This is a guest contribution by Bob Ciura of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios for the long run.
Today, income investors face a quandary: with interest rates at near-zero levels, bonds are extremely unattractive. In fact, legendary billionaire investors such as Warren Buffett and Ray Dalio have recent said that bonds are a terrible place to be and that the economics of investing in them are “stupid.” As a result, the bond market offers the lose-lose proposition of chasing yield from risky borrowers or settling for rates of return that are virtually guaranteed to underperform inflation over the long-term, thereby locking in negative real returns.
An attractive alternative to bonds is investing in real estate investment trusts (i.e., REITs). These investment vehicles are corporate tax-exempt and are legally required to pay out at least 90% of their taxable income as dividends. The combination of these two factors along with the generally stable and high-yielding nature of diversified portfolios of real estate means that many REITs pay out dividend yields that are far greater than bond yields.
Today we will discuss a few opportunities in the REIT sector that combine safety with attractive income. Although these are not the highest-yielding REITs, these 3 REITs have high yields and safe payouts.
1. Omega Healthcare Investors (OHI)
OHI is a healthcare REIT that generates the vast majority of its revenues from skilled nursing properties and supplements that income with senior housing development revenue.
This REIT weathered COVID-19 quite well as its FFO-per-share increased from $2.88 n 2019 to $3.23 in 2020. Even better, its forward outlook looks positive as well as the baby boomer population is just now starting to enter the years where their healthcare expenses are expected to surge, average lifespans are increasing, OHI only has a small percentage of its leases expiring in the near future, and the dividend payout ratio is expected to be a very sustainable 83% in 2021.
The valuation also remains attractive here with the 2021 dividend yield standing at 7.1% at current prices and is poised to combine with continued expected dividend and FFO-per-share growth and slight multiple expansion to generate annualized total returns of nearly 10%. Given the defensive industry in which it operates, the favorable industry dynamics, and OHI’s sizable yield and ability to grow with inflation, this REIT looks like a strong pick for an income investor.
2. W.P. Carey (WPC)
WPC is a triple net lease REIT that owns primarily industrial and warehouse properties supplemented by office, retail, and private storage portfolios. It has a sizable presence in both North America and in Europe and combines its asset and geographic diversity to opportunistically buy and sell assets as well as maximize its cost of capital.
This REIT also weathered COVID-19 exceptionally well with only a slight hit to revenue and FFO-per-share as it collected virtually all of its rents and maintained a very high occupancy rate. Given that many of its triple net lease peers suffered much larger declines in cash flows and rent collection rates, WPC proved its superior underwriting strength and asset quality.
Best of all, we love WPC’s capabilities as an income machine. It offers investors a 6% forward dividend yield that is backed by highly defensive assets with lengthy average remaining lease terms and a 22-year dividend growth streak. Furthermore, its balance sheet is rock solid with a strong investment grade credit rating, its forward payout ratio of 86% is very safe for a business with such a low rate of capital expenditures, and management has recently highlighted their robust growth pipeline in the in-favor industrial property sector.
We expect these new sale-leaseback investments to drive continued solid growth in the dividend in the years to come. Additionally, most of WPC’s leases are linked to inflation. Given that the Federal Reserve recently committed to not raise rates until 2024 at the earliest while also pointing to accelerating inflation, WPC is poised to outperform its peers in the years to come as its rental revenue will likely increase organically while its cost of capital should remain very low.
These qualities combine to make WPC the REIT-of-choice for income investors looking for a combination of yield, safety, and inflation-resistance.
3. SL Green Realty (SLG)
SLG is a commercial REIT concentrated in Manhattan and is in fact the largest office landlord in the city, owning 93 properties.
While the COVID-19 outbreak hit New York City hard – and SLG’s properties were no exception – the REIT still managed to maintain a strong occupancy level of 93.4% and collect 94.8% of its total rents in 2020. This was in large part due to the strong performance of its office rent collections (97.9%), which offset its much smaller retail rent collections (80.8%). Moving forward, the environment will likely still be challenging as New York City will likely take some time to recover and the work-from-home trend has gained momentum from the pandemic.
That said, the payout ratio is expected to be a very manageable 56% in 2021 and SLG offers investors a 4.9% forward dividend yield alongside 5% expected annualized FFO-per-share growth for the next half decade as it recovers from the pandemic. Combining the expected growth and multiple expansion with the attractive current yield, SLG offers investors double-digit annualized total return potential.
Given that it also has a very strong balance sheet and operates high quality assets with solid counterparties in one of the greatest markets in the world, we expect SLG to survive over the long haul and view it as an attractive investment for income investors looking to diversify their portfolio into real estate.
REITs can be fantastic income vehicles given their tax advantages and the income-focus of real estate. However, investors should not just chase the highest yielding REITs they can find as many times these REITs have high leverage or other risky qualities. Instead, we suggest you check out REITs with strong balance sheets, conservative payout ratios, and durable business models that can support their current dividend and ideally continue to grow it over time. The three REITs we mentioned in this article – OHI, WPC, and SLG – should provide you with an excellent start on building a great REIT dividend portfolio.