Special Report:Income Investing
When it comes to income investing , utility, tobacco stocks and bonds are usually the go-to investment vehicles. But investors should also check out REITs, or real estate investment trusts. They can offer investors income, as well as opportunity for price appreciation.
Just like stocks, REITs are traded on the major exchanges such as the Nasdaq and the NYSE. REITs are companies that invest in properties such as malls, apartments and office buildings. They can also invest in mortgages and mortgage securities.
"Real estate should be a part of every diversified portfolio," said Brad Case, senior vice president of research and industry information at the National Association of Real Estate Investment Trusts (NAREIT). "For nearly every investor, the best way to access real estate is by REITs that are traded on the stock exchanges."
With banks paying around 1% on savings accounts, REITs offer much more enticing yields. Juicy yields are usually the main attraction to REITs. Unlike most companies that can decide on my how much of their income to return to shareholders in the form of a dividend, REITs don't have that choice.
A REIT has to pay at least 90% of taxable income to shareholders, which helps result in a healthy dividend.
"The REIT can't choose whether to make dividend payments in a year and that means the income from the REIT is very steady even when the economy is tight. If the REIT earns the money, they have to pass it along to their investors," said Case.
While it's nice to be getting a large yield, investors shouldn't choose a REIT just because of this.
"I think the most important thing to look at is the balance sheet to start off with," said Andy Goodman, chief investment officer of CIC Wealth.
"You want to try to avoid REITs that have significant amount of debt. Since they're required to pay out so much of their income, there's very little on the reserve side. So if a company already has significant debt, you can see a company severely impacted in terms of profitability and in terms of being able to meet their liquidity needs," Goodman explained.
Besides big yields, REITs can also offer investors diversification, which can reduce volatility and damage to one's portfolio in tough times. NAREIT's Case noted that REITs and the broad stock market move together a little more than half of the time. They have a correlation of about 0.55 to perhaps 0.59.
"The reason for that is the real estate market cycle is very different from the business cycle that drives returns in the stock market," Case said.
As Case explained to IBD, the real estate market cycle averages about 18 years, compared with about four years for the stock market. "And the reason that the cycles are so different is because construction takes so long in commercial real estate," added Case.
With interest rates expected to rise in 2015, is this a worry for REIT investors? As Case told IBD, according to NAREIT's data which goes back to 1994, REIT returns were positive in 12 of 16 periods of rising interest rates.
Camden Property Trust ( CPT ) turned up as one of the best performers in a screen of top-rated REITS. It has surged about 21% for the year. The REIT invests in apartment communities across the U.S. It last paid a dividend of 66 cents a share in July. The REIT's dividend has jumped about 47% since 2010. Camden has an annual yield of about 3.8%.
Extra Storage Space ( EXR ) is a REIT that owns and/or operates 1,000 self-storage properties across 38 states. It last paid a quarterly dividend of 47 cents a share June 30. That's up from 25 cents a share in early 2013. Its yield is also about 3.6%. Extra Storage is up about 26% for the year.
Arlington, Va.-basedAvalonBay Communities ( AVB ) is also up about 26% year to date. The company has ownership interest in 275 apartment communities, containing more than 82,000 apartment homes.
It targets "high barrier-to-entry" markets or those with low supplies of land zoned for apartments. It last paid a dividend of $1.16 a share in July. AvalonBay has a yield of about 3.3%.
Apartment REITs are benefiting from high rents and high occupancy levels.