U.S. Markets open in 5 hrs 22 mins

This Warren Buffett REIT Is a Dividend Lover's Dream

Todd Campbell, The Motley Fool

Warren Buffett prefers investing extra cash for future growth rather than dividend payments, but that doesn't mean the Oracle of Omaha's Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) won't buy stocks that do both, especially if the price is right. For example, Berkshire swooped in and bought a nearly 10% stake in real estate investment trust (REIT) Store Capital (NYSE: STOR) last year after its share price took a tumble. Does this REIT deserve a spot in your portfolio, too? Here's why Store Capital's business model makes it one of the best income-producing stocks Berkshire Hathaway owns.

A strong defense is a good offense

One of the biggest risks facing REITs with retail real estate exposure is tenant bankruptcy. The rise of e-commerce has taken a big toll on traditional brick-and-mortar sales, and as a result, many national and regional retail store companies have shuttered locations or gone belly-up, leaving landlords in the lurch.

Warren Buffett walking through an investor conference.

IMAGE SOURCE: THE MOTLEY FOOL.

Although Store Capital makes its money renting to retail store operators, its business model is specifically designed to insulate it against vacancy risk. Instead of leasing mall space to retailers that get most of their money from selling goods that can be easily obtained elsewhere, it leases stand-alone real estate properties to service-oriented businesses, including gyms, movie theaters, furniture stores, restaurants, early childhood education providers, and others whose services aren't easily replaced.

The REIT protects itself even more from tenant bankruptcy risks by acquiring properties at prices below their replacement cost, vetting tenants carefully on a unit-level basis, and then signing middle-market-sized tenants across many industries to long-term leases. Its investment relative to market value per property averages 82%, and overall, it leases nearly 2,100 properties to more than 412 tenants operating in over 100 industries. And because no one tenant represents more than 3% of revenue, the impact on its business would be small if one customer falters.

Store Capital's approach has resulted in a 99% plus occupancy rate, and thanks to contracts that include automatic escalators averaging about 1.8% per year, renewals, and portfolio management of its properties, the company is in a good position to deliver on its projection for 5% internal growth annually for shareholders.

How it's paying off for income investors

The high occupancy rate, ongoing investment in new properties, and a model that relies heavily on direct leasing deals provide plenty of funds from operations (FFO) to return increasingly more money to investors in dividend payments. 

After including capital expenditures, routine maintenance amounts, and rent increases, the company's adjusted FFO (AFFO) has increased by an average of 7.2% per year since 2014. Thanks to those increases, Store Capital's been able to boost its annual dividend by an average of 6.6% per year over that period, and currently the REIT's dividend yield is a healthy 4.3%.

There's reason to believe its dividend payments will continue growing, too. Most of its loans are at fixed rates, so they won't spike because of rising interest rates, and the company's pipeline of new properties exceeds $12 billion even after adjusting for a net $495 million in acquisitions and dispositions so far in 2018. Given potential AFFO upside and the fact that the company's dividend payout ratio is only 70%, there's plenty of financial flexibility to support bigger payments in the future.

Is this REIT a buy?

There are other REITs that offer a higher dividend yield than Store Capital, but they're arguably investing in riskier projects that make them less attractive than Store Capital. I don't know how long this REIT will remain in Berkshire Hathaway's portfolio, but I think this company offers investors a very attractive balance between risk and dividend-friendly reward, and that makes owning it in income portfolios smart.

More From The Motley Fool

Todd Campbell has no position in any of the stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.