One asset class that dividend investors could use in order to diversify their portfolios is real estate. The sector includes rental real estate on residential buildings, offices, malls etc. Owning a piece of rental real estate outright however comes with headaches, such as dealing with tenants and not being properly diversified. In order to avoid managing buildings and finding tenants, investors could use real estate investment trusts (REITs).
Real estate investment trusts own different types of real estate, and they offer instant liquidity to investors, since most are publicly traded. In addition to that REITs are required to distribute almost all of their earnings back to shareholders. As a result REITs are not taxed at the corporate level, but distributions from earnings are typically taxed as ordinary income. The rest of distributions from REITs are typically treated as returns of capital, which reduce your basis and would be taxable as a capital gain if you sell your shares.
Real Estate Investment Trusts offer instant diversification to investors, as most of them typically own hundreds of properties across many states. In addition to that, since they distribute all of their earnings to shareholders, their yields are typically much higher than yields on stocks. An important metric for evaluating REITs is Funds from operations (FFO). FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items.
Most REITs have rather stable revenues and as a result are able to maintain and even consistently raise distributions over time. I have highlighted four trusts for further research:
Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The company leases its retail properties primarily to regional and national retail chain store operators. Realty Income is widely known among its investors as the monthly dividend company. The company is a dividend achiever, which has increased its dividend for 15 years in a row by raising its monthly distributions several times per year. (analysis)
Universal Health Realty Income Trust (UHT) operates as a real estate investment trust (REIT) in the United States. The company invests in health care and human service related facilities, including acute care hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers, and medical office buildings. The company is a dividend achiever and has raised distributions for 22 consecutive years. (analysis)
Health Care Property Investors, Inc. (HCP) operates as a real estate investment trust in the United States. The company invests in health care-related properties and provides mortgage financing on health care facilities. This dividend achiever has raised distributions for 24 consecutive years. (analysis)
National Retail Properties, Inc. (NNN) is a publicly owned equity real estate investment trust. The firm acquires, owns, manages, and develops retail properties in the United States. It provides complete turn-key and built-to-suit development services including market analysis, site selection and acquisition, entitlements, permitting, and construction management. The firm also focuses on purchasing and financing net-leased retail properties. The company is a dividend achiever as well as a component of the S&P 1500 index. It has been increasing its dividends for the past 20 consecutive years. (analysis)
While I generally find these companies attractive, each one has its own risks. Realty Income (O) has slowed the growth in distributions, and its FFO payout ratio is above 90%. In addition to that the rate of vacancies there has increased over the past few years, as the number of assets under management has increased.
National Retail Properties (NNN) has not raised distributions since 2008. The company does have a lower vacancy rate than Realty Income and in addition to that has a much lower FFO payout ratio. If the company doesn’t raise distributions by the end of 2010, it would lose its dividend achiever status.
Fifty-one percent of Universal Health Realty Income's revenues are derived from leases to Universal Health Services. UHT’s advisor is a subsidiary of UHS, and all officers of Universal Health Realty are employees of UHS, which could create conflicts of interest.
One warning statistic for Health Care Property Investors, Inc. (HCP) is the fact that average occupancy percentage for Senior Housing has dropped from 95% in 2005 to 86% in 2009. This occupancy ratio represents occupancy and unit/bed amounts as reported by the respective tenants or operators. Certain operators in HCP Inc’s hospital portfolio are not required under their respective leases to provide operational data however. The company’s focus on senior living facilities should benefit from increasing demand by retiring baby boomers. There will be a significant increase in the number of people over the age of 65 in the US over the next decade, which would be beneficial to overall healthcare facilities.
Overall, I like the stable income streams generated by real estate investment trusts. I believe that getting exposure to real estate through REITs could not only help in diversifying your income portfolio, but also boost your current yield. In addition to that most REITs also grow distributions, which provides some hedge against inflation.
Full Disclosure: Long O, NNN, UHT
Relevant Articles:
- Realty Income (O) Dividend Stock Analysis
- National Retail Properties (NNN) Dividend Stock Analysis
- Universal Health Realty Income Trust (UHT) Dividend Stock Analysis
- Health Care Property Investors, Inc. (HCP) Dividend Stock Analysis