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Spicing Your Portfolio With Small-Cap REITs

NEW YORK (TheStreet) -- It's not surprising many of the large real estate investment trusts fell victim to the latest sell-off in dividend stocks triggered by rise in Treasuries. \

It's also not surprising to see the dominant index-driven large-cap REITs absorbed most of the decline in value, while the small-cap REITs managed to fly under the radar.

The tradeoff for investing in large-cap stocks can be easily traced back to the institutional buyers - led by exchange-traded funds and mutual funds -- that have a higher degree of analyst coverage and much lower risk tolerances. Conversely, the small-cap REITs lack the same Wall Street coverage and investor interest can result in shares remaining undervalued -- especially in down markets -- for extended periods of time.

So these under-analyzed small-cap REITs flying under the radar can offer better potential for growth over the long term. Due to decreased institutional support, there's a better chance that small-cap REITs will have lower valuations that result in an underestimation of a company's operational health and prospects for growth.

In my Intelligent REIT Investor newsletter I offer investors two different portfolio options:

  • Swan Portfolio: A conservative REIT portfolio aimed to benefit the investor looking to harness the power of repeatable dividend income. Although growth is an important aspect to intelligent investing, my "sleep well at night" (aka SWAN) portfolio is rooted in principal preservation and durable and safe dividend income.
  • Salsa Portfolio: The second portfolio option is the Salsa portfolio and, as the name describes, it includes a few ingredients that help spice up the portfolio to deliver higher growth (than the Swan portfolio) with less focus on dividend safety and more focus on total returns.

I model my Salsa portfolio with REITs that are complementary. Although certain REITs are considered more risky than others, the essential element is bigger gains and lower valuations. In such, I maintain between 10% to 25% of my Salsa portfolio in small-cap REITs.

Collectively, small-cap REITs have always been seen as more risky bets than large-caps, and although they don't have the diverse revenue streams or stable cash flows as the big boys, they are complementary to my overall Salsa growth model. As a key ingredient for the Salsa portfolio, the small-cap REITs create a buoy effect as they are more susceptible to wide swings (by Mr. Market) in price due to lower trading volumes -- a key attribute since greater volatility deters action and often invites selling.

The key for any REIT portfolio is diversification. Whether you are a Swan investor or a Salsa investor, I cannot over estimate the importance of practicing diversification.

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