Over the past few weeks, bond yields have risen to multi-year highs, putting tremendous pressure on income-focused investments such as real estate investment trusts (REITs). Despite businesses that are doing just fine, many rock-solid REITs are trading near their 52-week lows and are paying high, sustainable dividend yields. Here are three in particular that could be great additions to any long-term investor's portfolio after the recent drop.
Recent Share Price
% Below 52-Week High
Public Storage (NYSE: PSA)
National Retail Properties (NYSE: NNN)
Welltower (NYSE: HCN)
Data source: TD Ameritrade. Prices and dividend yield information as of 2/23/18.
A low-cost business with high return potential
Self-storage is a lower-cost type of real estate compared with many others. Maintenance and operating expenses are low, for example, as are expenses associated with turning over a storage unit. This is especially true for Public Storage, by far the biggest player in the industry, which has said that it could break even with just 30% of its units occupied. Not only does Public Storage have advantages of scale, but it also has an extremely low debt load for a REIT.
Well, Public Storage runs at about three times that occupancy rate -- it was at 93.8% in 2017 -- so this is a pretty big margin of safety. And its dividend is well covered by the funds from operations (FFO) it generates. The 2017 payout ratio of 78% of FFO is quite modest for a REIT and indicates that the company could maintain its dividend even if revenue fell significantly.
Looking forward, I'm especially excited that Public Storage is beginning to emphasize ground-up development of storage properties, as opposed to its traditional method of growing through acquisitions. The company completed 16 newly developed facilities in 2017 and has more in the works. Development requires more effort but also has the potential for superior returns on cost, and this could be a strong catalyst for Public Storage over the next few years.
Image source: Getty Images.
The right way to invest in retail now
National Retail Properties is not your typical retail investment. Many investors are avoiding the retail industry because of the wave of bankruptcies and continuing e-commerce pressure, but it's important to realize that not all retail investments are the same.
Specifically, most of the company's tenants are in businesses that aren't affected much by e-commerce competition. For example, the largest industry in the portfolio of 2,764 properties is convenience stores. These sell non-discretionary products, many of which simply aren't available online, like gasoline. Restaurants, automotive service businesses, fitness centers, and theaters are other examples of National Retail's major property types that have little to worry about from e-commerce.
What's more, all of the tenants sign "triple net" leases that make the variable costs of property ownership (taxes, utilities, insurance, maintenance) the tenant's responsibility, and they also come with long initial terms -- typically 15 years or more.
This stable lease structure, along with partnering with the right kind of retailers, is why National Retail Properties has a 99.1% occupancy rate, has raised its dividend for 28 years in a row, and has generated 12.9% annualized total returns over the past 25 years, handily beating the S&P 500.
An amazing long-term opportunity
In addition to the interest-rate headwinds I mentioned, healthcare REIT Welltower has some sector-specific headwinds, such as oversupply fears in the senior housing industry and the shaky financial condition of several of its partners and property operators.
However, the fact remains that healthcare, and senior housing in particular, is a tremendous long-term opportunity. Not only is Welltower the largest healthcare REIT, but it's also one of the most senior-focused, with 83% of its portfolio composed of senior housing and post-acute/skilled nursing facilities.
Over the next few decades, the U.S. senior citizen population is expected to explode, with the 65-and-up age group set to roughly double by 2050 and the older age groups set to grow even faster. And Welltower has the financial flexibility to take advantage of the opportunity, while using its scale to run a leaner operation than its peers.
Remember, these are long-term investments
To be clear, REITs like these have the potential for excellent long-term returns, but I wouldn't recommend them if you plan to hold for just a few years. It's entirely possible that the REIT slump could continue, and if bond yields unexpectedly rise further, that's exactly what I would expect to happen. On the other hand, over longer time frames -- say, a decade at minimum -- the interest rate cycle is less meaningful, and these REITs should produce excellent returns.
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