Aristofanis Papadatos at Sure Dividend has written this excellent guest post on Real Estate Investment Trusts (REIT).
As inflation has surged to a 40-year high this year, investors are struggling to protect the real value of their portfolios from eroding.
REITs (Real Estate Investment Trusts) are great candidates for the portfolios of income investors, particularly in the current investing environment.
First of all, they can offset inflation, at least in part, by raising their rental rates. In addition, while the S&P 500 is offering an average dividend yield of 1.4%, many REITs are offering dividend yields above 5%.
In this article, we will discuss the prospects of three REITs that offer attractive dividends with a wide margin of safety.
Top 3 REITs
1) Realty Income Corp (NYSE: O)
Realty Income is a REIT that is famous for its impressive dividend growth history and its monthly dividend payments. The trust owns more than 4,000 retail properties, with an eye-opening occupancy rate of approximately 99%.
Its retail properties are not part of a wider retail development, such as a mall, but instead, they are standalone properties.
As a result, these properties are viable for many different tenants, including government services, healthcare services, and entertainment.
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They are also immune to the secular threats facing malls and some brick-and-mortar retailers. This helps explain the exceptional performance record of Realty Income.
Realty Income has grown its funds from operations (FFO) per share every single year over the last decade.
This is an admirable achievement, especially given the fierce recession caused by the pandemic in 2020. During the last decade, the trust has grown its FFO per share at a 6.4% average annual rate.
Realty Income has achieved its consistent growth record thanks to multiple growth drivers.
It grows rents at existing locations, either via contracted rent hikes or by leasing its properties to new tenants at higher rates, while it also acquires new properties.
The trust invested approximately $2.1 billion in new properties in 2020 and another $6.4 billion in 2021.
Moreover, Realty Income expects to increase its investments in international markets during the next couple of years. It made its first deal in the UK in 2019 and plans to do many more similar deals in the future when it identifies attractive targets.
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Realty Income distributes its dividends on a monthly basis and has achieved an exceptional dividend growth record. To be sure, the REIT has grown its dividend for 97 consecutive quarters.
As this period includes two recessions and the coronavirus crisis, the dividend growth streak is undoubtedly admirable.
The stock is currently offering a 4.3% dividend yield. Moreover, thanks to its disciplined business model, Realty Income spends less than 1% of its net operating income on capital expenses.
As a result, it enjoys excessive free cash flows and FFO. Furthermore, its payout ratio now stands at 75%, which is a decade-low level.
Given its reliable growth trajectory, its healthy payout ratio, and its solid balance sheet, Realty Income will continue raising its dividend for many more quarters.
2) Essex Property Trust Inc (NYSE: ESS)
Essex Property Trust was founded in 1971 and became a publicly traded REIT in 1994.
The trust invests in west coast multifamily residential proprieties where it engages in development, redevelopment, management and acquisition of apartment communities and a few other select properties.
Essex has ownership interests in several hundred apartment communities, which consist of more than 60,000 apartment homes.
Essex has grown at an impressive pace since its foundation thanks to the strong west coast property market.
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The REIT has issued a great number of shares but it has managed to grow its FFO at a faster pace. However, its business momentum has decelerated since 2014, when it merged with BRE Properties.
Since then, the number of shares has remained essentially flat but the growth of FFO has slowed. Essex has grown its FFO per share at a 7.1% average annual rate over the last decade but at a 2.5% average annual rate over the last five years.
On the bright side, Essex has proved much more resilient than most REITs throughout the coronavirus crisis thanks to the quality of its properties and the strong fundamentals of the west coast house market.
Essex has incurred just a 7% decrease in its FFO per share in the last two years. Even better, the trust is now recovering strongly from the pandemic and has provided guidance for FFO per share of $13.77-$14.13 in 2022.
At the mid-point, this guidance implies 12% growth over the prior year, to a new all-time high.
Thanks to its solid business model, Essex has grown its dividend for 27 consecutive years, i.e., every single year since its foundation.
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The trust has grown its dividend by 5.3% per year on average, much more than the 1.9% median dividend growth rate of the sector.
The meaningful dividend growth rate of Essex can compensate investors for the uninspiring current dividend yield of 2.7%, which has resulted primarily from the rich valuation of the stock.
Given its healthy payout ratio of 63%, its solid interest coverage ratio of 4.5, and its strong BBB+ credit rating, Essex is likely to continue raising its dividend meaningfully for many more years.
3) Federal Realty Investment Trust (NYSE: FRT)
Federal Realty is one of the largest REITs in the U.S. It was founded in 1962 and focuses on high-income, densely populated coastal markets in the U.S., which allow the trust to charge more per square foot than most of its peers.
Federal Realty has not proved immune to the coronavirus crisis.
Due to the impact of the pandemic on some of its tenants, the REIT incurred a 29% decrease in its FFO per share in 2020.
On the bright side, the trust partly recovered in 2021, when it retrieved approximately half of the lost ground. Even better, Federal Realty expects to remain in recovery mode this year.
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It signed a record number of leases in the fourth quarter of 2021 and has provided guidance for FFO per share of $5.75-$5.95 this year.
The mid-point of the guidance is just 8% below the pre-pandemic FFO per share of $6.33.
Federal Realty had grown its FFO per share every single year since 2012 until the onset of the pandemic.
The trust has grown its bottom line at a 2.9% average annual rate over the last decade but this growth rate somewhat underestimates the potential of the REIT due to the impact of the pandemic on its results.
We thus expect Federal Realty to grow its FFO per share by approximately 5% per year on average over the next five years.
This is much closer to the growth rate of the trust before the pandemic.
Moreover, Federal Realty enjoys some significant competitive advantages, such as its superior development pipeline, its focus on high-income, high-density areas, and decades of experience in its business.
Thanks to these advantages, the trust has grown its dividend for 54 consecutive years. In addition, it is currently offering a 3.5% dividend yield, with a payout ratio of 73%.
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The payout ratio is slightly higher than the target payout ratio of ~66% of the trust but it is likely to approach the target level as the REIT continues to recover from the pandemic.
Given also its healthy balance sheet, Federal Realty is likely to continue raising its dividend for many more years.
Final Thoughts on REITs
REITs are great candidates for the portfolios of income-oriented investors thanks to their attractive dividend yields, which are much higher than those of the broad market.
The above three REITs are offering attractive dividends with a wide margin of safety and hence they can constitute a safe haven for income-oriented investors in the current tumultuous investing environment.
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Disclosure: The author is not a licensed or registered investment adviser or broker/dealer. They are not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.
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