By Philip van Doorn
Shares of real estate investment trusts have soared this year as the economy has been recovering from the worst of the coronavirus pandemic. Because of the recent spike in delta-variant infections, we’re not out of the woods yet. But investors remain confident.
Some of the best performers in the REIT sector this year have been companies focused on investments that were hit especially hard during 2020 — retail and office properties. Looking forward, an emphasis on quality might serve investors well, rather than trying to catch the rebound wave late in the game.
Below is an updated screen of REIT stocks, based on a scoring-methodology framework provided in November by Frank Haggerty, a senior portfolio manager at Duff & Phelps Investment Management in Chicago.
Haggerty co-manages the Virtus Duff & Phelps Real Estate Securities Fund /zigman2/quotes/202863038/realtime PHRIX +0.34% , which is rated four stars (out of five) by Morningstar, the Virtus Duff & Phelps Global Real Estate Securities Fund /zigman2/quotes/200381804/realtime VGISX -0.02% (five stars) and the Virtus Duff & Phelps International Real Estate Securities Fund /zigman2/quotes/205218223/realtime PXRIX -0.47% (three stars).
REITs as a group are still trailing
So far in 2021, the REIT sector of the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.47% has returned 28% with dividends reinvested, ahead of the full S&P 500’s 17% return. But if we run a chart from the end of 2019, it is clear the REITs are lagging behind:
REITs are typically considered income investments, but those that hold attractive properties can also be growth stocks, with prices climbing over time as their rental income grows, or as they book profits on property sales.
For high current yields well-supported by expected funds from operations, 10 REITs are listed here . Funds from operations (FFO) is commonly used in the REIT industry as a measure of dividend-paying ability. It adds depreciation on real estate to earnings and nets out gains or losses on the sale of property.
A quality scoring might yield some REITs with relatively low dividend yields.
Then again, in a market with 10-year U.S. Treasury notes /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -0.16% yielding only about 1.29%, it’s easy for many REITs’ dividend yields to be compelling.
New REIT screen
Getting back to the scoring methodology suggested by Haggerty, we need to make clear that he hasn’t made any specific REIT stock recommendations for this article.
To take a look at a large set of data, we began with the 120 REITs in the S&P Composite 1500 Index, which is made up of the S&P 500, the S&P 400 Mid Cap Index /zigman2/quotes/219506813/composite MID +0.33% and the S&P Small Cap 600 Index. /zigman2/quotes/210599868/delayed SML +0.85% . Then we narrowed the list to 95 companies covered by at least five analysts polled by FactSet, for which the consensus estimates required for the screen are available.
We then made more cuts:
We removed any REIT for which the consensus 2022 AFFO (adjusted funds from operations; see definition in the paragraph below) is negative. That reduced the list to 89 companies.
We removed any REITs for which expected estimated dividends per share for 2022 are at least 10% lower than their pre-pandemic 2019 payouts. This took out 26 names, bringing the list down to 63. Half of the 26 REITs excluded because of dividend cuts are mainly invested in retail properties, while three own hotels and three own office properties.
Then we ranked the 63 remaining REITs by three factors: Total current debt to estimated 2022 EBITDA, 2022 estimated dividend growth and 2022 estimated AFFO payout ratio.