Seeking Alpha
Research analyst, portfolio strategy, income investing, REITs
Profile| Send Message| ()  

Three secular-growth stories that most Americans agree on today are the aging demographic, urban growth and the expansion of technology. Several real estate investment trusts (REITs) are in position to capitalize on these trends, which include healthcare, retail and office REITs.

Since the US stock market peaked in May 2013, the MSCI US REIT Index, a broad measure of the US REIT market, has pulled back 11.33%. With income a major directive of investors, especially those who are disappointed by cash and bond yields, REITs in general are attractive as their directive is to legally avoid corporate taxes by distributing at least 90% of their taxable income to investors (source: SEC website).

For income-oriented long-term investors, the following three sectors offer seven REITs at discounted prices and competitive yields. Each company preaches and produces stable and increasing dividends, while two REITs actually distribute dividends monthly rather than quarterly (another boon for income investors, who may prefer monthly draws).

Sector #1 - Healthcare

The economics of healthcare properties in the United States is one of a tremendous long-term demand story. There are a limited supply of healthcare properties with investments rushing to keep up. As the population ages, the demand continues to increase.

The leader in this field is HCP, Inc., (HCP) a $20.9 billion healthcare facilities REIT based in Long Beach, CA. HCP is the market leader in the healthcare REIT field. HCP was the first healthcare REIT to be put in the S&P 500, is the largest healthcare REIT by market value and has a 28-year history of increasing dividend distributions.

HCP owns a diversified basket of healthcare-related properties that include senior housing, skilled nursing facilities, life sciences buildings, medical offices and hospitals. Such a portfolio gives the company exposure to the growing senior population, while also providing versatility through other property types that will benefit from demographic trends and healthcare advances.

(click to enlarge)

Complementing HCP are two other large-cap healthcare REITs that warrant investor attention. The second largest healthcare REIT is Ventas, Inc. (VTR) valued at $20.37 billion. Ventas seems very similar to HCP, with the only major difference is a heavier 51% weighting in senior living facilities, versus HCP's 36%.

The third largest healthcare REIT, Health Care REIT, Inc. (HCN), is valued at $17.5 billion. With the recent acquisition of Sunrise Senior Living, HCN is now the dominant force in senior living worldwide with over 58,000 units.

All three of these companies have a similar historical stock performance, an increasing dividend and a diversified basket of healthcare properties. Each is valued between $17 and $21 billion, dwarfing over their competition in size.

In venturing down the pipeline, there are also small-cap healthcare companies worth investor consideration. One option is Medical Properties Trust (MPW), a $2.07 billion healthcare REIT operator based out of Birmingham, Alabama, that currently yields 5.4% and has had a stable dividend since 2005.

Most healthcare REITs focus on diversified portfolios; however, MPW is focused exclusively on hospitals. As the highest-percentage of Medicare payments for healthcare services and supplies are reimbursements for hospital care, MPW benefits. To ensure continued Medicare reimbursements, the company also follows Medicare legislation closely in D.C. to discuss with their hospital operators.

(click to enlarge)

This close landlord and tenant relationship also benefits MPW and their operators through real estate based asset funding. MPW understands that the operators must continue to invest in new technologies and equipment to stay relevant. If the hospital operator needs a new hospital facility, the company will discuss building a property to suit. When operators need capital for new equipment, MPW will consider a capital loan, making them the one-stop financial shop for an operating partner's capital needs (source: 2012 annual report).

Sector #2 - Retail

While healthcare REITs serve well regarding demographic and government compensation trends, another way to profit from secular growth is to invest alongside urban sprawl with retail REITs, the most dominant REIT sector in the world. As populations become more dense, traffic increases and retail revenues expand, thus increasing the value of retail property.

While there are many retail REITs in the US, one company is virtually unknown to retail investors and producing a 6.2% yield. This is American Realty Capital Properties (ARCP), a monthly income company that was founded in New York City in 2010. Over the past 52 weeks, the company is up nearly 40%, however due to the recent pullback, it now sits slightly below its 50-day moving average.

This newcomer has a strong, increasing dividend history with monthly distributions. The company owns 701 properties across 45 states and Puerto Rico, with major tenants that include FedEx, Walgreen, General Mills, Bed Bath & Beyond, Citizens Bank and Kaiser Permanente. Their properties are 100% occupied and a majority of their tenants have an investment-grade rating (source: company website).

(click to enlarge)

In reviewing other retail REITs for investment, the largest two US companies are Simon Property Group Inc. (SPG) and General Growth Properties Inc. (GGP), with market capitalizations of $59.6 and $19.3 billion, respectively. With investors earning respective yields here of 2.8% and 2.3%, the income-yield on capital invested in these large-cap REITs is modest compared to ARCP.

Another small-cap company in the retail sector is Realty Income Corporation (O), a competitor of American Realty Capital Properties. Realty Income is valued at $8.6 billion and also distributes a growing monthly dividend. This company yields 4.9% and is heavily diversified with over 3500 properties. O has a 54-year history and a tenant occupancy rate of 97.7%.

O and ARCP have some very important similarities. The CEO, President, CFO and COO of ARCP all came from American Realty Capital Trust, a REIT that O purchased in 2012. Also, both O and ARCP distribute monthly income derived from the retail REIT sector. With similar structure, vision and management, these companies are easy to compare side-by-side.

O and ARCP both offer a great yield with strong upside growth prospects, however ARCP is distributing 25.8% more money to shareholders. By analyzing the yield differential on a cash basis, a 10k investment in ARCP will yield nearly $620, while O will yield about $493. By trading up the yield curve, O investors could swap out for a nearly-identical, yet smaller version REIT to generate a higher income. The ARCP income-investor is generating 25.8% more cash than the O investor, while the O investor is generating 20.5% less cash than the ARCP investor at these levels (two ways to tell the same story).

(click to enlarge)

Sector #3 - Office Space

When venturing into the office REIT sector, there are many risks as there are low barriers to entry, high inventory and stagnant growth. According to Bloomberg however, "the demand for office space is strongest in areas where technology and energy firms are major employers."

One of the top 20 REITS in the United States and leader in the technology-landlord space is Digital Realty Trust (DLR). This $7.66 billion office REIT, based in San Francisco, California, yields 5.2% at current levels. Also to note, each year since the company went public in 2004 there has been a dividend increase. In fact, the dividend growth is remarkable. What started out at 15.6 cents per quarter is now 78 cents per quarter, an outstanding 400% total increase.

DLR owns 123 properties, which range from North America (80%) to Europe (18%) and Asia (2%), has over 600 tenants and leases only to companies with an investment grade rating. The company has a strong balance sheet and operates in a field that has high barriers to entry and a strong secular demand trend.

The company is banking on the two major trends of this demand story, data storage and the evolution of IT. Data storage involves corporate data, social networking, telecom, stock trading and online retail sales, while IT expansion is required for cloud computing, outsourcing and cost management.

According to DLR, in 2013-2014, 98% of technology corporations are looking to expand their facilities and 80% are seeking a partner. DLR is the market leader in North America, positioned well to capitalize on these trends. Current tenants include Verizon, AT&T, Starbucks, Visa, JP Morgan Chase, Deutsche Bank and Pepsi (source: Company Overview June 2013).

(click to enlarge)

When searching for growth, secular demand stories are to investors what nursery rhymes with happy endings are to children. To capitalize on the technology expansion era, the allure of collecting a 5.4% and growing yield alongside the strong balance sheet of DLR is a compelling story.

Secular-Growth REITs Pricing & Yield

To recap, several REIT stocks are set to benefit from three major secular-growth trends: the aging demographic, urban sprawl and technology expansion. With the recent pullback offering a discounted entry-point into REITs as a whole, the seven companies discussed here are all being offered at deep discounts to their 52-week highs. Each is off between 16% and 26% from their high, with the average discount coming in at 19% (median = ^MED).

(click to enlarge)

As a basket, this group of seven offers a median yield of 5%, with individual yields ranging from 3.9% - 6.2%.

(click to enlarge)

The MSCI US REIT Index, mirrored by the Vanguard REIT Index ETF (VNQ), is off its high as well. The basket of secular-growth REITs reviewed here are discounted much further than VNQ.

(click to enlarge)

As a bonus, these REITs also collectively yield an average of 5%, which equates to over 43% more income in dividend payments per year versus VNQ ((^MED-VNQ)/VNQ*100).

(click to enlarge)

In today's investment climate, many income-oriented investors are looking for stable companies with bright futures and most importantly, stable and increasing dividends. For income-investors who allocate a portion of their portfolio in stocks, a 10-25% weighting of REITs versus total stocks owned may help boost aggregate income while setting the stage for both dividend growth and long-term capital appreciation.

Source: 7 Secular-Growth REITs To Generate Income Now