Dividend investors, or investors who focus on generating current period income, were hit hard earlier this year as many companies decided to halt or cut back on shareholder distributions due to headwinds related to the Covid-19 pandemic. For example, airlines were forced to suspend dividends and stock buybacks under theterms agreed upon with the government in the $25 billion federal payroll support program that provided much-needed funds to the industry a few months ago. A massive hit to earnings was the primary reason behind the decision by many oil companies to reduce dividends.
Real estate investment trusts, or REITs as they are commonly referred to, are considered one of the most attractive investment vehicles for dividend investors because these companies are required by law to distribute the bulk of their profits to enjoy tax benefits. The real estate industry, however, has been under pressure since March because of low occupancy rates in commercial properties, lack of foot traffic to malls, the shutdown of hotels and nonpayment of rent by many tenants due to financial difficulties. These negative developments led to a wave of dividend cuts in the first half of the year. The following table provides a summary of a few notable companies that had to go down this path.
Source: Hoya Capital Real Estate.
After many months of disappointing performance resulting from macroeconomic challenges, the REIT sector is finally poised to deliver attractive returns as the U.S. economy sets up to grow in 2021. Higher earnings for REITs automatically lead to dividend hikes, which is good news for dividend investors. This also indicates now is the best time to get back into this sector. That being said, focusing on the best subsectors in this industry will be necessary to mitigate the downside risk.
The outlook
The mall sector is one of the market segments that looks very promising. Retail sales in the U.S. collapsed dramatically in the first three months the year, but have since reverted to the levels seen before the pandemic. In fact, both July and August sales numbers were better than the pre-recession level, which indicates the strong recovery that has prevailed since late April. The multitrillion-dollar stimulus package introduced by the federal government and the monetary policy boosts provided by the Federal Reserve have played a major role in this phenomenal recovery.
Source: Statista.
Earlier in the year, sales dried up as a result of the stay-at-home orders issued by state governments. For this reason, many tenants did not honor their contractual rent payment obligations to mall owners. Over the last few months, however, rent collection ratios of the top mall REITs have improved considerably from the lows reached in April and May.
| Company | Rent Collection in March | Rent Collection in April | Rent Collection in August | Rent Collection in September |
| Simon Property Group, Inc. (SPG, Financial) | 72% | 72% | 85% | 85% |
| The Macerich Company (MAC, Financial) | 61% | 61% | 80% | 80% |
| Brookfield Property Partners L.P. (BPY, Financial) | 34% | 34% | 70% | 70% |
| Tanger Factory Outlet Centers, Inc. (SKT, Financial) | 43% | 43% | 89% | 89% |
Source: Company filings.
It's clear that there has been a remarkable improvement in rent collection numbers over the last couple of months, and this trend should continue if the American economy grows as expected in 2021. This noteworthy development has not been overlooked by top Wall Street analysts. In a research note sent to clients on Nov. 29, Odeon Capital analyst Alex Arnold wrote:
"Third-quarter collections were not only up in aggregate but also across all shopping center types. October is looking even better."
The unemployment level in the U.S. spiked sharply in the first quarter, creating a significant level of uncertainty regarding the outlook for shopping centers. In the last few months, however, the unemployment rate has improved considerably, with many companies getting back to their normal business routine, creating employment opportunities on a nationwide basis.
Source: USA Facts.
To gain exposure to the expected revival of retail sales and physical store sales, the best option is to invest in the largest mall owners in the country, such as Simon Property Group. In February, the company reduced its quarterly dividend from $2.1 per share to just $1.3, but shares still yield over 6% as of Nov. 30. If the company continues to report improvements in rent collection, which is very likely, an increase in dividends can be expected to the delight of income investors.
In the commercial real estate sector, investors should ideally avoid taking on the risks associated with office properties. The work-from-home movement has gained traction at a rapid pace in every corner of the world, and things are not different in the U.S. as well. Even if health risks subside in the coming months, many large companies have agreed to allow their employees to work remotely on a permanent basis. Top employers in the country, such as Twitter, Inc. (TWTR, Financial), Alphabet Inc. (GOOG, Financial) and Amazon.com, Inc. (AMZN, Financial), have all announced plans to allow employees to work remotely for an extended period of time. As this trend gains momentum, the occupancy rates of office properties can only go down, which is not encouraging news from the front of property owners. Considering this possibility, income investors should ideally ignore the high yields at which some of the largest office REITs are trading in the market as cash flows might soon dry up for this business sector.
The outlook for residential REITs is mixed. Even though homebuilder stocks have rallied since March, owners of apartments and multifamily properties have shed millions of dollars in market value due to low rent collection numbers reported in quarterly filings. Another factor that fueled the negative sentiment surrounding this sector is the declining rents seen over the last few months. The key to finding best-in-class opportunities in residential REITs is to consider the changing demographic factors. For instance, certain suburbs in the U.S. have seen a significant drop in rents, whereas it has been quite the opposite for some other regions. Investing in companies that focus on suburbs with increasing demand for rental properties is the best way to mitigate the risks of investing in this cyclical segment of the real estate market.
Takeaway
Income investors look to high-quality REITs to generate income, but 2020 has not been a good year so far for this practice. The future, however, looks much brighter because of various developments discussed in this analysis. Mall REITs stand out as a subsector with a promising outlook, but the expectations for office REITs remain gloomy. A growth-oriented investor might not find REITs attractive at this point, but income-oriented investors might find lucrative opportunities in this high-yielding sector amid the low-interest rate environment.
Disclosure: The author does not own any stocks mentioned in this article.
Read more here:
- Southwest Airlines: Be Greedy When Others Are Fearful
- It's Not Too Late to Invest in Small-Cap Stocks
- BlackRock Continues to Expand
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
