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Margaret Moran
Margaret Moran
Articles (260) 

REIT Investing: Time to Chase Strength, Not Yields

While REITs are famous for their high yields, now is the time to focus on quality over payout

April 17, 2020 | About:

In addition to allowing investors to gain exposure to a wide range of real estate assets, real estate investment trusts, or REITs, are known for their impressive dividend yields. This unique asset class is required to distribute at least 90% of real estate-related income directly to investors, resulting in some pretty impressive dividend yields.

Those yields may appear to become more impressive during market selloffs, with many shooting into the double digits. Given the lower valuations for most names in this sector, investors may be tempted to chase the highest yields. For example, the dividend yield of EGR Properties (NYSE:EPR) is up to 18.47% as of April 17 after its stock dropped 67% year to date compared to the S&P 500’s 16% loss.

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On April 15, the company announced its monthly dividend would be 38.25 cents per share, which is in line with the previous payment. However, EGR’s financial strength is rated 4 out of 10 by GuruFocus. The Altman Z-Score of 0.58 indicates that the company could be in danger of bankruptcy within the next two years, while the interest coverage of 1.97 times suggests that it may have trouble making interest payments on its loans.

Furthermore, the company focuses on properties that provide leisure and recreation opportunities in Chicago, meaning that if wealthy consumers cut down on their discretionary spending in the city, EGR could see its earnings drop.

In the volatile market environment ignited by Covid-19 and high debt among U.S. companies and individuals, rented real estate (and REITs by extension) could see a drop in value as customers lose their ability to pay rent or become more interested in buying instead.

With this kind of high-risk environment, investors may need to pay even more attention to the historical association between yields, leverage and risk. When yield is higher, both rewards and losses are magnified. It’s the same with leverage; the more leveraged a company is (i.e., the more debt it has), the more both rewards and losses are magnified. This is because, in order to achieve massive growth in earnings and higher yield, REITs must take on more risks, including high (and often high interest) debt and rapid-fire acquisitions.

Thus, with data from RENTCafé already showing that traffic to its site decreased by 22% in the second half of March compared to a typical drop of 4% for the same time period, investors looking to allocate capital to REITs may want to consider names that are at a lower risk of losing business due to declining economic conditions.

The following REITs have high financial strength, dividend yields in the single digits and a history of not suffering devastating losses during economic recessions. They also operate in real estate sectors that have a comparatively lower risk of seeing profit declines.

PS Business Parks

California-based PS Business Parks Inc. (NYSE:PSB) is a REIT that operates commercial properties, with a focus on multi-tenant industrial, warehouse, flex and office spaces. It has properties located in California, Texas, Washington, Florida, Virginia and Maryland.

On April 17, shares of PS Business Parks traded around $134.36 for a market cap of $3.68 billion and a price-earnings ratio of 33.82. According to the Peter Lynch chart, this is a better valuation than what the stock has historically traded at.

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This REIT has a dividend yield of 3.14%, which is above its median yield of 2.64%. Its financial strength has a GuruFocus rating of 9 out of 10; the company has no debt and an Altman Z-Score of 25.8.

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As per the chart below, PS Business Parks saw its revenue and net income remain steady throughout the past two recessions.

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Public Storage

Public Storage (NYSE:PSA) is a California-based REIT that runs a chain of self-storage facilities by the same name. It is the largest self-storage company in the U.S.

On April 17, Public Storage shares traded around $197.38 for a market cap of $34.21 billion and a price-earnings ratio of 26.93. According to the Peter Lynch chart, the stock is trading near its intrinsic value.

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Public Storage has a dividend yield of 4.07%, which is higher than the historical median of 3.05%. GuruFocus gives the company a financial strength rating of 7 out of 10; the cash-debt ratio of 0.22 and Altman Z-Score of 9.52 are higher than 84.31% of competitors.

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The chart below shows that the company’s revenue and net income declined approximately 5% per year during the 2008 financial crisis. However, it has shown overall strong growth, proving that the 30% reduction in share price over the same time frame provided a value opportunity.

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Medical Properties Trust

Medical Properties Trust Inc. (NYSE:MPW) is an Alabama-based company that owns and operates health care facilities that are subject to triple net (NNN) leases, in which the renter is responsible for all property expenses.

On April 14, shares of Medical Properties Trust traded around $17.17 for a market cap of $8.93 billion and a price-earnings ratio of 19.92. The Peter Lynch chart suggests that the stock is trading near its fair value.

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The dividend yield is 6.06%, which is below the median historical yield of 6.93%. GuruFocus gives the company’s financial strength a rating of 4 out of 10; the cash-debt ratio of 0.21 is higher than 82.88% of competitors, but the Altman Z-Score indicates potential distress. This is because the company took on more debt to make acquisitions in 2019.

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In the chart below, we can see that revenue and net income remained little changed during the 2008 financial crisis. Overall, the company has shown strong growth in both its top and bottom lines (excluding the abnormally high net income for 2018, which was the result of asset sales).

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Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research or consult registered investment advisors before taking action in the stock market.

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