Get Yields Up To 7.5% From This Little-Known Group Of Stocks

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A couple months ago, I asked some people I didn't know if I could take over their house for a day.

I had no idea whether the people living there would jump at the chance to pick up a few bucks, or call the cops.

I was betting on the former, with good reason...

You see, the house is located just off the campus of one of the largest universities in the Midwest. And better yet, it sits just a few blocks from the football stadium. You know the mantra: location, location, location.

To mark the 40th anniversary of some of the best pre- and postgame house parties in the history of the University of Wisconsin-Madison, my former roommates and I intend to relive the magic. During homecoming weekend this October, we're inviting a few dozen of our closest college friends for a homecoming of our own.

That is, if we can get the house. One of the current occupants, a student, told me I'd have to get in touch with the new tenants, who were moving into the house the day after he and his four roommates were moving out.

So it goes in the student-housing market.

No sooner does one set of tenants leaves than the next batch arrives. That's the scene around college campuses all across the country. In many university communities, the rental income stream from student housing is steadier and more reliable than most others.

And if you're renting out a house to a group of students who each signs his or her own lease, chances are you're able to eke out more income than you might by renting the same space to a single family.

This is the house on Milton Street near the University of Wisconsin campus in Madison that I lived in four decades ago. Landlord Karen Scott, who's been renting the property to students since 1975, tells me she's never had a vacancy.

But even if you don't happen to own a spare house near the football stadium, there's still a way to glean income from the higher-education crowd.

As the description implies, student-housing real estate investment trusts (REITs) specialize in investing in student-housing complexes, generating income through the collection of rent.

To be sure, these have not been the best of times for REIT investors. The Dow Jones Equity All REIT Index, which tracks 141 REITs, delivered a total return of negative 2% in the three months ended in June, compared with a gain of 7.9% in the first quarter.

The culprit? Concerns that rising interest rates will eat into borrowing costs, crimping profits and expansion.

At the same time, however, many REITs remain a favorite among income investors because of their larger-than-average payouts. But are the payouts safe?

College housing valuations are based more on cash flow and less on speculation -- thus providing a layer of insulation from the full effects of the bubble and subsequent burst from which the residential and commercial real estate markets are still recovering.

At the moment, though, concerns about rising interest rates are still taking their toll on stocks in general and on REITs in particular.

That means there's no better time to turn to High-Yield Investing's Nathan Slaughter, who's built a career on identifying undervalued, out-of-favor investments before they became fully valued and in favor.

Bob: Your team has just put the finishing touches on a report about student-housing REITs. Can you share with our readers a sneak peek at your favorite pick in this space at the moment?

Nathan: I like Campus Crest Communities (NYSE: CCG ) , which manages 86 communities (and 44,000 beds) on campuses around the country.

When analyzing these companies, I look for many of the same traits that I would demand in any other industry: trustworthy management, comfortable payout ratios and the like. But there are some metrics that are unique to this particular business, such as revenues per occupied bed (RevPOB).

From the end of 2010 through the midpoint of 2013, Campus Crest's occupancy rate rose from 88% to 92.4%. It goes without saying that occupied beds earn money, empty ones don't. But there is a second important determinant of cash flows: rental rates. The steady increase in RevPOB from $489 to $505 indicates good progress in this department.

More important, the company is operating more efficiently and pocketing a greater percentage of every dollar of rental income. The best barometer of that is NOI margins (net operating income/revenues), which have expanded to 59.9%. That easily bests the competition.

It's also a smart idea to see how far along these companies are in booking their properties for the 2013-'14 school year. Through the end of July, Campus Crest had already pre-leased 82.9% of its available space for next year. And cash flows are on track to meet the generous $0.165 quarterly dividend payments with room to spare. That payout translates to a beefy yield of 5.9%.

The company is also expanding its footprint. Since its initial public offering in late 2010, funds from operations (FFO) and student-housing revenues are up 82.6% and 138.2%, respectively. And management is on the ground evaluating 80 new properties in the development pipeline.

As the most profitable (as measured by NOI margin), and given the robust growth trajectory, you'd expect Campus Crest to merit a premium price. But to sweeten the deal, it actually trades at a discount to the group -- 13.7 times FFO, versus 17.4 for one of its peers and 19 for another. Just earning an average peer group multiple for this best-in-class player would point to a stock price north of $15 per share (as compared with a recent $10.55).

Bob: What is your take on REITs in general?

Nathan: I'm a big fan, to say the least. I currently hold four in the High-Yield Investing portfolio. Some of these were initially recommended by my predecessor, Carla Pasternak. But I'm not about to unload them -- they've already delivered returns of up to 65% and carry yields ranging from 5.2% to 7.5%.

Real estate is a timeless investment. At a time when the specter of rising interest rates is casting a cloud over bonds and other fixed interest-bearing instruments, tangible assets like land and buildings are far more reassuring than holding paper. Their appraised market value doesn't hinge on whether Ben Bernanke is in a dovish or hawkish mood over the next few months.

Real estate is also insulated from the erosive effects of inflation and a depreciating dollar. These insidious forces aren't huge concerns at the moment, but we haven't seen the last of them. Commodities offer similar protection and can also appreciate in value when the government printing presses heat up -- but coal and copper don't exactly generate steady rental income each month like apartment complexes, shopping centers, office parks, storage facilities and doctors' offices.

At the end of the day, a dividend is only as safe as the cash flows that support it. And for most industries, those cash flows are largely unpredictable.

By contrast, REITs enjoy steady income that is locked in by multi-year leases (often with built-in annual rate increases). So these companies enjoy some of the most reliable and visible cash flows you'll find. And that tax-advantaged income is quickly returned to investors.

There is a good reason why ultra-wealthy investors such as Ted Turner and Sam Zell have sunk most of their fortunes in real estate. Of course, you and I probably don't have the net worth or borrowing capacity to sign the deed on a high-rent skyscraper in Manhattan. REITs give us a way in.





The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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