3 REITs To Help You Sleep Well At Night

One of the key components for building a durable income portfolio is to be discriminating, even picky, when buying shares in REIT securities. Remembering that REITs own real estate, so just like investing in a building, it’s important to pay close attention to the foundation of your real estate empire.

As a REIT investor, you are essentially a builder in which your job is to take your blueprint from foundation to the finished product (that’s called wealth-building).

Your building plan should include ingredients that can withstand a variety of economic conditions , so that the finished product can withstand any force of nature, including a recession or even rising rates.

Much like building a castle, your essential REIT portfolio should include a wide moat that will prevent competitors from reaping mayhem to the foundation (aka, the building blocks).

While interest rates have been extraordinarily low for quite a while, rates have begun to creep up, and investors need to be prepared for the forces of nature that could damage the fortress and disrupt the durable dividends that pay the light bills, among other things.

REITs Are In The Sweet Spot

Sometimes the best way to predict the future is to consider the past. We all know that REIT stocks have had the wind at their back over the last few years with recovering markets, little construction, and record low interest rates. Simply put, anybody could build a fortress in these conditions.

However, as Cohen & Steer points out, “the perception that REITs always underperform when interest rates are rising is simply not supported by historical data. Higher rates may unsettle markets in the short term, but what tends to matter more for REITs in the long run is the direction of the economy and job growth.”

Year-to-date REITs have under-performed broader equities, and by focusing on short-term changes in interest rates, Cohen & Steersexplains that REIT investors could be “losing sight of the bigger picture”.

The economic data (job growth, 18-year low unemployment, etc…) gives “landlords greater ability to raise rents” and “when rents are rising, history shows that REITs can deliver strong returns – despite higher interest rates”.

3 REITs To Help You Sleep Well At Night

As the editor of the Forbes Real Estate Investor, I am always reminding readers and subscribers that the best way to build a stress-free REIT portfolio is to own shares in companies with solid dividend growth attributes.

Accordingly, I analyze both historical, current, and prospective dividend growth characteristics in an effort to build the very best “sleep well at night” REIT portfolio, that’s what I call S.W.A.N. investing.

Today I am going to provide you with 3 of my all-time top SWANs, and these are companies that you can put on cruise control. Given their wide-moat ability to mitigate risk, I am recommending these best-in-breed REITs for their fortress-like attributes.

Realty Income (O) is a Net Lease REIT that owns a portfolio of over 5,300 free-standing properties in 49 states. Within Realty Income’s retail portfolio, over 90% of rent comes from tenants with a service, non-discretionary and/or low price point component to their business. These characteristics allow for Realty Income’s tenants to compete more effectively with e-commerce and operate successfully in a variety of economic environments.

Realty Income has a “fortress” balance sheet, and last year the company obtained an A3 rating from Moody’s, one of just a handful of other REITs (with an A3 or better rating). In early April, Realty Income issued $500 million in seven-year fixed rate unsecured bonds at a yield of 3.96%. The offering allowed the company to term out borrowings on the revolving credit facility.

Accordingly, because of Realty Income’s size and scale advantages, the company has been able to grow and maintain a powerful business model, that is rooted in growing dividends. Since going public in 1994, Realty Income has raised its dividend each and every year, a measure of predictability that only a handful of REITs enjoy.

Realty Income shares now trade at $52.97 and a P/AFFO of 17.0x. The shares have under-performed YTD (-5.0% YTD) and the dividend (paid monthly) is right in my sweet spot (shares now yield 5.0%).

Ventas, Inc. (VTR) is a leading healthcare REIT that owns a portfolio of more than 1,200 properties located in the United States, Canada and the United Kingdom. The company focuses on high-quality real estate that is well-located in attractive markets with high barriers to entry, and the balanced portfolio mix includes Institutional Life Science and Medical Office (26%), Net Lease (37%), and Senior Housing Operating, (32%), and Skilled Nursing (1%).

One of the key differentiators for Ventas is that the company has been able to successfully build a strategy founded on solid strategic vision, foresight and innovation, proactive capital allocation decisions, rigorous execution and a stable expert team. Accordingly, the company is to deliver sustained excellence through cycles for two decades.

One of the key ingredients for the success at Ventas has been the company’s focus on the balance sheet. The company is expected to reduce debt to further improve the company’s net debt to adjusted pro forma EBITDA ratio to approximately 5.5x by year-end 2018.

Ventas has substantial dry powder and continued de-leveraging puts the company in an enviable position to grow its cash flow and pounce on opportunities when they arise. The company continues to invest in future growth through development and redevelopment, focusing on medical office buildings, life science and innovation centers, and highly selective senior housing projects.

Ventas shares are trading at $54.23 with a P/FFO multiple of 14.7x. Similar to Realty Income (referenced-above), Ventas shares have traded sub-par in 2018 (-7.2% total return), yet the dividend yield is attractively priced at 5.8%.

Simon Property Group (SPG) is a Mall REIT that has ownership interests in over 230 retail properties totaling over 190 million square feet located across North America and Asia. Additionally, the company has an expanding footprint in Europe with its 29% interest in Klepierre (a leading European mall operator based in France) and a joint venture with McArthurGlen (a leader in European designer outlets).

Simon’s portfolio is well-diversified from a geographic, tenant, and revenue by real estate sector perspective. Major state concentrations by net operating income include Florida (15%), Texas (10%) and California (13%). Additionally, roughly 9% of Simon’s net operating income is derived from its international properties, which are located in Europe, Japan, Mexico, Malaysia, and South Korea.

Simon does an excellent job releasing space to new tenants, and it possesses some pricing power given its high-quality properties. The company has reasonable debt levels with a balanced debt maturity schedule, and a solid fixed charge coverage ratio. Simon’s debt ratings are among the best unsecured debt ratings in the REIT industry, and this underscores the balance sheet strength.

Similar to Realty Income and Ventas, Simon also enjoys the power of scale and cost of capital. Shares now trade at $164.48 with a P/AFFO multiple of 14.1x. Simon has generated impressive dividend growth over the years (averaging double digit since 2015) and shares now yield 4.7%.

In closing, the best performing REITs will generate consistent earnings and dividend growth, by utilizing a blue-chip blueprint rooted in predictability. Today Realty Income, Ventas, and Simon Property Group can be purchased at sound value, or what Benjamin Graham would have referred to as a wide margin of safety. As Graham wrote in The Intelligent Investor, the value investor’s purpose is to capitalize upon “a favorable difference between price on the one hand and indicated or appraised value on the other.”