As most income investors know, higher-yielding investments often come with higher risk (payouts greater than 100%, volatility etc.). For years I have focused on investments that allow one to eat well-sleep well and many times, the focus has been on equity REITs - throughout the capital structure. In this article I will focus on the equity portion of the capital structure. Please note that financial information is from Bloomberg, BMO (via reitcafe.com) and company filings/presentations.
As many are aware, REITs must pay out 90% of their taxable income (a GAAP convention) while they are measured on their payout relative to funds from operations or adjusted funds from operations (often called funds available for distribution). This requirement, when applied to REITs with a stable operating portfolio and a conservative financial structure results in consistent income to investors. Below I have listed five high-yielding, high grade REITs.
My standard for inclusion (and rationale) is:
- Investment grade rated - the rationale is twofold: IG ratings help a company issue debt to a much wider investor base at lower yields and IG REITs have financial covenants the keep them from over-levering (or securing) their company and its assets. Note that I am using the senior debt ratings as these are most relevant to capital raising.
- Minimum $3B market capitalization - the rationale here is that companies with a market capitalization will have an easier time issuing equity to keep their financial structure balanced and the information content is typically greater.
- Sustainable payout ratio - the rationale for this is that a quality REIT should have a "margin for error" in order to sustain dividends. A payout of adjusted funds from operations greater than 90% makes me leery.
With that said, here are my candidates for inclusion into a balanced, eat well-sleep well REIT/income portfolio:
Digital Realty (DLR) [BBB/Baa2]
Digital Realty Trust, Inc. engages in the ownership, acquisition, development, redevelopment, and management of technology-related real estate. Digital Realty's 98 properties, excluding three properties held as investments in unconsolidated joint ventures, include approximately 17.4 million square feet as of October 27, 2011, including 2.1 million square feet of space held for redevelopment. Digital Realty's portfolio is located in 31 markets throughout Europe, North America, Singapore and Australia.
Dividend yield: 3.90%
AFFO Payout (2011 consensus AFFO): 82%
2011 total return: 35%
Market Cap: $7.5B
Fixed charge coverage: 3.7x
Why digital realty? The company has been experiencing tremendous growth as the outsourcing of datacenters and the use of "cloud" based computing (and subsequent need for datacenters) has increased. The company's platform covers all the bases (build to suit/powerbase, turnkey solutions and sale/leaseback) and the company has a conservative financial profile as well as a sustainable payout percentage. Over the last five years, the company has grown EBITDA at a 32% CAGR, grown FFO at a 19% CAGR and grown the dividend at a 18% CAGR.
Realty Income (O) [Baa1/BBB]
Realty Income Corporation owns and manages a portfolio of commercial properties located across the United States. The company focuses on acquiring single-tenant retail locations, leased to regional and national chains, and under long-term net lease agreements.
Dividend yield: 4.80%
AFFO Payout (2011 consensus AFFO): 87%
2011 total return: 7.5%
Market Cap: $4.9B
Fixed charge coverage: 2.8x
Why Realty Income? Realty income has built the franchise around paying dividends monthly (both preferred and equity) and has structured finances in such a way as to allow flexibility and yield. (I did a deeper analysis of O here. Management is known for both the ability to analyze tenant credit as well as maintain a high occupancy rate. As a result, the company has recorded 56 consecutive quarterly increases in the dividend while maintaining a sustainable payout ratio.
Kimco Realty Corporation (KIM) [Baa1/BBB+]
The company is an owner and operator of neighborhood and community shopping centers. As of December 31, 2010, it had interests in 951 shopping center properties aggregating 138 million square feet of gross leasable area (GLA) and 906 other property interests, primarily through the company's preferred equity investments, other real estate investments and non-retail properties, totaling approximately 34.4 million square feet of GLA, for a total of 1,857 properties aggregating 172.4 million square feet of GLA.
Dividend yield: 4.16%
AFFO Payout (2011 consensus AFFO): 78%
2011 total return: -5.9%
Market Cap: $7.4B
Fixed charge coverage: 2.5x
Why Kimco? Kimco is the largest operator in the shopping center space. This alone does not warrant inclusion, but the company's history of managing through cycles and keeping a conservative financial profile while doing so warrants inclusion. As Kimco is the epitome of anchored retail, it has mastered expanding the franchise into new locations and maintaining high quality portfolio (and fund) properties (its move into Mexico is a prime example of this). The supply of new retail properties is also near its lowest point in decades, increasing the company's pricing power as evidenced by recurring retail revenue growing at approximately 8% over the last five years.
Ventas (VTR) [Baa2/BBB]
Ventas, Inc. is the leading seniors housing and healthcare real estate investment trust in the United States, with a highly diversified portfolio of over 1,300 senior housing and healthcare properties in 46 states, the District of Columbia, and two Canadian provinces.
Dividend yield: 3.93%
AFFO Payout (2011 consensus AFFO): 76%
2011 total return: 9.8%
Market Cap: $17B
Fixed charge coverage: 4.3x
Why Ventas? Demographics are on the side of this REIT with the senior housing portfolio (85+year old age group forecast to grow at 2.8% CAGR over the next 25 years) and demand is on its side for medical office building (often on the same campus). The REIT is well diversified and financially conservative. The company has a history of dividend increases while rolling up many players within the industry. In the period 2004 to 2011 the company has averaged an 8% annual dividend growth while keeping payout at sustainable levels.
Duke Realty (DRE) [Baa2/BBB-]
Duke Realty Corporation owns and operates approximately 143 million rentable square feet of industrial and office assets, including medical office, in 18 major U.S. cities.
Dividend yield: 5.01%
AFFO Payout (2011 consensus AFFO): 90%
2011 total return: 2%
Market Cap: $3.5B
Fixed charge coverage: 1.8x
Why Duke Realty? Duke is somewhat of a value play in the bunch as the industrial and office sectors have been pretty well beaten up over the last few years - but seem to be turning the corner as occupancy rates increase (portfolio occupancy at 90.7% Q3 '11) and NOI growth strengthens (2.1% same property NOI growth in Q3 '11). The company is in the middle of a portfolio repositioning program, which will reduce the office investment (evidenced by the $1B, 10MM SF office portfolio sale to Blackstone) and redeploy it into high quality industrial and medical office. The company has stated goals to increase financial strength (<6x debt/EBITDA, 2x FCC) and maintain a healthy payout ratio.
The above companies are leaders in their chosen markets, are geographically diversified, financially sound and high grade with dividend yields above that of "non-REIT" common equity and share-price upside potential. These companies should allow an investor to eat well and sleep well, which, in my opinion, translates into strong core holdings.