SCHH: Buy The Correction, 3 Must-Have REITs To Own

Summary

• REITs are popular with income investors because of their high dividend yields. They are also an asset for growth investors because the market value of REITs increases as their assets.
• Schwab U.S. REIT ETF is an ETF with an exposure to 128 American REITs.
• The regional banking crisis could indicate a slowdown in interest rate increases. This is a positive sign for REITs' values.
• In my article, I describe 3 REITs from the SCHH ETF that are very attractive to invest in.

Kwarkot

Introduction

REITs are popular with income investors because of their high dividend yields. They are also an asset for growth investors because the market value of REITs increases as their assets grow.

Schwab U.S. REIT ETF (NYSEARCA:SCHH) is an ETF with an exposure to 128 American REITs. The low expense ratio of only 0.07% makes this a suitable ETF to gain exposure to REITs cheaply.

The allocation of REITs is distributed as follows in the Schwab U.S. REIT ETF (see the image below). The ETF is now trading at a small premium of 0.11%. The dividend yield totals 3.1%, and the dividend has had a wild ride. It declined until 2021, and as of 2022 the dividend is rising again. That’s why I took a closer look at 3 interesting REITs within this ETF with steadily growing dividends.

Schwab U.S. REIT ETF Holdings (Charles Schwab Asset Management)

REITs have recently experienced a price correction due to increased interest rates --investors aim to buy safe government bonds rather than REITs. Investors are beginning to question whether the dividend yield and dividend growth are attractive compared to these bonds. My ideal REIT has an attractive dividend yield plus dividend growth.

The regional banking crisis could indicate a slowdown in interest rate increases. This is positive for REITs because 1. These companies can refinance their debt at lower interest rates, and 2. Because equity valuations rise when interest rates are lower.

In my article, I describe 3 REITs from the Schwab U.S. REIT ETF that are very attractive to invest in.

#1 Prologis

Data by YCharts

The first REIT that is attractive concerns Prologis (PLD). I recently wrote an article about this. Prologis is one of the largest REITs specializing in logistics real estate solutions. With tenants like Amazon, FedEx, DHL, UPS and the like, Prologis has a strong position and investors can expect a steadily growing dividend. Not surprisingly, Prologis' allocation in the Schwab U.S. REIT ETF is very high at nearly 10%.

Its total return over ten years is even higher than that of the S&P500. Prologis achieved 293% return, compared to 207% for the S&P 500.

Prologis is a good buy as revenue and adjusted funds from operations grew strongly in 2022 by 26% and 22% compared to 2021, respectively. Prologis also expects 10% rental growth and 9% overall growth for 2023. So the outlook looks strong. The balance sheet also looks neat. The average maturity of debt is 9.1 years, so no worries about rising interest rates.

REITs distribute 90% of their taxable profits to shareholders in the form of dividends, and for Prologis that represents a dividend yield of 3.1%. The dividend is expected to grow 5.9% next year, in line with historical growth (excluding the sharp increase in 2022). Prologis is worth buying because of its strong growth, strong balance sheet, rising dividend and attractive stock valuation.

#2 American Tower

Data by YCharts

At number 2 is American Tower (AMT). I also covered this stock recently, in February of this year. I gave it a "buy rating" because the price correction offers an attractive entry point. The business model is focused on the rental of wireless infrastructure. This is a lucrative business because many users are glued to their cell phones on a daily basis. Growth toward new Internet technologies (5G) continues to increase, guaranteeing American Tower a stable revenue stream. American Tower develops and leases its towers, but does not lease 5G (or other wireless) equipment. This reduces their risk of technology stagnation.

Revenues increased 14% in 2022 and Funds from Operations increased 9%. Although analysts expect FFO to show a small decline next year, the outlook beyond 2023 looks fine. Like Prologis, the dividend yield is now 3.1% and the dividend rate is expected to rise strongly at 10.8%.

#3 Realty Income

Data by YCharts

At No. 3 is Realty Income (O). Many know Realty Income as a leader in triple-net leases, where tenants are responsible for property taxes, maintenance and insurance. It is a lucrative profit model with significantly higher profit margins than, say, American Tower.

Realty Income operates internationally and has well-known tenants such as J Sainsbury's (OTCQX:JSNSF) in the UK, 7-eleven, Chipotle Mexican Grill (CMG), Walmart (WMT), Starbucks (SBUX) and so on.

What is interesting about Realty Income is that they pay the dividend monthly. This is beneficial for income investors who have dividends as their only source of income. The dividend yield is now a solid 5%, and the dividend rate is expected to increase by 3.3% next year. Historically, the average dividend yield has been 4.2%. With the current dividend yield at 5%, it is safe to say that Realty Income's shares are undervalued. So the recent stock price correction provides a good opportunity to get in cheaply.

Risks To Mention

Of course, potential risks must also be considered before making an investment decision. REITs distribute 90% of their taxable income to shareholders, leaving only 10% in cash on their balance sheet. REITs finance properties by borrowing from banks, issuing bonds or issuing shares. The debt will be refinanced at maturity or, on the other hand, properties are sold to pay off the debt. Rising interest rates are the biggest risk for REITs because refinancing rates will be higher.

Asset values will also fall as interest rates rise, and so will equity values. Investors are considering investing in safe government bonds or REITs. The trade-off is mainly in the dividend yield versus government bond yield, and the expected growth in dividends per share.

A second risk is a possible recession due to the regional banking crisis. However, I do not think this crisis will persist because regional banks are largely backed by large banks. So depositors need not fear that they will not see their money back. It is also noteworthy that 3 major crypto banks have collapsed: Silvergate, SVB Financial and Signature Bank. First Republic received a solid liquidity boost totaling $30 billion from major banks. To me, this gives confidence in the financial system.

Key Takeaway

• The Schwab U.S. REIT ETF is an interesting investment to gain exposure to U.S. REITs.
• My preference for REITs involves an attractive dividend yield plus dividend growth.
• 3 REITs from the Schwab U.S. REIT ETF are very attractive to invest in. These offer a high dividend yield and the dividend is expected to grow steadily.
• Prologis has well-known tenants such as Amazon, FedEx, DHL, UPS and the like. As a result, it has a strong position and investors can expect a steadily growing dividend.
• Growth toward new Internet technologies (5G) continues to increase, guaranteeing American Tower a steady revenue stream.
• Realty Income's triple-net lease model is lucrative because it generates significantly higher profit margins than other REITs.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.