By Lisa Springer
Real estate investment trusts (REITs) can add diversification, stability and generous yields to any portfolio. This is particularly true this year, with the REIT sector returning nearly 18%, as a result of the improving real estate market. The fact that REITs have no risk of dividend tax hikes related to the "fiscal cliff" makes them even more appealing investments. This is because REITs never qualified for the Bush-era dividend tax cuts. Instead, REITs benefit from no corporate income tax, which results in higher dividend payments for investors. This also reduces the cost basis of the initial investment, since the dividends aren't taxed until shares are sold.
A downside to the strong performance in the REIT sector this year has been gradually-declining yields. At present, retail REITs yield only about 3.5%, while office REIT yields are just slightly better at roughly 4%. These are better than the 2% yield of the S&P 500 Index, but not that exciting for yield-hungry investors.
But I know a way to own REITs without sacrificing high yields: Preferred REIT shares. This year is shaping up to be a record year for preferred REIT stocks. U.S. REITs have raised about $7.02 billion through preferred equity sales so far in 2012, according to SNL Financial. Yields on recent preferred issues range as high as 7%, which is nearly twice the average yield for REIT common shares. The best part about these preferred stocks is that yields are fixed, so they don't fluctuate according to the REIT's earnings.
If you're looking for steady high yields, then here are three high-yielding REIT preferred stocks you should consider:
1. SL Green Realty Corp. (NYSE: SLG)
Coupon Rate on Series I Preferred: 6.5%
SL Green is New York City's largest office property owner and is the only REIT that focuses on Manhattan's business district properties. The REIT owns interests in 77 Manhattan buildings, totaling more than 39.3 million square feet of leasable space. SL Green also owns stakes in New York suburban areas totaling 5.4 million square feet, and California properties representing 4.5 million square feet.
The company's funds from operations (FFO), a key REIT cash flow metric, improved 9.2% to $4.14 per share in the first nine months of 2012 and SF Green signaled its confidence in future growth by increasing its dividend 32% to a new annualized rate of $1.32 a share. So far this year, the REIT has signed 240 leases covering nearly 3.9 million square feet, or roughly 8% of its portfolio.
SL Green Series I preferred stock has a 6.5% coupon and a "B+" rating. This is a huge spread given that common shares yield just 1.7%.
2. National Retail Properties (NYSE: NNN)
Coupon Rate on Series D Preferred: 6.6%
This is the country's second-largest single-tenant properties REIT and one of only four REITs that have produced dividend growth for 23 or more consecutive years. National Retail owns free-standing, net-leased properties characterized by long-term leases and low risk. Tenants are responsible for covering maintenance, utilities, taxes and other expenses. The REIT rents to about 300 different tenants. Their average lease term is 12 years. National Retail Properties Series D preferred stock was priced to yield 6.6%, well above the common shares yield of 5%.
National Retail owns 1,530 properties in 47 states with a gross leasable area of about 18.3 million square feet. This includes an investment of $452.6 million to acquire 124 properties so far in 2012. The portfolio occupancy rate is high at 97.9% and never fell below 93% during the worst years of the recession.
National Retails FFO increased 11% to $1.32 per share during the first nine months of 2012, and the company increased its full-year FFO guidance from $1.69 to $1.72 a share. That's more than enough to cover the per-share $1.55 annual dividend. National Retail targets roughly 4% FFO growth next year.
In addition, only a handful of the REIT's properties are encumbered by mortgages and the balance sheet is solid with about $1.5 billion in debt, representing roughly 42% of capitalization.
3. Healthcare REIT (NYSE: HCN)
Coupon Rate on Series J Preferred: 6.5%
Healthcare REIT is the nation's third-largest medical property REIT. The company's $16.5 billion medical properties portfolio includes senior living communities, medical office buildings, inpatient and outpatient medical centers and life science facilities. Healthcare REIT owns 1,030 properties and has established a presence in 46 states, the United Kingdom and Canada.
This REIT is focused on expansion and has grown its real estate portfolio 28% a year for the past five years. Healthcare REIT is closing the acquisition of 125 properties from former competitor Sunrise Senior Living. It has acquired $8.9 billion worth of health care real estate in the past two years. This REIT still has plenty of acquisition capacity with about $1.4 billion of cash on hand and $2 billion available on its bank line of credit. The balance sheet is strong. Long-term debt is $7.3 billion, which is just 31% of enterprise value.
Healthcare REIT increased FFO 6.8% in the first nine months of this year to $2.67 per share, which more than covered the $2.22 per share annualized dividend. The REIT anticipates full-year 2012 FFO to come in at $3.49 to $3.53 per share. Except for two quarters six years ago, Healthcare REIT has consistently raised the dividend. The latest increase was 3.5% in September to a new annualized rate of $2.96 per share, yielding 5.1%. The REIT plans another 3.4% dividend hike next year.
Conclusion: Given the huge spread between the yield on its common stock and preferred shares, SL Green may offer the best deal of the group, but all three of these REIT preferred shares provide safety and above-average yields.
Risks to Consider: REIT preferred coupon payments are fixed, but yields vary based on whether preferred shares are trading above or below par value. For that reason, I would think twice before purchasing any REIT preferred shares trading significantly above par value. Also, while preferred shareholders have no risk from dividend cuts, they also don't participate in the benefits from dividend hikes. There is some reinvestment risk for preferred share investors, since REITs generally can redeem preferred stock. Almost all REIT-issued preferred stocks have a five-year redemption period.