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Here Comes 'The Fed Is Meeting' Folly, Right on Schedule

- By Joseph L Shaefer

If the past is prologue to the future, a 0.25% rate increase will send thousands of issues tumbling 3%, 4%, 5% and more. Is it possible the portfolios of the income stocks and mutual funds (ETF, CEF or open-end) you own will be yielding 3% to 5% less the day or month after the rate rise? Unlikely. Yet, this knee-jerk reaction strikes every time we are within a week of the Federal Reserve meeting. I know this because our profitable investments in this arena are now executing as our trailing stop prices are reached.


"Weird," you say. "But how does that make me any money?"

The selloff is overdone, not only numerically but also "geographically." That is, stocks in almost every sector are punished simply because they pay a good dividend. This makes no sense. Many dividend-paying companies, most notable for their yield, do better when rates are higher, not worse -- yet their stocks will sell off too.

Nowhere is this more in evidence than among the best quality utilities and REITs. We currently own just one utility, Madison Gas & Electric, now called MGE Energy Inc. (MGEE), and I do not recommend it today. I bought it as a growth utility when it was $21.13 a share; it is now above $60 and has been paying me better than 5% a year ever since. For some positions, especially those in our asset classes that are designed for good ballast, you really can hold forever.

This boring utility held like a rock through the 2007 to 2009 decline.

We own more REITs than utilities, however, and if the usual reaction to a Fed rise holds, we will soon own more. If you are in any business that rents property (very often, whether you know it or not, from a publicly traded REIT or one of their subsidiaries) one thing is certain besides death and taxes: your rent will go up when your lease is up for renewal. The same holds true if you rent your apartment. Here is something else you know: if interest rates are higher, meaning your landlord's borrowing and other costs have gotten higher, your rent will increase by that factor as well.

So, why the selloff in REITs that begins this week and will likely continue next week? No logic, but a wonderful opportunity. Yes, as rates rise, the yield currently paid by REITs may become incrementally less attractive than it was last week. But also, as rates rise, increased borrowing costs will be passed along via rent increases to commercial and residential tenants. In this area, I particularly like triple-net lease REITs and am taking some profits on currently held REITs in the health care and alternative energy fields in order to have cash available to buy the very best of these.

There are two triple-net lease REITs that I particularly respect for the quality of their balance sheets, the savvy of their management teams and the sustainability of their revenue and earnings streams. Now if I can just get the final piece of the puzzle to fall into place - a price I am happy to pay. That moment may come this week or next.

Realty Income Corp. (NYSE:O) is already owned by some clients and has been for a long, boring, profitable time. The story at Realty Income is it owns more than 4,600 properties, most of which are free-standing, triple-net lease, single-tenant properties. It covers the waterfront, with tenants in 49 states and Puerto Rico and in 47 diverse industries.

The company's latest coup has been to add industrial, manufacturing, warehousing and distribution and office buildings to its portfolio. It also recently brought on a portfolio of 7-Eleven stores. This new tenant may represent only 2% of the portfolio, but it is one that generates enough revenue in good times and bad to meet its obligations. Other, larger tenants include Walgreens (WBA) at 7% of the portfolio, FedEx (FDX) at 5.5%, Dollar General (DG) at 4.2% and LA Fitness at 4%. Like these, most tenants are either non-discretionary or quite defensive during downturns.

The company pays a dividend monthly that yields an annual 4.2% at its current price and has a history of increasing those dividends every single year. It has never missed paying a dividend since its founding in 1971.

The second company I favor and some clients already own at lower prices is W.P. Carey (WPC). It is the nation's third-largest net lease REIT after Realty Income and Vereit (VER), though it is a global company not limited to just the U.S. One big difference between W.P. Carey and Realty Income is the latter relies heavily on the retail sector, albeit defensive and non-discretionary retailers that do not depend on consumers having discretionary income to spend.

W.P. Carey, on the other hand, has most of its properties rented to industrial companies and for office services. Retail comprises just one-sixth of the mix, just above warehousing as another key component. More than a third of its business comes from properties outside the U.S., primarily in Germany, the U.K. and other European nations.

W.P. Carey also manages some private REITs. Unlike other externally managed entities, however, its management receives no compensation, bonuses or incentive compensation for their efforts. Their successes in this area flow directly to shareholders.

The company pays a dividend priced to yield 6.2% and sells at a funds from operations ratio of just 13.

I plan to purchase both companies on the pullback I expect to see as a result of the knee-jerk reaction from a likely Fed rate increase.

Disclosure: I do not own any securities mentioned. I have limit GTC orders to purchase O and WPC at lower prices.

Disclaimer: I encourage you to do your own due diligence on issues I discuss to see if they might be of value in your own investing. Past performance is no guarantee of future results. Even our 18-year track record of solid returns does not guarantee continued success. Good luck or other factors could have played a role. You are welcome to contact me at joe@stanfordwealth.com for a free portfolio review or with any questions.

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This article first appeared on GuruFocus.