All
I do understand that small-cap stocks have a bad rap. They’re risky, we hear over and over and over again. They don’t have enough financial backing or know-how. Besides, how do we know we can trust them?
Those might be valid concerns. And I’m all about doing one’s due diligence before investing in a company, but that includes the big ones. Because, as we’ve already established, size doesn’t determine all.
While it’s true that small-cap companies probably don’t have the long track records their big-cap cousins can offer to investors to analyze… that might just mean they will work harder, knowing very well that they can’t take anything for granted.
Likewise, small-cap stocks might not have the steadily climbing shares that large-caps can boast, but they can shoot skyward at a much faster pace. After all, it’s a whole lot easier to double in price when that price is on the lower side.
In the end, we can argue up and down about the pros and cons of investing in small caps. And we’d be right to weigh the risks and rewards – just as long as we’re also doing that for large caps along the way.
Diversification is key in every regard. When one segment of the market dips, another could be rising. And you just never quite know which one is when.
Don’t wait until some personal or history-making crash proves that large caps shouldn’t be your investing everything… any more than anything else.
Check out these small-cap real estate investment trusts today.
3 Small Caps Poised To Profit
City Office (CIO) is a small cap office REIT that invests in secondary markets that remain supply constrained (four of those markets are the fastest-growing major metro areas of the country). The City Office portfolio has grown to 62 office building located in seven cities. The company’s goal is to acquire new properties for cap rates (cash yield) of 7% to 8%) and the key to this long-term value investing strategy is to own building in markets with faster population and economic growth (to minimize the risk of oversupply).
City Office needs to obtain dividend safety by lowering its AFFO payout ratio to below 100% (and likely below 90% before investors can expect dividend growth). Over the long-term (five years), analysts are expecting that rapid growth rate to continue with about 8% AFFO per share growth (that’s compared to the REIT’s historical growth rate of 4.7% since its IPO in 2014). We consider 8% long-term growth to be a reasonable and achievable growth forecast that, even should the REIT never see its valuation improve, City Office would deliver excellent mid-double-digit long-term total returns for investors.
Easterly Government (DEA) is another small cap REIT that stands out. The company is also an office REIT that focuses on class A commercial properties that are leased to U.S. government agencies through the General Services Administration. Remember that the U.S. government is the largest employer in the world – and the largest office tenant in the U.S. – so, when you’re looking to invest in a REIT that’s 100% focused on the U.S. government, well, that’s exactly what Easterly does. Since 2010, this REIT has acquired 65 properties encompassing 5.6 million square feet, including 31 properties leased primarily to U.S. Government tenant agencies.
2018 was a significant year for growth, as Easterly successfully closed on 15 properties, accretively growing the portfolio by nearly 40%, “while maintaining true to the bull’s-eye acquisition strategy” (according to the CEO on a recent earnings call). In 2018, the company grew NOI by 22% year-over-year, EBITDA by 24% and FFO by 21%. Up until December 2017, Easterly was growing its dividend, albeit modestly, but the company opted to freeze the growth in 2018, this was likely due to the elevated payout ratio, in excess of 100% based on AFFO. Much like City Office, Easterly is expected to grow earnings (or AFFO per share) in order to deliver a safer and growing dividend.
Gladstone Lane (LAND) is another small cap REIT that invests in farms that produce specialty crops such as fruits, vegetables and nuts. The company’s primary focus is acquiring land to be purchased and rented for annual (or more frequent) plantings. These crops are grown mostly in California, Florida and adjoining states. Because Gladstone Land is a small cap REIT it doesn’t have access to unsecured debt so the company’s loan-to-value is higher (than traditional REITs). The company said it is “comfortable with these levels” (around 55%) given the relative low risk of quality farmland as an overall asset class. About 98% of borrowings are currently at fixed rates and on a weighted average basis the rates are fixed at 3.55% (for another six plus years).
Unlike City Office and Easterly, Gladstone Land is externally-managed, but given the small cap capitalization, I’m not as concerned with conflicts of interest. The external manager provides services for other REITs and BDC’s, but none of them invest in farms, and Gladstone Land benefits from the lower G&A cost structure (economies of scale). In addition, Gladstone Land has a good history of dividend growth and this validates the fact that management is aligned (in addition, LAND insiders own around 13.6% of shares).
I own shares on CIO, DEA, and LAND.