Diversify Your Exposure to REITs

Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I keep my eyes on a few mREITs, but these use mortgages to make their money. However, not all REITs need to rely on a paper note to generate an income that is paid out to investors. There are a lot of public REITs that buy, sell, and lease properties to earn money.

REITs are dividend investments, because they must pay out 90% of their income. That means that the companies are not increasing their sticker price like traditional companies. Capital appreciation is possible, but it is slower unless sentiment comes into play. Also, as they get more expensive, the dividend becomes less attractive.

Land in demand

I always felt that my focus on the mortgage-based REITs was a mistake. I liked the idea of actually leasing out property as well as buying and selling. It seemed more stable, but I never looked too deep into these. My normal information watering holes just covered mREITs far more. Recently, I came across an article discussing Senior Housing Properties Trust (NYSE: SNH) and its long-term potential.

Anything related to an aging population is worth taking a look at. The demand for senior homes and care will increase as the population ages. I am not too worried about healthcare reform risks, because I think the known risks have been known for a long time. I am also more optimistic than some that companies are capable of changing to deal with threats as they arise, as long as the company has a history of solid results.

The company has seen its revenue grow consistently over the years, and with a long-term outlook, I think there is more reward than risk. Also, the aforementioned article makes a point that most of the properties in Senior Housing’s portfolio are private pay, which is reiterated in the earnings conference call. That means risk from government programs is limited.

The dividend yield of 5.75% is lower than what you could find with the mREITs, but considering the risks those have, it would not be unwise to divide the exposure to REITs. The company also has no debt with a healthy balance sheet. That will take care of its capital needs for the near future. The last earnings conference call mentioned that there was more acquisition activity as of late to close deals before the next tax year.

Acquisitions are good. Considering that the company has occupancy rates in the mid-90% for both its medical office space and senior housing businesses, it needs more properties to increase income.

This is not the most complicated of investments, but the company seems like a solid one. Demographics are working in the company’s favor, and not having debt while having all those properties is a real draw for me. Also, the share price has done very well over the last 10 years, which is very good considering what has happened to real estate during that period.

You can also consider Hospitality Properties Trust (NYSE: HPT), which is a REIT that rents out hotels and other properties. The company has a higher dividend yield of 6.67%, but I do not like the industry as much. Demographics say that the U.S. population is aging and will require more medical care. There is no guarantee that people will travel in increasing numbers and occupy hotel rooms.

The economy is improving, so if there is a time when hotel rooms will be filled, it will be sometime later. Aging is not optional, however, and neither are many medical issues. The dividend at Hospitality Properties has stayed fairly flat in absolute terms, while Senior Housing has seen its dividend rise fairly regularly. This REIT is here if you have a massive portfolio and would like to diversify further, but Senior Housing seems like the better investment.

No need to ignore mREITs

I still like Annaly Capital Management (NYSE: NLY), but am not blind to its risks. I still think that interest rate and quantitative easing risk will only make themselves felt over time. Interest rates will rise slowly, and that could mean an increase in the spread between long-term and short-term interest rates that Annaly uses to make its money.

The risk comes from the decline in book value for Annaly’s existing assets as interest rates rise. That is the trade-off. The value of existing assets falls, but there is more opportunity to make money. Annaly is a dividend investment, so more income is better in my opinion. There is a risk to the share price, so it does not make sense to go in heavy, because there is a chance to get shares cheaper.

Annaly has made an effort to lower its expenses by moving to external management. It also uses less leverage than some of its peers. The 13%+ dividend is the big draw, but that yield is buoyed by a falling share price. The dividend’s absolute value has fallen over the last few years. Falling spreads and the company using less leverage are the causes.

The company is not in the red, and most of the fear is whether there are better places to park your money. I see no reason Annaly can’t benefit from interest rates rising slowly, considering the spreads have been under pressure for so long. It would be great to get this at $10 or less, but even at current levels, it could warrant an investment if it fits your portfolio and risk profile.

Conclusion

There are a lot of dividend investments out there, so I would have thought mREITs were enough. Annaly has had quite a few problems, though if it is cheap enough, I would still jump into it. Those problems require some REIT diversity, and I would be far more comfortable holding Senior Housing long-term. It seems like less of a headache than Annaly, since you do not have to watch for interest rates and their push-pull effects on book value and income.

Hospitality Properties might be one to consider if you need even more diversity, but I am fine passing on that one. The rising dividend of Senior Housing seems like a better draw than splitting a position with Hospitality Properties.

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