U.S. Markets open in 4 hrs 30 mins

I Bought My First REIT! Here's Why

Timothy Green, The Motley Fool

Real estate investment trusts, or REITs, are tailor-made for dividend investors. REITs must derive at least 75% of their gross income from real estate, and they're required to pay out at least 90% of their income as dividends to shareholders. Meeting those requirements and a few others frees them from paying income tax at the corporate level.

This means REITs often sport high dividend yields. The downside is that dividend requirement leaves little left over to invest in growth, so REITs often use debt to fund expansion. That debt can cause problems if a REIT's assets lose value and earnings power over time. A REIT that owns second-tier shopping malls, for example, may run into trouble if it's overloaded with debt.

REIT acronym in white letters on top of a yellow mosaic pattern.

Image source: Getty Images.

I don't consider myself a dividend investor, although most of the stocks I own do pay dividends. REITs have always seemed expensive to me. Sure, you get a nice dividend, but I'd rather buy an undervalued stock that pays a decent dividend that could rise substantially in value. The total return of the Dow Jones Equity All REIT Index, including dividends, has trailed the total return of the S&P 500 index by more than 70 percentage points over the past 10 years.

Well, I finally found a REIT that I could get behind. Not only does it pay a solid dividend near 7%, but it's extremely cheap relative to funds from operations, the relevant earnings figure for REITs. The stock has been cut in half since peaking in late 2016, driven lower by pessimism engulfing the retail industry. I think it has a good chance of recovering once that pessimism lifts.

Here's why I bought shares of Tanger Factory Outlet Centers (NYSE: SKT).

Upscale shopping centers

Tanger owns all or part of 44 upscale outlet shopping centers in the U.S. and Canada. Stores within these outlets provide discounted prices on designer and brand-name products. Major tenants include Ascena Retail, The Gap, Under Armour, Nike, and Tapestry.

Tanger is certainly exposed to retailers closing stores and going bankrupt, and that's one reason why the stock has tumbled over the past few years. The Gap, for example, recently announced plans to close hundreds of stores. And two of Tanger's tenants, Gymboree and Charlotte Russe, recently declared bankruptcy.

It's a legitimate concern. The company expects retail bankruptcies to continue to be a problem this year, projecting as much as 200,000 square feet of store closings for 2019 in its centers. Tanger sees average occupancy for 2019 falling to as low as 94%, after staying above 95% for more than 25 years.

Tanger expects to produce funds from operations between $2.31 and $2.37 per share this year, down from $2.48 per share in 2018. The upheaval in the retail industry is doing a number on Tanger's bottom line.

But there are reasons to be optimistic that Tanger's troubles won't last. Unlike REITs focused on traditional shopping malls, Tanger has a diversified base of tenants. While malls depend on large anchor stores, usually struggling department stores, Tanger does not. Tanger's largest tenant accounts for less than 7% of the total gross leasable area, and its top 25 tenants comprise just over half of that.

Tanger is going to lose some stores and some tenants as the retail reckoning continues, but there are plenty of other brands that could benefit from having stores in Tanger's high-end shopping centers. Think of all the online-only fashion and apparel brands that have popped up in recent years. Having at least some stores can help introduce those brands to a larger customer base.

There's a reason why online retail giant Amazon.com has been pushing into brick-and-mortar retail. Even as sales continue to shift online, stores are important.

A very cheap REIT

At the midpoint of Tanger's 2019 guidance, the stock trades for just 8.5 times funds from operations. The stock sports a dividend yield above 7%, and that dividend eats up just 60% of the projected funds from operations for 2019. The dividend should be able to survive even if it takes Tanger a few years to get its occupancy metrics back in order.

E-commerce is changing retail, but some things will never change. People will always love a deal, and that's exactly what Tanger's outlets provide. The next couple of years will be rougher than shareholders are used to, as bad retailers downsize or die. But given the extremely pessimistic valuation, Tanger looks like a great deal for long-term investors.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Timothy Green owns shares of Tanger Factory Outlet Centers. The Motley Fool owns shares of and recommends Amazon, Nike, Tapestry, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool recommends Tanger Factory Outlet Centers. The Motley Fool has a disclosure policy.