- REITs are appealing due to their high yields.
- Dividend Growth Investors stay away from many REITs due to the inconsistency of their dividends.
- Taken as a whole a group of REITs can still be an appropriate investment for DGIers.
As a dividend investor I have always been intrigued by REITs and their high yields. And as I look to increase my income, I find the dividends they pay to be very appealing. I hope to eventually fund my retirement using just my dividends, and the large dividends from REITs would go a long way in helping me achieve that goal. But as a dividend growth investor their uncertainty has made me wary of them. The problem is that the dividend stream from REITs seems to be much more variable than the one from the usual DGI stocks such as KO or MCD.
I'm looking for my stocks to grow their dividend year after year. And this is something you do not find with most of the REITs. I presently do own some REITs, including DLR, O, and OHI. But I've always been attracted to the mortgage REITs such as NLY and DX which tend to have a much higher yield. But with that higher yield comes higher risk. In fact both NLY and DX have cut their dividend in the past year. Twice. If I buy REITs for my portfolio, but sell them as soon as any of them cut their dividend (which is the rule that I use to decide when to sell any of my stocks), the group as a whole may not last very long. To try to prevent this from happening I would hope to invest in the best REITs, the ones with the strongest financials, and the best history of dividend payments. If possible I would like to find a way to get the benefit of the high yield, while minimizing the risk.
In the comment section of a recent article on SA I saw where someone described how they had created their own personal Canadian bank ETF by buying many of the best Canadian banks, rather than trying to pick the single best one. I thought perhaps this is something I could do with REITs, set up my own personal REIT ETF. I know that there are already REIT ETFs in existence, but by creating my own I could pick and choose which ones I wanted in the "ETF." But I questioned the long-term viability of doing this. Would the up and down nature of their dividends, and likely their prices, cause the "ETF" to be a poor long-term investment? How would this work over the long term? It would help my peace of mind to know that investing in a basket of REITs would be an effective, long term, income producing and total return strategy. To try to figure this out I decided to look at the past performance of REITs.
Most back tests are worthless due to survivorship bias. Picking REITs in existence now, and looking back to see how they would have fared had I bought them many years ago would skew my results because I would automatically be choosing from the REITs that have survived. Any REIT which had gone out of business would not be included in such a study, so the results would not be valid. But I have a secret weapon. I have two books that were published in 1997 and 1998. They are Standard and Poor's 100 Best Dividend Paying Stocks, and Moody's Handbook of Dividend Achievers. Between the two books there are thirteen REITs that were mentioned as the "best" REITs at the time. So I used these thirteen REITs to create a portfolio, and then I followed it forward in time to see how well the portfolio performed. This is the closest I could come to performing a prospective study. I know it's not perfect, because I cannot account for decisions that would have been made during the 17 years of the study, but it is still better than a retrospective study.
Here is how my "prospective" study went.
These were the thirteen REITs mentioned in the two books. The stocks, and their beginning yields, are as follows:
- Commonwealth REIT (CWH) (7.7%)
- Criimi Mae ((NYSE:CMM)) (7.5%)
- Capstead Mortgage Corp. (NYSE:CMO) (9.2%)
- EastGroup Properties (NYSE:EGP) (6.8%)
- Federal Realty Investment Trust (NYSE:FRT) (6.1%)
- Health Care Properties (NYSE:HCP) (7.5%)
- Meditrust ((NYSE:MT)) (7.3%)
- Merry Land trust (MRYP) (7.0%)
- New Plan Realty Trust (NPR) (6.3%)
- United Dominion Realty (NYSE:UDR) (7.7%)
- United Mobile Homes (NYSE:UMH) (5.6%)
- Weingarten Realty Investors (NYSE:WRI) (5.8%)
- Washington Real Estate Investment Trust (NYSE:WRE) (6.3%)
$10,000 was invested in each of these companies on Feb 18th, 1997, the date used for the stock data in the Standard and Poor's book. For those companies that are still in existence today their returns were calculated based on their closing price on 5/8/14, and with the assumption that all dividends were reinvested. Nine of the original 13 companies are still in existence. They are CWH, CMO, EGP, FRT, HCP, UDR, UMH, WRE, and WRI. The historical price and dividend performance for these stocks was taken from Yahoo.com.
Some of the companies were bought out for cash. In these cases the cash received was invested equally back into all of the remaining stocks.
NPR merged with Excel Realty in 1998, and then was bought out by Centro in 2007 for $33.15 per share.
MT had a very complicated history after being mentioned in the book and was somewhat difficult to follow. From the best I could tell it changed its name to La Quinta (LQI) and was later bought out by Blackstone in 2006 for 3.2B dollars. I could not find an actual buyout price per share, but by comparing the 3.2B to the market value of MT in 1997 (2.3B), I calculated an overall return and applied that to the $10,000 initial investment. I'm sure this did not give a perfectly accurate result for the return from MT, especially since reinvested dividends were not accounted for, but it was the best I could do with the information I could find.
MRYP was bought out by Equity Residential (NYSE:EQR), and MRYP shareholders received 0.53 shares of EQR for each share of MRYP. For my study these shares remained in the portfolio and are included as the final result for the initial MRYP position.
Finally, CMM went bankrupt in 1998. For the purposes of this study this was considered to be a complete loss, even though an investor most likely would have been able to salvage some of the investment. But to make sure I remain conservative and don't overstate the returns, I decided to give a final value of $0 to this position.
Once the final value of each position was determined they were added up, and the overall portfolio return was calculated.
Here is the final value of each of the thirteen positions, and the annual return of each of the REITs that still exist:
The portfolio as a whole started with an investment of $130,000 in Feb of 1997 and grew to a final value of $606,184.32 (as of 5/8/14). This is an annual return of 9.34% for the entire portfolio. This is in comparison to the S&P 500 ("The Market"), which returned 6.31% over the same time period.
Of course someone investing in REITs is most likely holding them for the income. So it's also important to see what kind of income this portfolio produced over this time period. Here is a chart, and a graph, of the total income received from this portfolio each year:
A special dividend was paid by CMO in 2001 and 2003, explaining the spike in income for those two years. These income numbers are actually probably a little lower than they actually would have been, at least in the early years, because the dividend paid by CMM, MT and NPR were not included since that information was not available to me. Still, the steady growth in dividend income is impressive.
The dividend growth rate for the portfolio for the 17 year period was 7.27%.
This portfolio of presumably (based on recommendations from the two books) high quality, high yielding stocks outperformed the S&P 500 over the past 17 years. An investor who invested in the group of REITs as a whole would have done very well on both a total return, and an income basis. This is over a time period which included the dot.com bubble and crash, and the financial meltdown. And even during the time period of 2007-2009, when many companies, especially financial companies were cutting or eliminating their dividends, the income from this portfolio would have held up very well, decreasing slightly in 2010, but then immediately growing again in 2011.
Of course we all know that past performance does not guarantee future success. Would a similar portfolio of REITs perform just as well in the future? I don't know. Is the good performance of this portfolio at least partially due to the shrinking of interest rates over this time period, and the desire of investors to reach for yield? Probably. But I don't think it accounts for all the return. People will always be interested in high quality high yielding investments, and REITs can fit that bill. And this study shows that if you invest in a basket of them, forming your own REIT ETF, even if some perform poorly, or even go bankrupt, the portfolio as a whole may still deliver excellent income and total return.
I already own many REITs, including, Digital Realty Trust (NYSE:DLR), Annaly Capital Management (NYSE:NLY), Realty Income Corporation (NYSE:O), and Omega Healthcare Investors (NYSE:OHI), and I will most likely add more in the future. After doing this study I feel more secure that over time the group as whole should do well for me, and that by considering all of them as a group, rather than as individual stocks, a personal REIT ETF can be an acceptable holding for a DGI portfolio.
Thank you for reading my article. I welcome your comments and criticisms.
Disclosure: I am long NLY, O, OHI, DLR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: This article is not a recommendation to buy any stock or investment. I am not an investment professional. Please do your own due diligence before buying any investment.