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15 REITS for Retirement Income

The following first appeared on Kiplingers.com as The 15 Best REITs for Retirement Income

Few asset classes are better suited to retirement portfolios than real estate. If managed sensibly, a portfolio of real estate investment trusts (REITs) can provide a steady stream of retirement income that will last a lifetime.

To start, REITs are incentivized by the tax code to pay outsize dividends. REITs pay no corporate tax at the federal level so long as they distribute at least 90% of their taxable income to their investors as dividends. The U.S. corporate tax rate is a punishing 35%, so we’re talking about a lot of extra cash.

But a good retirement income portfolio needs more than just a high dividend yield. You also want rock-solid stability. If you intend to live on cash from your investments, you can’t afford to suffer a dividend cut or a major business setback. So your best REITs for retirement will tend to be moderate yielders in stable, non-cyclical subsectors. Experience also counts for a lot here – you typically want to trust REITs that have survived a recession or two with their dividends intact.

Today, we’re going to look at 15 of the very best REITs to generate long-term retirement income. You’ll notice certain areas are missing, such as malls and office buildings; these are too sensitive to economic swings, and their biggest players slashed dividends during the 2007-09 meltdown and aftermath. Instead, you’ll find 15 reliable companies that should continue paying their dividends like clockwork, come what may in the economy.

Public Storage (PSA)

Few corners of the market are as durable as self-storage REITs.

“Self-storage requires modest capital outlay to operate, property taxes are skinny and the demand is inelastic,” says Ari Rastegar, founder of Dallas-based Rastegar Equity Partners, a private equity firm specializing in commercial real estate. “The recession resiliency of the asset class was showcased in 2008 by returning 5% cumulative with dividends. Another way to look at it is investors generate the rent of a class B multi-family apartment from what is essentially a shed.”

Public Storage (PSA) is America’s largest self-storage landlord, and over its life, it has been a dividend-raising machine. The REIT has improved its annual dividend for eight consecutive years, and it was able to keep its payout stable throughout the 2008 meltdown. At current prices, PSA yields nearly 4%, which isn’t exceptionally high. But the stock has raised its dividend at nearly 16% per year over the past decade, which isn’t too shabby.

Public Storage has been down of late because of oversupply concerns, and shares have dropped nearly 25% from their early 2016 highs. However, this setback could be viewed as a buying opportunity in one of the very best REITs on the market.

To continue reading, please see The 15 Best REITs for Retirement Income

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Searching for Value in the REIT Rubble

Leave it to the stock market to do the exact opposite of what you expect it to do. Following Donald Trump’s surprise win, stocks have spent the past three weeks pushing higher.

Ironically, given that the President-Elect is a world-renown real estate developer, real estate investment trusts (REITS) have gotten clobbered. REITs as a sector peaked in July, but the selling has continued well past the presidential election.

As I’m writing this, the sector is down nearly 20%… ouch!

Whenever I see a sector flirting with bear-market territory at a time when the rest of the market is hitting new all-time highs, I sit up and take notice. Sometimes it can be the sign of a sector facing deep, long-term problems with no easy solutions. But just as often, it’s a classic market overreaction.

So, as we look at the carnage in REITland, which is it?

Is the market correctly forecasting real estate doom… or is Mr. Market working himself into a stomach ulcer over nothing?

Let’s take a look.

The narrative right now is that the Fed’s pending rate hike is bad news for REITs, as it potentially raises their cost of capital. Adding to this anxiety is the spike in longer-term bond yields. See, higher bond yields hurt REITs in two ways.

To start, it raises their borrowing costs. REITs, as with most real estate investors, tend to borrow a lot of money, and every additional dollar paid in interest is a dollar not kept as profit. But perhaps worse, REITs tend to be priced relative to bonds. So rising bond yields (and falling bond prices) mean rising REIT yields (and falling REIT prices).

This latter point has been a particular worry since investors have come to view REITs as bond substitutes over the past few years. With bond yields too low to be worth considering, investors have been chasing the higher yields of other income sectors, particularly REITs.

Again, that’s the narrative. But is it actually true?

Well, let’s see. The following chart shows the performance of REIT stocks during periods of rising bond yields. The shaded areas represent periods in which 10-year bond yields were rising.

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If the narrative you read in the financial press were true, you’d expect REIT stocks to tank every time bond yields had a significant bounce. But that is clearly not the case here. Of the six times since 1981 that we saw bond yields rise by a meaningful amount, REIT prices actually rose in three of them.

With President-Elect Trump pushing for large tax cuts and major new infrastructure spending, there’s a lot of worry in the market right now that outsized budget deficits will cause long-dead inflation to come back with a vengeance.

Don’t bet on it.

Let’s get serious. If large budget deficits were all it took to stoke inflation, then Japan – with the largest budget deficits in the world – would also have the highest inflation in the world. Suffice it to say, it doesn’t. Japan has been fighting deflation, not inflation, for three decades now.

And while I would love to get a tax cut, I don’t see it giving a major jolt to consumer spending. The cohorts most likely to have incomes high enough to benefit – baby boomers and early gen-xers – have already crossed their peak spending years, so any extra cash due to tax cuts is likely to get saved or invested rather than spent.

The generation most likely to actually spend the money – millennials – is already paying close to zero in taxes at its current income levels, so it’s hard to see Trump’s tax plan having a major impact.

So, what’s next for REITs?

I’m betting that we see another repeat of the scenario we had a year ago. Then, as now, bond yields ended the year relatively high, and REITs were under pressure. But when yields started to ease, REITs enjoyed a spectacular rally.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Rising Bond Yields Smash REITs. What Happens Next?

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Photo credit: clement127

Real estate investment trusts have gotten absolutely crushed over the past three months and particularly since Donald Trump’s surprise victory in the 2016 presidential election. The perception is that Trump’s economic policy will blow out the budget deficit, fuel inflation and send bond yields higher. And as REITs have become proxies for bonds in the low-yield world of recent years, as go bonds, so go REITs.

That’s the consensus view, at any rate. I have my doubts. To start, surging budget deficits do not automatically lead to higher bond yields. If that were true, Japan would have the highest bond yields in the world. Instead, Japanese yields are essentially frozen at 0% and have been for years. Furthermore, the biggest peacetime deficits in history happened during the 2008-2009 meltdown… when bond yields plunged to lows no one dreamed possible before. And all of this depends on Trump getting his budget through a Tea-Party-controlled House of Representatives that ties its entire indentity to reducing the size of the government.

Nevertheless, REITs are taking it on the chin at the moment. This is the third time in four years that this has happened. The first and second, respectively, were after the 2013 Taper Tantrum and as Janet Yellen first raised the Fed Funds rate above zero this time last year. In both previous cases, REITs dropped about 20% in value before recovering to new highs. This time around, REITs are down by a comparable amount… might a repeat rally be in the cards?

I think it’s highly likely. I’ve argued for years that, even at their current low yields, REITs remain attractively priced relative to bonds and most other income investments. And Evercore ISI, writing for Barron’s, was kind enough to work out the numbers for us. Evercore ISI examines REIT prices relative to:

  1. price/net asset value (NAV)
  2. price/adjusted funds from operations (AFFO)
  3. implied cap rates versus 10-year Treasury yields and corporate bond yields
  4. a sensitivity analysis looking at upside/downside scenarios based on implied cap rates and spreads to the 10-year Treasury looking out one year from now.

These were their findings:

Price/NAV: Given the steady decline in REIT prices since early August, REITs are now trading at an 11% discount to our current NAV estimates and a 12% discount to our forward NAVs. This 11% discount is the widest we’ve seen since January 2014 (that’s nearly three years).

Price/AFFO: The sector is trading at 20.2 times AFFO on a forward-12 month basis which is two turns below the sector’s trailing three-year average but slightly less than four turns above the sector’s long-term average which is just shy of 16.5 times. However, when we adjust the AFFO multiple for the lower interest rate environment, a 20 times multiple doesn’t look out of place and in fact using historical spreads (AFFO yields minus 10-year Treasury yield) an AFFO multiple of 20 times would imply a 10-year Treasury yield of 2.65% which is 60 basis points above Wednesday’s closing yield.

Implied cap rates versus 10-year Treasury: The spread Wednesday versus 10-year Treasury yield is 370 basis points and is 53 basis points higher than the long-term average suggesting that REITs are modestly undervalued versus Treasuries or are fairly valued assuming the 10-year Treasury yield reaches 2.5% in the near to intermediate-term.

Implied cap rates versus BAA bond yields: The spread Wednesday is 127 basis point and is wider than the long-term average of 42 basis points and roughly double the spread experienced over the past 24 months. What’s interesting to note is that while the 10-year Treasury yield has backed up 55 basis points since June, the BBA bond yield is only up 10 basis points over the past four months implying that credit spreads have narrowed while the base rate has expanded.

While it’s helpful for investors to look at a snapshot of valuation metrics, we also wanted to provide a more dynamic implied cap analysis which allows two variables to move at the same time. In this exercise, we let Treasury yields and future net operating income (NOI) growth fluctuate within a range while keeping the “spread” constant at 311 basis points which is equal to the long-term average. If an investor assumes that the 10-year Treasury yield will approach say 2.75% in 12 months and the REIT sector could generate NOI growth of say 3% one year from now, then REITs should rise about 5% over the next year.

So in a nutshell, REITs are pretty reasonably priced right now. If you’re bearish, you’re essentially betting that the 10-year Treasury yield is going north of 3% within the next year or that earnings ar about to fall off a cliff. While I suppose either of those outcomes could happen, I wouldn’t bet on it. I would expect REITs to enjoy another solid rally… just as they did the last two times they sold off on yield fears.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Seritage Growth Properties: Warren Buffett Bought WHAT?

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Leave it to Warren Buffett to keep us guessing. The Oracle of Omaha just reported 8% stake in Seritage Growth Properties (SRG), a REIT spinoff of struggling old-line retailer Sears Holdings (SHLD). SRG owns a portfolio of 266 Sears properties, some of which it owns via joint ventures. But it’s essentially a dumping ground for Sears real estate and a vehicle for Sears Chairman Eddie Lampert to extract as much value as he can from a sinking ship. (I wrote about this earlier this year; see article.)

So, why would Warren Buffett want a piece of SRG? When I saw the news, I legitimately thought it was a joke. I actually had to check the SEC site to verify.

Interestingly, Mr. Buffett is not alone here. Contrarian value investor Bruce Berkowitz had amassed a 10% of the company as of the end of last quarter, though he’s been trimming back recently. Berkowitz has been a large shareholder of Sears Holdings for years. In fact, it’s his single biggest holding. So if he sees value in Sears, it’s not shocking that he would also see value in Sears’ spun-off property portfolio. (I wrote about Berkowitz and his highly-concentrated value portfolio earlier this year; see Seven Masters of the Universe.)

Both Warren Buffett and Bruce Berkowitz have had some high-profile mistakes in recent years. Sears has been a disaster for Berkowitz, and Buffett has lost a fortune in IBM (IBM). But both of these gentlemen have absolutely crushed the market over their careers, so when they make a large new position, it’s worth picking into the details.

First, we should clarify a point on size. Yes, Berkshire Hathaway (BRK.A) now owns 8% of SRG, and Berkowitz’s fund owns 10%. But SRG is a tiny REIT with a market cap of about $1 billion. So Berkshire Hathaway’s position, which had a cost basis of just $70 million, is a tiny drop in the bucket. Berkshire Hathaway has a market cap of well over $300 billion. So while the SRG purchase looks big in the headlines, it’s pretty much pocket change for Warren Buffett, the equivalent of buying a Cherry Coke (Buffett’s favorite…) for the rest of us.

Likewise, while Berkowitz owns 10% of SRG, it only accounts for less than 4% of his portfolio.

Still, might there be some value here? Let’s take a look.

Seritage is a new REIT that only began trading in July, so there is not a lot of history to it. And to date, SRG has yet to pay a dividend, though it has promised to do so before year end.

Looking at the financial results, nothing particularly jumps off the page. “Normalized” funds from operations (“FFO”) last quarter came in at $0.52 per share. Annualizing that, SRG trades at a price/FFO multiple of 19. That’s not particularly cheap though not completely out of line for the industry. It also suggests a dividend yield in the 3%-4% range is doable.

Normally, I’m somewhat skeptical of “specialty” REITs that are spun off from a single large property holder. To start, there is major concentration risk. What if Sears finally goes belly up?

And you have to legitimately ask if a spinoff REIT is truly to be run independently for the benefit of its shareholders or if it is little more than a funding vehicle for the former parent company. For example, might Seritage give Sears preferential treatment with below-market rents? Maybe, maybe not. But questions like these should normally cause a spinoff REIT like SRG to trade at a discount to its more diversified and more independent peers.

That was my initial thought. But I was pleasantly surprised to see that 22% of SRG’s rental income comes from tenants other than Sears. And that number should grow over time, presumably allowing for respectable growth in rents as non-Sears tenants pay market rates.

So while a discount to larger peers like Realty Income (O) would still be warranted, that discount should definitely close with time.

When Eddie Lampert first took control of Sears, we all more or less assumed it was his intention to unlock its real estate value while slowly allowing the retail business to wither and die. It might have all gone according to plan had the 2008 meltdown and Great Recession not hit. But with his launch of SRG earlier this year, it looks like Mr. Lampert is still more or less doing what he had always planned to do. (See Is Sears the Next Berkshire Hathaway.)

I wouldn’t be a buyer of SRG at today’s prices. The shares are up about 15% on the news of Warren Buffett’s position, and I think it’s likely that shares drift back down once the news properly sets in. But SRG might be a REIT to watch. In particular, look for progress in the coming quarters in reducing exposure to Sears Holdings and look for dividend guidance in the next quarterly report.

Disclosures: Long O.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

Photo credit: DonkeyHotey

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Will the Fed’s Rate Hike Kill REITs?

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The Federal Reserve has spoken, and it’s all pefectly clear now.

Ok, I sincerely hope you realize that I’m joking. Janet Yellen gave us no real insight in her statement this week as to what comes next. We’re left to assume a rate hike will be coming before year end, but Yellen insisted in her comments that, even post lift off, policy would remain “highly accomodative” for as long as inflation remains muted.

I have no Rosetta Stone to translate Fedspeak into English. But Yellen’s words would seem to suggest a “one and done” scenario in which the Fed raises rates by a quarter point or two and then sits on its hands for a while to see what happens.

We’ll see. In the meantime, yield-sensitive assets like REITs continue to get whipsawed as investors handicap the likely move in interest rates. The received wisdom is that Fed tightening will take a wrecking ball to REIT prices, and REITs have been selling off for most of 2015 in anticipation.

But is it true? If interest rates really do rise significantly, will REITs suffer? Let’s take a look at past tightening cycles to see.

The chart below tracks the price performace of the NAREIT All Equity REIT Index going back to the early 1980s and compares it to the Federal Reserve’s targeted Fed funds rate. Periods of extended tightening are highlighted in blue.

Slide1

Note: Past performance no guarantee of future results.

We’ve had five periods of extended tightening since 1981. In three of them, REIT prices did indeed suffer. But in the other two — and keep in mind, that is fully 40% of the total — REIT prices actually did very well. The tightening cycle of the mid-2000s coincided with one of the greatest bull markets in the history of REITs as an asset class.

A few points have to be made here. We only have five observations in our sample, which is far too few to draw strong conclusions. The quants in the room will rightly point out that you need a sample size of at least 30 to draw meaningful conclusions. But this data should at least cast doubt on the received wisdom that rising interest rates automatically mean falling REIT prices.

It’s also worth noting that, the 2008 meltdown notwithstanding, REITs have arguably been in a secular bull market for over thirty years now… a thirty-year period that also happened to correspond with the “great moderation” in inflation and interest rates. We’ve never had interest rates this low for this long, so the historical precedents might not be the most appropriate.

Let’s step away from the Federal Reserve for a second. As long-term income investments, REITs should be less affected by Fed policy and more affected by moves in long-term bond yields. The next chart takes a look at REIT performance during periods of rising bond yields.

REIT Price Performance

Note: Past performance no guarantee of future results.

There really haven’t been too many extended periods of rising 10-year Treasury yields over the past three decades. The dominant trend has been one of falling yields. That said, I found six periods where 10-year yields trended upward for an extended period. Again, the story is ambiguous. In the early-1980s and mid-2000s, REITs did very well during periods of rising bond yields. But in the mid-1980s, early-1990s and late-1990s, REITs performed poorly. And most recently, during the “Taper Tantrum,” REITs performed poorly.

This suggests that rising bond yields would “probably” hurt REITs. Of course, it is by no means certain that we’ll see rising bond yields for a sustained period of time. Bond King Bill Gross said this week in a CNBC interview that a 2.4% yield on the 10-year Treasury was “about right” over the next several years. Gross swings and misses from time to time, but I agree with him here.

Finally, let’s look at REIT valuations by comparing their current dividend yields to the yield to maturity on the 10-year Treasury. The following chart tracks the yield spread between the two. Conventional wisdom says that REITs should yield more than bonds due to their higher risk. But is this actually true in the real world?

Slide3

Note: Past performance no guarantee of future results.

Not exactly. Since the 1990s, REIT yields have been about 2% higher than the 10-year Treasury yield. But in the mid-2000s, REIT yields actually dipped below Treasury yields. And this was pretty standard for most of the 1970s and 1980s.

Given that, unlike bond coupons, REIT dividends are presumed to grow over time, I believe a a relatively tight spread is completely appropriate. At a yield spread of 3%-4%, I would consider REITs a “fat pitch” investment worthy of a home run swing. But even today’s smaller spreads of 1.5%-2% are attractive if you believe, as I do, that Treasury yields will stay below 3% for the next several years and stock market returns will be middling at best.

Many of my favorite REITs, including Realty Income (O), LTC Properties (LTC) and Ventas (VTR), are yielding near or above 5% at current prices. But even the Vanguard REIT ETF (VNQ) is yielding close to 4%. I consider all of these to be strong buys on any Fed-induced sell-offs.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long VNQ, O, LTC, VTR.

Photo credit Kuba Zawadski

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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