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Looking for Income? See These 2 High-Yielding REITs

- By Ben Reynolds

Real estate investment trusts, or REITs, can offer investors high dividend yields. These stocks are often owned by dividend growth investors because they are required by law to distribute 90% of their taxable income to shareholders each year in order to avoid paying corporate taxes. These high-yielding REITs can offer investors a steady, sizable income stream.

Two REITs worth highlighting are Kimco Realty (KIM) and Lexington Realty Trust (LXP).

Kimco Realty background

Kimco is North America's largest publicly traded owner and operator of open air shopping centers. The REIT owns almost 500 shopping centers in the U.S., focused mostly in large urban areas. The REIT's tenants include clients such as TJX Companies (TJX) and Lowe's (LOW). The REIT has a market cap of $7.15 billion.

Second-quarter earnings results

For REITs like Kimco and Lexington, funds from operation, or FFO, is a better measurement of profitability and cash flow than the traditional earnings per share metric that is used to value most stocks. Because depreciation costs weigh on earnings and REITs often have high rates of depreciation, earnings per share is not an accurate measure of how a company is performing.

Kimco reported second-quarter results on July 26. The REIT's funds from operations were 37 cents, beating the average analyst estimate by 1 cent. This was, however, a 1% decline from the second quarter of 2017. This decline is due to the company's plan to sell certain assets. Revenue inched up 0.1% to $293.4 million. This came in ahead of expectations by $32,000.

Kimco's occupancy rate was 96% during the quarter and income from same properties grew 3.8% year over year. New leasing spreads, the difference in rent per square foot compared to the previous lease, increased 11.5%. This marks seven quarters in a row that the new lease spread was higher than 10%. Of the company's small shop properties, 90.2% were occupied during the quarter, the highest mark since the company started reporting this metric in 2010. Businesses in this category include restaurants, fitness centers and other small businesses.

Kimco sold 17 shopping center properties during the second quarter. For 2018, the company has already disposed of 38 properties for more than $530 million. Kimco expects to sell upwards of $900 million worth of assets during the year. The REIT will use capital from these actions to help pay down debt. Kimco has a BBB+ credit rating.

While Kimco does have quality tenants, some of its properties are leased to retail companies experiencing difficulty. Included in this are Sears (SHLD), J.C. Penney (JCP) and Toys 'R' Us. Sears and J.C. Penney are both struggling and Toys 'R' Us went bankrupt earlier this year. While half of the Toys 'R' Us properties have now been leased, Kimco still has exposure to underperforming businesses. Investors should keep this in mind when considering the stock.

Dividend and valuation

Kimco has increased its dividend for the past eight years. Over the last five years, the REIT has raised its dividend by an average of 7.3% per year. Kimco currently sports a 6.60% dividend yield and is projected to have a payout ratio of 78% for 2018. This low rate should allow the REIT to offer increases in the future.

Kimco expects funds from operations of $1.44 per share in 2018. Based off of the Sept. 4 closing price of $16.96, Kimco has a price to funds from operations ratio of 11.8. This is meaningfully below the REIT's 10-year average valuation of 14.7. While the underperforming retailers that occupy some properties may prevent the REIT from returning to this valuation, Kimco's valuation is rather low and the dividend can be considered safe.

Lexington Realty Trust background

Lexington Realty Trust focuses on single-tenant industrial and office properties.The company owns 168 properties in 37 U.S. states. Most properties are concentrated in the Midwest and southern parts of the country. More than 97% of the company's properties are leased as of the most recent quarter. Most leases run seven to 20 years in length. Some of Lexington's clients include FedEx (FDX), Honeywell International (HON) and Huntington Ingalls (HII). Lexington has a current market cap of $2.1 billion.

Second-quarter earnings results

Lexington released second-quarter results on Aug. 8. The company produced 25 cents in funds from operations in the second quarter, topping estimates by 1 cent and improving 8.7% from the previous year. Revenue increased 10.3% to $105.5 million, beating estimates by $5.2 million.

During the quarter, Lexington added several properties to its portfolio, including nearly 3 million square feet of industrial space in Memphis that has been leased to Sephora and Hamilton Beach for a weighted average lease term of seven years. The cash cap rate, the measure of net operating income divided by the cost of the investment, is 5.8%.

At quarter's end, Lexington had an occupancy rate of 97.3% and a weighted average lease of 8.8 years. The REIT now has resolved the vast majority of its lease expirations for 2018 and will begin to address lease expirations for 2019.

Lexington's industrial portfolio was nearly 100% leased in the second quarter. Accounting for 60% of revenues, this extremely high occupancy rate means that almost every industrial property the REIT owns is generating income for the company. Nearly 70% of leases have built in yearly increases and an average weighted lease term of 10.1 years. Office properties had an occupancy rate of 99.4% during the quarter. Approximately 59% of these properties have annual rent escalators in place, but the weighted average lease term is just six years.

Lexington sold $66 million worth of non-core assets during the quarter. Year to date, the REIT has disposed of $175 million worth of non-core assets. The company targets $300 million in asset sales for the year.

Dividend history and valuation

Lexington has paid a dividend for the last 24 years and increased it for the past nine years. Over the last five years, the company has increased its dividend at an average of 5.9% per year. The REIT has a current dividend yield of 8%. Based off of funds from operations guidance for the year, Lexington has a payout ratio of a little more than 70%. This is relatively low for a real estate investment trust.

Lexington expects funds from operations to be in the range of 95 cents to 98 cents per share for 2018. Based off of the midpoint of funds from operations guidance for the year and the Sept. 4 closing price of $8.87, Lexington's shares trade at price to funds from operatons multiple of 9.2. Compared to the REIT sector valuation of X, Lexington appears to be undervalued. Investors should be aware the company does carry a lot of debt (more than six times net-debt-to-adjusted-EBITDA).

Final thoughts

Kimco Realty and Lexington Realty Trust both offer attractive dividend yields. Investors looking for exposure to the REIT sector and generous income could do well with both of these companies as their valuations are low. Both REITs are also in the process of selling off non-core assets. This is likely a good strategy given the hardships that brick-and-mortar retailers are facing. Depending on what investors are looking for, either REIT could be a quality purchase. Kimco offers exposure to open air shopping centers, while Lexington derives the majority of revenues from industrial properties.

Of the two REITs, I prefer Kimco at the moment. The company may have a lower dividend yield, shorter dividend growth history and a higher valuation, but the shopping center REIT is trimming its struggling properties in order to focus on the better performing centers.

Disclosure: I am not long any of the stocks mentioned in this article.

This article first appeared on GuruFocus.