REITs And You: An Introduction, With Some Tips
Jul. 20, 2015 2:52 PM
- The REIT sector has surged in popularity, but detailed information on it can be scarce, which can lead to lost opportunities for even experienced investors.
- While many investors think of REITs as only being landlords of brick and mortar buildings, that is only a portion of this wide-ranging tax-advantaged sector.
- I run through the various flavors of REITs and suggest some leaders in each category for further consideration.
I have written extensively about the REIT realm this year, from individual REITs to Exchange Traded Notes ("ETNs"). Some of the articles have gotten very detailed and perhaps a bit intense for the ordinary investor just looking for a good starting point. With this article, I want to step back and put it all together, to provide an outline of the REIT landscape and toss in a few pointers on what to look for.
The REIT category has been around since the Eisenhower Administration, but in recent years it has surged in popularity. This is evidenced by the decision of The S&P Dow Jones Indices and investment tool provider MSCI to give real estate its own sector separate from financials. Some REITs will go into the new sector, while others will not, which just increases the confusion.
Why REITs have suddenly become such darlings of ordinary question is debatable. Ten years ago, many considered them a sleepy investing backwater. It may be partly due to changing demographics, as aging Baby Boomers look for steady income, which REITs can provide. The tax advantages of REITs have long been known by professionals, but ordinary investors are now taking advantage of them, too.
Accompanying any sudden wave of enthusiasm should be easily understandable guides on what to look for, and that is where I come in. My pet theory is that many investor losses are due to lack of information rather than poor judgment. Once you enter the market, there is no training period: immediately, you are competing on completely even terms with the most experienced and sharpest stock market professionals who have access to sophisticated trading tools. While the market is impossible to predict, it also is not completely random, like buying a lottery ticket. Understanding the playing field is vital for success. Blithely "taking a chance" based on some random thing you read or saw on television is a terrible way to gain a "learning experience" as the saying goes.
So, this article is intended as a practical guide for the active investor. I link to my articles on these, so if something piques your interest, click through and read further.
Types of REITs
Even as simple a question as "what types of REITs are there" can lead to different answers. Those answers, whether on the Internet or elsewhere, will tend to either be so general or get so technical as to be useless for the average investor. Below, I propose some categories that may not exactly match the most intricate explanations, but also should give a beginning investor some ideas for further thought beyond "look at REITs."
All REITs invest in real estate one way or the other, but some do it directly and others indirectly. Most investors choose REITs for their relatively high dividend yields; as of this writing, the S&P U.S. REIT Index (STCGUSRE) yields about 3.2%, which compares favorably to a 10-year Treasury bond yield of roughly 2.4%. In exchange for the higher yield in these "bond equivalents," however, REIT investors must take on the volatility of equity investments. Many REITs, of course, have yields well above that average.
As perceived bond equivalents, REITs are highly sensitive to interest rate fluctuations. I discuss this further in "The Case for REITs in 2015 " and "Update On Forecast For 2015 ." In general, the market sends REITs of all flavors down when rates rise, and vice versa. However, technical factors such as the slope of the yield curve (you knew high school algebra would come in handy some day!) play a larger role than many realize.
The two major branches of REITs are called equity and mortgage. Equity REITs tend to invest primarily in brick and mortar real estate, while mortgage REITS tend to invest primarily in paper assets. This is the crucial division to understand. The two groups have vastly different characteristics and tend to be followed by completely different groups of people who may not think very highly of people in the other group, but we all know how that goes.
Most investors stop there and focus on one group or the other, forgetting about anything outside their group. However, there are several other important flavors of REITs and REIT securities that everyone should at least consider. I will address Specialty Finance REITs and high-yield ETN REIT products, which many investors overlook but which can be quite lucrative, toward the end of the article.
The equity REITs are what casual investors tend to think of when someone brings up the sector. As owners of buildings and other "real" real estate such as farmland and various types of infrastructure, equity REITs encompass the classic landlord class. Equity REITs themselves, however, encompass a number of different types of investment that deserve to be broken down into their own sub-categories. I will run through a few of them to show how they differ, but this is intended to be illustrative, not comprehensive.
The "Establishment" REITs
Many investors don't want to worry about what a REIT invests in, they just want steady returns. The goal is steady performance with a reliable income stream that pros call a "bond equivalent." The premier example of this type of REIT is Realty Income Corp. (NYSE:O ).
Realty Income is known by its registered trademark "The Monthly Dividend Company®." It was founded in 1969 and is well-known in the industry for grinding out monthly dividends without any fuss.
Realty Income statistics. Source: RealtyIncome.com
Realty Income has one of the best track records in the industry, if not the entire stock market. At a share price around its recent $46.50, the company yields just under 5%. It is the REIT of choice for many of the most conservative investors in the sector, and its yield hearkens back to the long-gone "passbook savings rate," a reference that just reveals how old I am.
However, that doesn't mean that Realty Income has a boring stock price. In fact, it bounces around quite a bit. Within just the past year, it has fluctuated between $40.56 and $55.54. Currently, it sits roughly midway in that range.
Realty Income price performance, July 2014-July 2015.
Despite these swings, though, the long-term trend for Realty Income is decidedly higher.
Realty Income price performance, 2000-2015.
If you want to park your funds for the longer-term and want a very reasonable return, Realty Income is a good choice. However, it pays to catch Realty Income on its occasional big dips (invariably due to interest rate panics). Everyone knows about how reliable Realty Income is, so in my opinion it tends to get overbought quite often and most definitely is not a stock you should buy at just any random time.
Another popular Establishment REIT is Washington REIT. which was founded with the category itself in 1960
and has its own venerable dividend streak going. However, Washington REIT cut its dividend a few years ago, unnecessarily in the opinion of some, and dividend cuts are not something that REIT investors look upon lightly. It also is tied to the fortunes of the Washington, D.C. real estate market. This, incidentally, brings up another whole category of REITs that focus on narrow slices of territory such as American Assets Trust (NYSE:AAT ) (West Coast), Urstadt Biddle (NYSE:UBA ) (the Northeast), Acadia Realty Trust (NYSE:AKR ) (primarily the northeast and upper Midwest), Chambers Street Properties (NYSE:CSG ) (primarily the east coast, but with growing national diversity) and Liberty Property Trust (NYSE:LPT ) (rare REIT exposure in England).
Government Properties Income Trust (NYSE:GOV ), which serves as the landlord to the federal and state governments, is another popular choice. I see lots of ads for it while browsing around, which is kind of unusual for a REIT and sort of raises my suspicions about the sophistication of some of its investors. It pays a good dividend, but its performance by some measures has been a bit spotty and some have questions about its management.
I hesitate to include American Realty Capital Properties (ARCP), which I wrote a series of articles about in early 2015, in the Establishment category, but there is no better place. It has all the trappings of an established REIT even though it has only been around for a few years. ARCP is the largest triple net lease REIT, with properties all across the country, and is still emerging from various 2014 accounting issues. It suspended its dividend at the end of 2015 as new management took over due to the issues, but appears to be on the verge of reinstating it. Activist shareholder Keith Meister, who holds a 7.8% stake in it, recently called ARCP his top pick for the coming year, but the company still has a lot to prove and is only for aggressive REIT investors.
Health Care REITs
Healthcare REITs own and lease out healthcare and medical office properties. If there is one sector of the real estate market that is stable, it is healthcare, and there are a lot of REIT choices within it.
The effect of the Affordable Care Act aka "Obamacare" sent the big dog of the healthcare REIT field, HCA Inc. (NYSE:HCA ), soaring relative to its peers HCP Inc. (NYSE:HCP ), Omega Healthcare (NYSE:OHI ), Ventas (NYSE:VTR ), Medical Properties Trust (NYSE:MPW ), and Cogdell Spencer (NYSE:CSA ). The others did not experience the same effect.
Various long-term trends aside from Obamacare are working in favor of the healthcare REITs. These include changing demographics, with Baby Boomers gradually heading toward long-term care facilities. For this reason, healthcare REITs have defensive properties, but note that many of them still follow the main REIT herd in reacting to interest rates.
These companies barely scratch the surface of the healthcare subsector. Senior Housing Properties Trust (NYSE:SNH ), for instance, is a favorite of many investors, but I place it solidly in the second tier of this extremely competitive sub-sector.
My personal choice in the healthcare REIT field is not HCA, which I feel has had a good run and seems just a bit too tied to Obamacare for my liking. Instead, I favor Omega Healthcare. which pays a healthy dividend that consistently increases. I also like Medical Properties Trust and own a few shares. You really can't go wrong in this subsector, though, particularly when picking through the ones that have sold off in 2015 despite continuing to deliver solid results. After the Establishment REITs, this is the most fertile ground for new REIT investors to consider.
There are many niche sub-sectors in the REIT field. As another example, the Industrial REITs primarily own and sometimes operate warehouse/distribution facilities. This sub-sector is a bit unusual because in a way it is a play on the growth of online commerce, which appears unstoppable. As more and more retail sales take place in cyberspace, all those goods that people have clicked to purchase have to be stored somewhere both in the long and short term as they sit waiting for customers. There also is a big job of keeping everything organized as the goods proceed through different distribution facilities to customers. This is steady work that doesn't appear to be going anywhere any time soon.
Some of the major players in the industrial REIT field are EastGroup Properties Inc. (NYSE:EGP ), DCT Industrial Trust (NYSE:DCT ), STAG Industrial (NYSE:STAG ), Prologis, Inc. (NYSE:PLD ), and Monmouth REIT (NYSE:MNR ).
One danger to watch out for in this area is over-concentration. For instance, Monmouth has FedEx as the tenant in about half of its warehouse properties. Its stock price has languished, though it pays a large dividend. While there is a lot to like about MNR, it is not my top choice.
Instead, I like Stag Industrial. It has been growing at a fast clip, largely using share offerings to finance its acquisitions. STAG has sold off recently with the rest of the REIT sector, but there should be sunny skies for companies associated with e-commerce in years to come.
There are several other sub-sectors of the equity REIT field that merit a look: lodging, apartment, retail, farmland, office, data center, and many others. They all have their fans, but the ones I went through with examples should be a good starting point.
Mortgage REITs, as noted above, are the other main category of REITs. They are completely different animals from equity REITs. The mREITs, as they are known, generally pay spectacularly high dividends, which confuses a lot of investors -- how can this be? The companies produce these by borrowing short term and buying mortgage backed securities ("MBS"), often residential MBS ("RMBS"). Most mREITs don't own any property aside, perhaps, from their own base of operations.
Many equity REIT investors won't touch mREITs, which are notoriously volatile. Some conservative investors just don't trust businesses which earn their profits by paper transactions rather than rents and which are perceived as being hyper-sensitive to interest rates. The mREITs use leverage to fund their massive dividends, levering their assets by 5-10x, which only increases that sensitivity.
The entire mREIT sector sells off at regular intervals, as if by clockwork. It invariably is a result of the Fed stating once again that it is going to raise rates or end QE or whatever else the market doesn't want the Fed to do. Higher rates hit the book value of mREITs, and also increase their borrowing costs, so there is plenty of justification for those fears, but they also can be overblown.
Major mREITs include (among many others) Annaly Capital (NYSE:NLY ), American Capital Agency (NYSE: AGNC ), Two Harbors (NYSE:TWO ), New York Mortgage Trust (NASDAQ:NYMT ), and CYS Investments (NYSE:CYS ). As the chart below shows, stock picking in this sector is particularly important.
Over the past year, the entire sector has had some difficulty, though many of the declines in share price value are off-set by the large, usually quarterly, dividends with annualized yields of 10%-14%.
The charts paint a grim picture, but total return figures are a substantially better due to the dividends.
Selected One-Year mREIT Total Returns