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Aug. 25, 2018, 9:05 a.m. EDT

REIT prices push higher despite the Federal Reserve’s interest-rate increases

Patient investors have been rewarded as dividend income continues to flow

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By Philip van Doorn, MarketWatch


Bloomberg
Hospitality Properties Trust invests in hotels that operate under more than 20 brand names, including Courtyard by Marriott. The REIT has a dividend yield of about 7.29%.

When interest rates rise, investors fear that income-producing investments such as bonds and real estate investment trusts (REITs) will fall because of the inverse relationship between rates and prices.

Interest rates have jumped over the past two years from record lows, causing price disruptions. So why haven’t REITs fallen?

Here’s a chart that may open your eyes to a longer-term view:


FactSet

The chart shows that the weighted price of the S&P Composite 1500 real estate sector is higher now than it was two years ago, while the yield on 10-year U.S. Treasury notes /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y 0.00% rose to 2.87% on Aug. 21 from 1.63% two years earlier. There have been two major declines in REIT prices over the past two years, but prices recovered as the economy continued to grow.

So a REIT investor who ignored conventional wisdom and didn’t sell, received his or her dividend income (the primary purpose of most REIT investments) the entire time, while the value of the investments ultimately recovered (and then some) from two significant declines.

All things being equal, if interest rates increase, the market value of a bond will decline because a newly issued bond (of similar quality) will pay more. The old bond’s market price falls so that its yield will attract a buyer. But for REITs, the story is different. Interest rates normally increase during a period of economic expansion. So while there is downward pressure on a REIT’s share price, the REIT’s rental income may be increasing and the value of the properties it holds may go up as well.

So for an investor who really needs the income , patience is required during periods of rising rates. The income will continue to flow, as long as the REITs he or she selects have sufficient cash flow to cover or raise their dividend payouts.

Analysts at Pimco have argued that REITs are competitive long-term investments , factoring in total returns, volatility and tax advantages. But for these long-term periods, as a group, the REITs have underperformed the S&P Composite 1500 Index (made up of the large-cap S&P 500 /zigman2/quotes/210599714/realtime SPX -0.39% , the S&P 400 Mid-Cap Index /zigman2/quotes/210599897/delayed MID -0.10%  and the S&P 600 Small-Cap Index /zigman2/quotes/210599868/delayed SML -0.53% ):

Total returns through Aug. 21
3 years 5 years 10 years 15 years
S&P 1500 Composite Real Estate Sector 28% 69% 130% 288%
S&P 1500 Composite Index 55% 93% 181% 301%
Source: FactSet

The REITs have trailed the S&P 1500 Composite significantly for all these periods except for 15 years. But the very long-term data supports Pimco’s argument.

If you wish to diversify your portfolio with real estate, here are two examples of ETFs that track the performance of the SPDR Dow Jones REIT ETF /zigman2/quotes/201703743/composite RWR +0.53% :

• The Schwab U.S. REIT ETF /zigman2/quotes/204218354/composite SCHH +0.57% has a 30-day yield of 3.51%, according to Morningstar and annual expenses of 0.07% of assets. The ETF’s five-year total return through Aug. 21 was 61%, according to FactSet.

• The SPDR Dow Jones REIT ETF /zigman2/quotes/201703743/composite RWR +0.53%  has a 30-day yield of 3.50% and annual expenses of 0.25%. Its five-year total return through Aug. 21 was 59%.

Higher yields

The yields on the two ETFs mentioned above are not particularly attractive. Among the 106 REITs included in the S&P 1500, there are 29 with market values of at least $1 billion and dividend yields above 4.5%:

REIT Ticker Primary investment activity Dividend Yield FFO yield based on past four quarters ‘Headroom’ based on past four quarters Total return - 3 years
Washington Prime Group Inc. /zigman2/quotes/204787457/composite WPG Shopping centers 12.63% 23.99% 11.36% -15%
Uniti Group Inc /zigman2/quotes/203478257/composite UNIT Communications infrastructure 11.56% 12.09% 0.53% 41%
Government Properties Income Trust Properties leased to government agencies 10.12% 12.65% 2.53% 40%
Global Net Lease Inc /zigman2/quotes/208494689/composite GNL Diverse commercial properties 9.89% 8.92% -0.98% 13%
Senior Housing Properties Trust /zigman2/quotes/204636982/composite SNH Senior housing and health care properties 8.19% 8.35% 0.16% 50%
Omega Healthcare Investors Inc. /zigman2/quotes/208032080/composite OHI Health-care properties 8.03% 5.95% -2.08% 15%
Sabra Health Care REIT Inc. /zigman2/quotes/206860861/composite SBRA Health-care properties 7.74% 10.96% 3.22% 15%
Lexington Realty Trust /zigman2/quotes/201674751/composite LXP Commercial properties 7.71% 10.97% 3.26% 35%
GEO Group Inc /zigman2/quotes/209855552/composite GEO Prisons 7.45% 7.37% -0.08% 54%
Hospitality Properties Trust Hotels 7.29% 12.00% 4.71% 35%
Kite Realty Group Trust /zigman2/quotes/204637140/composite KRG Shopping centers 7.27% 11.51% 4.24% -19%
CoreCivic Inc. /zigman2/quotes/200590180/composite CXW Prisons 6.74% 8.42% 1.68% 7%
Medical Properties Trust Inc. /zigman2/quotes/201233436/composite MPW Health-care properties 6.67% 9.47% 2.80% 47%
Kimco Realty Corp. /zigman2/quotes/202836571/composite KIM Shopping centers 6.57% 9.09% 2.52% -19%
Iron Mountain Inc. /zigman2/quotes/208929343/composite IRM Document and data storage facilities 6.47% 5.67% -0.80% 50%
Ramco-Gershenson Properties Trust /zigman2/quotes/206639131/composite RPT Shopping centers 6.35% 9.31% 2.96% 0%
EPR Properties /zigman2/quotes/206791795/composite EPR Entertainment, recreation, education 6.18% 7.25% 1.07% 53%
Tanger Factory Outlet Centers Inc. /zigman2/quotes/204622836/composite SKT Outlet shopping centers 5.67% 8.72% 3.04% -13%
HCP Inc. /zigman2/quotes/205497622/composite HCP Senior housing and health care properties 5.50% 7.13% 1.63% -12%
Ventas Inc. /zigman2/quotes/206376229/composite VTR Senior housing and health care properties 5.34% 7.05% 1.71% 16%
Summit Hotel Properties Inc. /zigman2/quotes/207222920/composite INN Hotels 5.26% 8.69% 3.43% 28%
Welltower Inc. /zigman2/quotes/200485564/composite WELL Senior housing and health care properties 5.24% 6.15% 0.90% 14%
Easterly Government Properties Inc. /zigman2/quotes/209079809/composite DEA Properties leased to U.S. Government agencies 5.18% 6.28% 1.10% 47%
Macerich Co. /zigman2/quotes/203054096/composite MAC Shopping centers 5.06% 6.21% 1.15% -11%
Weingarten Realty Investors /zigman2/quotes/208519310/composite WRI Shopping centers 5.04% 7.53% 2.49% 7%
LTC Properties Inc. /zigman2/quotes/203985819/composite LTC Senior housing and health care properties 4.97% 6.61% 1.64% 20%
Chesapeake Lodging Trust Hotels 4.88% 5.79% 0.91% 29%
Lamar Advertising Co. Class A /zigman2/quotes/200816636/composite LAMR Billboards 4.83% 6.36% 1.52% 58%
Realty Income Corp. /zigman2/quotes/200487782/composite O Diverse commercial properties 4.51% 5.05% 0.55% 40%
Source: FactSet

An attractive dividend yield doesn’t tell you very much. You need to have confidence that a REIT will continue to be able to cover or raise its dividend payout over the long term. This means you need to do your own research to understand the strategy of any REIT you consider for investment.

We have included each company’s real-estate specialty, as well as 12-month FFO yields. Funds from operations (FFO) is a non-GAAP figure used in the REIT industry to gauge dividend-paying ability. It adds depreciation and amortization back to earnings, while subtracting any gains from the sale of real estate. Dividing FFO per share by the current share price gives us the 12-month FFO yield.

If a company’s FFO yield is well above its dividend yield, it appears to have “headroom” to pay higher dividends. But 12 months of FFO data cannot be your only indication of dividend-paying ability. There may have been an extraordinary event that drove it up or down over the past year. This underlines the importance of gaining a level of comfort before committing to a long-term investment,.

As you can see from the three-year total return figures, some of these REITs, especially those that own shopping centers and malls, have been hit very hard over the past several years. A very high yield certainly indicates a lack of confidence among investors that the dividend will be maintained.

Don’t miss: Ignore ‘multidecade growth’ companies in emerging markets at your own peril

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Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.

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