| Investing
in Real Estate Investment Trusts (REITs) |
Published: August 2, 2005
In recent days my staff and I
have scoured the investment landscape in a search for new opportunities
in the REIT market. For those of you unfamiliar with this unique asset
class, Real Estate Investment Trusts -- or REITs -- are companies that
own real-estate-related assets such as land, buildings and real estate
securities. Most firms in this industry make their money by purchasing
real estate properties and renting them out to consumers and
corporations. Meanwhile, others merely purchase real-estate-related
securities such as mortgage bonds and/or lend money to fund third-party
real estate projects.
Let's start off with a quick
rundown of the advantages and disadvantages associated with investing in
REITs...
Advantages:
In order to qualify as a REIT for tax purposes, a company must return at
least 90% of its earnings to its shareholders in the form of dividends.
Because of this, the average REIT boasts a roughly 5.0% annual dividend
yield.
REITs aren't as highly
correlated with the major indices as most industries are. As such, they
may provide you with some much-needed diversification and should help to
smooth out your overall portfolio returns, particularly during market
downturns.
REITs own hard, tangible assets
such as land and buildings, and often sign their tenants to long-term
lease contracts. Because of this, REITs tend to be some of the most
stable companies on the market.
Disadvantages:
Because they can only reinvest up to 10% of their annual profits back
into their core business lines each year, most (but not all) REITs tend
to grow at slower-than-average clip. The average publicly-traded REIT
has posted earnings growth of around 9% over the past five years
(relative to about 11% for the S&P 500).
Although the business tends to
be a fairly stable one, REITs are not without risk. For example, their
dividend payments are not guaranteed and the real estate market is prone
to cyclical downturns.
What To Look For In A
Good REIT
When investing in REITs, my staff and I generally start by looking at
the same fundamental factors that we examine for all other equity
investments. We seek out companies with solid track records, winning
management teams, reasonable valuation levels and favorable growth
prospects. In addition to this analysis, serious REIT investors should
also pay close attention to:
- Geographic
Diversification -- Large, broadly diversified companies have
less exposure to regional economic weakness and/or natural disasters
than their smaller counterparts.
- Current Dividend Yields
-- When investing in REITs, I generally look for stocks that pay an
annual yield of at least 5.0%.
- Long-Term Dividend Growth
-- I also look for companies with long track records of consistent,
growing dividends.
- Dividend Payout Ratios
-- You can calculate this ratio by taking a firm's annual dividend
payment per share and dividing that figure by its EPS (earnings per
share). The payout ratio gives a measure of the percentage of its
earnings that a particular firm pays out in the form of dividends.
Since REITs are required to pay out at least 90% of their earnings
in the form of dividends, most of these firms carry relatively high
payout ratios. However, occasionally a company may pay out more than
100% of current earnings in the form of dividends. Since this type
of payout ratio is unsustainable over the long haul, many of these
firms are eventually forced to lower their dividends. Therefore,
when screening for high-quality REITs, I usually look for companies
with payout ratios below 100%.
- DRIP Available? -- I
also like to know whether or not a particular company offers a
dividend reinvestment plan, or DRIP. Among their many benefits, such
plans help to minimize or eliminate the transaction fees that one
would otherwise have to incur in order to reinvest their dividend
payments back into the underlying stock. To view a comprehensive
listing of all REITs that current offer dividend reinvestment plans,
please visit
this link.
What To Watch Out For
When Investing In REITs
The most common mistake that REIT investors make is to focus
exclusively on dividend yields. After searching for and investing in
those companies that offer the highest yields on the market, many
investors blindly sit back and wait for the cash to roll in. The problem
with this strategy, of course, is that corporate dividend payments are
by no means guaranteed. Those investors who purchase a particular REIT
solely for its current dividend yield could be setting themselves up for
serious disappointment.
With all of these factors in
mind, I recently went on a search for real estate firms with solid
dividend yields and strong financial track records. In the process, I
limited my search exclusively to high-quality REIT names that met the
following criteria:
-- Operate in the Real Estate
industry
-- Market capitalization of greater than $200 million
-- Dividend yield of at least 5%
-- Three-year average annual dividend growth of at least +3%
-- Five-year average annual sales growth of at least +10%
-- Dividend payout ratio of less than 100% (based on projected EPS for
current fiscal year)
My goal was to come up with a
list of REITs that are fairly large with high dividend yields, solid
dividend track records, strong sales growth and reasonable payout
ratios. After running this data through StreetAuthority's advanced
scanning software, I came up with the following list of companies:
| Company
(Symbol) |
Ent.
Value |
Div.
Yield |
DRIP? |
| Thornburg
Mort. (TMA) |
$34.8B |
9.1% |
Yes |
| IMPAC
Mortgage (IMH) |
25.5B |
17.0% |
Yes |
| New Century
(NEW) |
21.4B |
9.3% |
No |
| Entertain.
Prop. (EPR) |
1.7B |
5.2% |
Yes |
| Annaly
Mortgage (NLY) |
19.4B |
14.4% |
Yes |
| RAIT
Invest. (RAS) |
1.0B |
7.6% |
Yes |
| MFA Mortgage
(MFA) |
6.8B |
10.9% |
No |
| iStar
Financial (SFI) |
10.4B |
6.7% |
Yes |
Although each of the above
stocks may be worth exploring further, as always, please make sure to do
your own due diligence on each of these firms to decide if they are
right for your portfolio. Any and all final investing decisions for your
own account are entirely up to you.
|
Please Note: The above article was merely a
small excerpt from an issue of our premium, long-term-oriented investing
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-- Paul Tracy
Editor
StreetAuthority
Market Advisor
Paul Tracy
founded StreetAuthority and became Editor in Chief in 2001. Prior to
that he spent several years as Managing Editor at a multi-million dollar
financial publishing firm with over 150,000 subscribers. In addition to
his role as managing editor and lead financial writer, he was also
responsible for equity research and managing a team of seasoned
professional financial writers, researchers and market commentators.
Paul's previous experience
includes a position at Robert W. Baird & Co.'s full-service
brokerage operations as well as economic research work on a Money and
Banking project funded by the National Bureau of Economic Research. He
has also spent time doing outside consulting and research for the
University of Virginia, has appeared as a guest expert on several
prominent financial radio shows, and has been a featured speaker at
various investment conferences across the U.S.
Paul graduated with a B.S.
in Finance and Management from the McIntire School of Commerce at the
University of Virginia.
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