Make REITs a part of your portfolio

Real estate investment trusts are having a fabulous cycle, rewarding shareholders with both dividends and appreciation.

By May 13, 2013 1:59PM

Home for sale copyright Digital Vision Ltd.The's Nancy Zambell sat down with R. Brad Thomas of the Intelligent REIT Investor to discuss why real estate investment trusts (REITs) have grown so popular of late.

My guest today is Brad Thomas, the founder and editor of a brand new REIT newsletter called Intelligent REIT Investor. Thanks for joining me, Brad.

Always glad to be here. Thank you so much.

You do a lot of writing for Forbes, Seeking Alpha, and Motley Fool, but this newsletter is a new venture for you. Why don't you tell us a little bit about what that is going to include?

I'm focusing this newsletter on the retail investor -- not the institutional investor -- and the reason is, the retail investor really thinks about dividends. That's the most important thing today for people who are investing in REITs. Unlike institutional investors who really focus more on total returns, this has really been strategically crafted for the retail investor.

I know that your philosophy is that REITs should be good for investors pretty much at any time, that everyone should always have a REIT in their portfolio. And that has not always been the case with financial advisors.

You're absolutely right. REITs have been around since 1960, which was in the Cigar Tax Extension signed into law by President Eisenhower. We really have over 50 years of history. It's still a fairly new sector, but still there's been a lot of historical evidence to support the fact that real estate should be a core component to an investor portfolio.

This year, the REITs have just done phenomenally well. I'm looking at the returns of the FTSE NAREIT index and industrial/office returns are almost 27%; retail, 31%; residential, 25%. Those are healthy returns.

REITs are forced to pay out dividends. That's a law. So, because of that forced demand -- that forced dividend component -- dividends are really, really attractive today.

Especially when you compare a REIT dividend to a non-REIT dividend. You're seeing some really attractive alternatives today, and that's really what's driving that demand in the market today.

What is the average yield for equity REITs?

Off the top of my head, it's around 3.5% on dividend. However, I think the total return so far this year for the equity REITs is somewhere in the low teens -- 13% or 14%.

So it's pretty amazing. You're right, most of the REITs have really done well. There's a lot of wind behind the sails today based on this demand for income.

You're not a big fan of mortgage REITs. Why is that?

Mortgage REITs are very leveraged. In my opinion, mortgage REITs do not belong in a retirement portfolio. They're just way too volatile because of the leverage.

Obviously, we're in a market -- in an environment today -- where interest rates are at historical lows. But there is a day coming -- who knows when -- where REIT interest rates will go up.

In the equity REIT sector, most of the management teams have really deleveraged balance sheets. They've really been focused on balance sheet fundamentals and reducing risk and preparing for that storm. I think the storm today is interest rates, rising interest rates.

Do you have any favorite sectors right now in the equity REITs?

Funny you mention that. There are a lot of new sectors, so it's hard for me to get a favorite, because every time I like one there's a new one.

One sector I really like is the data sector. Three years ago, if you asked me what a data sector REIT was, I couldn't have told you the answer. But I've been to several conferences trying to get more knowledgeable in the data space.

Today you've got four data REITs. Digital Realty (DLR) is the largest. They've got around an $8 to $9 billion market cap. There are three other small ones. Combined, that industry's around $10 billion.

Equinix, which is also a large data sector company, is not a REIT yet, but they have announced their intention to be converted to a REIT. It's around $10 billion. In the next several months, this industry could go to $20 billion and much, much larger. There's a lot of demand for cloud-based storage today, and that's really what this business model is all about.

Another sector I really like, which is really very defensive -- perhaps the most defense sector today -- is the triple net sector. Those are the single tenant long-term leases -- companies like Realty Income (O), National Retail Properties (NNN), or W.P. Carey (WPC).

I just interviewed NNN a couple of weeks ago, and they have just had a fabulous year.

Absolutely. At National Retail Properties, Craig McNabb is in charge. He's doing a splendid job there.

Interesting thing about National Retail is they have not only paid dividends every year for I believe 22 or 23 years now, but they've also increased it every year -- an amazing record. In fact, they're a dividend aristocrat, which means that they made it to 20 years. Now S&P ranks the dividend aristocrats over a 20-year period. National Retail is definitely a crown jewel of a REIT.

When you're analyzing a REIT, what are the top two things that you're looking for? I know it's not just yields.

Yield is important and I think No. 1. That's why most retirees invest in REITs today -- based on the dividends.

Dividend safety is No. 1, and that means how sustainable is that dividend? I really look at a very high level at the income behind the dividends. Of course, the earnings of the REITs are measured on funds from operations, which is a little different from earnings. But nonetheless, I look very hard at the income that drives these, the occupancy trends, and also the future occupancy projections.

I really focus hard on the income fundamentals, then I'll go to the balance sheet. As I alluded to earlier, I like companies that have very low leverage -- somewhere around 35% debt to market cap, or lower. I don't like to see a lot of leverage on the balance sheet.

National Retail Properties has around 1% of secured mortgage debt, so that means 99% of their portfolio is unsecured. They obviously have an investment grade rating as well.

Read more about the Intelligent REIT Investor here.

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