One of the biggest misconceptions in investing has to do with real estate investment trusts (REITs) and rising interest rates. As a high-yielding security — thanks to their tax structures — dividend-hungry people often look for REITs to buy to pad their portfolios. However, common wisdom is that investors tend to dump shares of REITs as the Federal Reserve raises rates. After all, when rates are higher you can get bigger yields from “safer” securities like treasury bonds.
However, that relationship isn’t 100% cut and dry.
Yes, there is an initial dip from REITs when inflation spikes and the Fed raises rates. Hoever, REITs have historically been able to overcome that dip quite easily. That’s because top-notch property owners have long been able to raise their rents at faster rates. And thanks to their tax requirements, much of those high rents make their way back to investors pockets as dividends. With a faster pace of dividend increases, REITs have managed to outperform the S&P 500 the majority of the time during rising rate/high inflation environments.
The reality is, REITs are a great investment in today’s market conditions. The key is to bet on the top-notch REITs that have the ability to really raise rents. Here are five such REITs to buy today.
Great REITs to Buy: Douglas Emmett (DEI)
Dividend Yield: 2.6%
The key for REITs and their ability to beat inflation comes down to the old adage “location, location, location.” The better and more in-demand your properties are, the easier it is to drive up rents. And that’s just what Douglas Emmett (NYSE:DEI) has been able to do.
DEI’s focus continues on Southern California office and apartment market. We’re talking L.A., San Francisco, Santa Monica, etc. These areas continue to feature high demand and are very constrained. There simply isn’t any room to build a new apartment or office complex in Los Angeles. Luckily for Douglas Emmett, it controls on average about 28% of the Class A office space in its target submarkets. When it comes to real estate, that’s near monopoly status.
DEI knows this and benefits by using a slightly different rental scheme than other office REITs. Douglas Emmett purposely keeps its agreements shorter — around five years vs. the industry average of nearly eight years. This forces tenants to renew more often. The kicker is that DEI is then able to raise base rents faster. Even better still, the very high occupancy rates for its properties allow Douglas Emmett to build in yearly rent increases of 3% to 5% into its leases. That means it gets a big boost when a firm renews its lease and gets smaller jumps each year.
All of this does one thing — boost DEI’s cash flows and dividends at rates higher than inflation. The REITs last dividend bump was an inflation-beating big 8.7% increase.
In the end, DEI is exactly what investors should be looking for in this environment.
Source: Thomas Harrison (flickr)
Great REITs to Buy: Prologis (PLD)
Dividend Yield: 2.9%
Shopping is getting a big makeover these days as online and omnichannel become the norm. And that means big things for REITs like Prologis (NYSE:PLD). PLD is one of the largest international owners of warehouses and so-called flex space. That’s a big deal as more online shopping and two-day delivery options require more and more warehouse space. In fact, property owners like Prologis can’t build them fast enough.
Naturally, that creates a very constrained rental environment. Last year, the REIT managed to see an average of 9% rent growth in the U.S. and 7% across the entire world. This rent growth has helped PLD drive continued funds from operations (FFO) growth over the year. And the rent increases are continuing as more and more retailers take the omnichannel plunge.
After keeping its payout steady during he recession, Prologis has started returning its extra cash back to investors in spades. In the last five years, PLD has increased its quarterly payout by more than 70%.
For inflation protection, PLD has the goods to keep investors income rising.
Great REITs to Buy: Kimco Realty (KIM)
Thanks to rising online sales, the retail sector has been hit pretty hard over the last few years. But not all retailers are suffering. In fact, some are doing quite well. Once again, it all comes down to location, and Kimco Realty (NYSE:KIM) has the ideal locations in spades.
KIM is the largest owner of strip malls and power centers in the country. The key is that Kimco has been pruning its portfolio to focus on more affluent areas of the country. This “signature series” of properties feature more restaurants and shops that cater to higher-end customers. Plenty of Amazon (NASDAQ:AMZN)-proof retailers dot these locations. Ironically, Amazon’s Whole Foods Market is one of KIM’s largest tenants.
Again, like the other REITs on this list, Kimco has been able to leverage its prime locations to boost rents over the last few years. Rents have increased by an average five-year growth rate of 5%. That has transitioned into higher FFO metrics and dividends for shareholders.
With portfolio pruning continuing and the focus being set on successful omnichannel retailers, KIM should be one of the better REITs to play rising inflation. Dividends and rents will continue to rise at faster rates.
Source: Phillip Capper via Flickr
Great REITs to Buy: Equity Residential (EQR)
Expense Ratio: 3.2%
Home affordability has gotten much easier for many areas of the country. But that isn’t the case everywhere. In fact, there are plenty of places where it’s simply too expensive for the average joe to afford a home. Equity Residential (NYSE:EQR) has tapped into this fact in a big way.
Founded by real estate guru Sam Zell, EQR is a powerhouse in the apartment sector with more than 300 different communities and 78,280 apartment units. The key is that these units are located primarily in Boston; New York; Washington, D.C.; Seattle; and San Francisco. These are eactly the areas where home ownership is still pretty difficult to come by. Because of that, EQR has a long history of pretty strong occupancy rates as well as strong rent growth.
This has translated into hefty increases to funds from operation (FFO). Last quarter alone, Equity Residential saw a 4.05% year-over-year jump to its FFO. Steady increases to the FFO metric is critical because it directly translates to dividends and dividend growth potential. EQR has long been able to raise its payout at rates well above measures of inflation. Even better is that the REIT has been known to throw out plenty of special dividend cash to investors as well — including two payouts totaling over $11 per share over the last two years.
Given its focus areas, strong rent growth and continued high occupancy, EQR could be one of the best REITs to hold in today’s market environment.
Great REIT ETFs: iShares Cohen & Steers REIT ETF (ICF)
Dividend Yield: 3.1%
Expense Ratio: 0.34%, or $34 per $10,000 invested annually
Perhaps a single great REIT isn’t enough. You certainly could buy all the picks on this list … or you could get them all in one ticker. That’s where the iShares Cohen & Steers REIT ETF (BATS:ICF) comes in.
ICF focuses its attention on the biggest of the big. That means honing in its portfolio on the REITs that dominate their respective property subsectors. You simply get the topd dogs in the asset class. For example, ICF top-ten holding AvalonBay Communities (NYSE:AVB) owns nearly 78,000 apartment units and Simon Property Group (NYSE:SPG) holds more than 241,000,000 square feet of leasable retail space. They don’t call the ETF the “Realty Majors” index for nothing.
Because of this focus, ICF’s 30 holdings are able to take full advantage of the growing economy and the fruits that it brings. This includes being able to raise rents to compensate for the better economic environment and strong demand. For investors looking for an all-in-one play on beating inflation, this REIT ETF could be where it’s at.
And returns have proven that fact. Since the ETF’s inception back in 2001 — which includes both a tightened and easing interest rate cycle — ICF has managed to return about 9.96% annually. That’s not bad at all and has beaten the pants off the S&P 500 over that time. Even better is that the ICF charges a rock-bottom 0.34%, or $34 per $10,000 invested, in expenses.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.