Why REITs Can’t Compound Like Berkshire | The Acquirer's Multiple®

During their recent episode, Taylor, Carlisle, and Bill Lenehan discussed Why REITs Can’t Compound Like Berkshire. Here’s an excerpt from the episode:

Jake: Yeah. Do you have any– Is there any reticence or– I don’t want to say regret, that’s not the right word. But the fact that the REIT can’t really retain capital and compound the way that a holding company could, the way that Berkshire has, and therefore that compounding series, we all know what the math turns into on that. There’s a forced discipline, which is good, I think, because you always have to go raise capital again and then distribute it when you get it back, but you do kind of miss out on that compounding element. How do you think about that?

Bill: Yeah, it’s a great point. I thought at some point that I’d make a t-shirt for my team that says, “We don’t have to pay corporate tax. We don’t have maintenance capex. We can have 1200 buildings and 35 people. Not a bad business.”

Jake: [laughs] Yeah.

Bill: You’re absolutely right. The bargain for not having to pay corporate tax is the distribution requirement. The bargain of being in the public domain is that you have to have what I call permission from your investors to buy things. And obviously, when I buy an asset, it needs to be approved by a board. Obviously, the team needs to be aligned with what we’re buying. But even if it was approved by the board and the team was aligned to do it, if the investors don’t agree with it, you would–

If I went out and bought an apartment building, which would be not part of our strategy and obviously our investors have a way to express a view on apartments with the dozens of public REITs that do that exclusively, if we bought an apartment building, I would anticipate the value of our equity would go down by more than that apartment building. So, you have some constraints on what you can do.

I came from an environment that was incredibly creative, super interesting. Mentioned an island in the Bahamas. That wouldn’t actually have been all that unusual. We did amazingly interesting things. Whereas I don’t have permission to do that at Four Corners, which is something I knew when we signed up for this, and it is okay. We’ve expanded from restaurants to other sectors, but it has to be in sort of concentric circles.

I would say, Jake, in some ways the almost– I can calculate sending the money out and then we figured out some really interesting ways to raise capital that’s very efficient, much more efficient than it’s been done in the past. So, I can sort of calculate the frictional cost of that. What is less obvious, but maybe if you were to build a 30-year, 50-year model, even more impactful, is we don’t have organic reinvestment opportunities with high ROIs. And that in the long-term algorithm of the business means that we don’t have that-

Jake: That runway.

Bill: -Buffett-esque with his insurance investments, type of ability to take retained free cash flow, reinvest in things that he knows and earn high rates of returns from that. That said, we have an acquisition program that’s active if it’s timed correctly with the right sort of capital. And so, that’s provided much higher than organic earnings growth over time. But I think you have to think correctly about that because if you’re just buying stuff, no matter what equity price you’re using to raise the money, you can quickly destroy any opportunity for excess returns.

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