Despite rising rates that dinged the performance of this asset class in late spring, and a widely held belief the Federal Reserve will raise short-term interest rates sooner rather than later, REITs may be worth a look, said Jon Beadell, a Mequon money manager.
“They offer a good yield and, because they did so poorly last year, there may be a little less risk in these compared to the average equity out there,” said Beadell, research analyst and portfolio manager at A.D. Beadell Investment Counsel Inc. in Mequon.
REITs, which own income-producing properties and pass the majority of their income through to investors in the form of healthy dividend payments, eked out average returns of just 2.5 percent in 2013, as measured by the MSCI U.S. REIT Index. The Standard & Poor’s 500 index had a total return of 32.4 percent, creating the widest gap between the performance of real estate stocks and the broader market since 1998.
Some worry that REITs will always perform badly when interest rates are rising, but they generated a 12.6 percent annual return during six rising rate cycles since 1979, according to a report published in April by REIT specialist Cohen and Steers.
Yields on 10-year Treasury notes, which were about 1.8 percent in early 2013, now are around 2.8 percent. Many expect the Federal Reserve to raise rates, although perhaps not until at least 2015.
“If economic growth continues to sputter, rates don’t rise and inflation remains subdued, then people will value the income and defensive nature of the REITs,” Beadell said. And if the economy takes off, REITs will continue to deliver healthy yields, he added.
Vanguard REIT Index ETF (VNQ, $66.28) is an option for investors looking for broad exposure to REITs, Beadell said. This fund seeks to provide a high-income level and moderate capital appreciation by tracking the performance of an index of publicly traded equity REITs.
Realty Income Corp. (O, $39.54), Escondido, Calif., specializes in so-called triple net leases, where the tenant is responsible for taxes, maintenance and insurance, along with rent. The company historically had mostly retail tenants, but has expanded to industrial, distribution and other nonretail tenants, Beadell said. Major tenants include Federal Express, Walgreen, Family Dollar and LA Fitness.
Realty Income has had an average occupancy rate of about 98 percent since 1970, Beadell said.
With exposure to more economically sensitive tenants, Realty Income should be able to raise rents if the economy performs well, he said. The company has grown its dividend at an annual rate of about 6.2 percent over the last decade, and has a 5.7 percent dividend yield, he said.
Realty Income shares have a 52-week trading range of $36.58 to $55.48.
Health Care REIT Inc. (HCN, $55.92), Toledo, Ohio, focuses on senior housing and skilled nursing facilities, hospitals, medical offices and life science buildings, mostly in the U.S.
Health Care REIT is well positioned to benefit from the aging of baby boomers, Beadell said. Sixty percent of its properties are senior housing, with half of those in triple net leases. The company operates the remainder, and that is its fastest-growing segment, he said.
Health Care REIT has increased its dividend at an annual rate of 2.5 percent over the last decade and has a 5.5 percent dividend yield, Beadell said.
The Health Care REIT shares are trading in a 52-week range of $52.43 to $80.07.
The biggest risk with both REITs is that they have had to alter their business models – Realty Income by expanding beyond retail and Health Care REIT by operating some of its senior housing properties, Beadell said. Both REITs have potential to provide an annual total return of 8 percent to 10 percent, he said.
Copyright © 2014 the Milwaukee Journal Sentinel, Distributed by MCT Information Services.
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