Why Simplicity in REITs Wins | The Acquirer's Multiple®

During their recent episode, Taylor, Carlisle, and Bill Lenehan discussed Why Simplicity in REITs Wins. Here’s an excerpt from the episode:

Bill: I had been thinking about this idea for a decade when you used that example. And I have to admit, I had to look up what it was, but I think it’s really perfect. Why would a scientist experiment on a very, very simple organism? Because it isolates variables. And so, you could be really bad at capital allocation at a pharma company, and you issue equity at a low price, and you waste money on overhead, and you do a dumb acquisition, that’s dumb on the face of it. But some scientist somewhere in the lab figures out how to combine two compounds and make the next killer drug, and your stock goes up like crazy. And the fact that you issued equity 20% too cheap, or the fact that you blew some money on overhead, or you offered too much stock to employees for a long period of time to make your income statement look like it was more earnings generative, might not matter.

Whereas with REITs, it’s pretty simple. And I tell people my job is sort of like someone who goes to a baseball card conference and says, “Here’s my collection.” And the person at the front door says, “I will value your collection at X.” And I can say, “Not enough,” and walk home for the day and come back the next day, or I can say, “That value for my collection works,” and I’m going to take and sell a little bit of my collection and take the money and go into the convention and buy more cards.

Now, what’s particularly interesting– And in some ways, were a spin off out of Darden. I was on the board. An activist named Starboard Value did a long process of maximizing the value of that company, and part of it was taking the real estate and creating Four Corners. In some ways, that’s almost not the only way you could do this the way it’s been done, but it’s really helpful that we could start with such a high-quality portfolio.

And so, in the beginning, to use this baseball card collection analogy, when I went to the stock market to say, “How much would you value this?”, it was like a collection of All-Star cards. High investment grade, 100% occupied, all triple net, good disclosure in the leases. The leases were very well covered by cash flow. And so, it wasn’t practical to say, “Okay,” and then we’re going to only buy All-Star cards. But we needed to have a framework to say what we’re buying is high enough quality that while not all All-Star, cards that will have real value later on. And so that’s how I think about the business, and what I find interesting about it because– and I actually love this.

The fact is the buildings we buy are not– There’s no other reason to buy them than other than the economic reason. So, when you buy a tire store, it’s not something you’re going to fall in love with like you might a–

Jake: Yeah, there’s no Picassos in the portfolio.

Bill: I used to work at a big hedge fund here in San Francisco and we did all sorts of stuff. So, I developed an island in the Bahamas. And while really fun, it’s harder to be dispassionate. And again, to just to use your comment, an island in the Bahamas is the opposite of the simple organism. It needs to be complex. And so, there’s all sorts of variables that get put into that, entitlements. What are you able to get for the lots? What’s the construction cost? Can you placemake? We weren’t responsible for the placemaking aspect of it, but the person who was did an incredible job and that changed the value of that investment enormously. There’s no placemaking in a tire store. It’s just a much more simpler proposition.

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