REITs are up by over 50% over the past six months, and finding high-yielding opportunities is increasingly difficult:
If you look at the largest REIT ETF, the Vanguard Real Estate ETF (VNQ), its yield is down to only 3.5%. Once you take into account taxes and inflation, you may be left with just around 2%. If you suffer a few dividend cuts, the yield could be even lower.
For a real estate investment, this is not acceptable for us. We strongly believe that real estate should be an income investment first. Private real estate investors commonly target 5-10% annual yields, and it should not be any different when investing in REITs.
Even putting total returns aside, a lot of investors would prefer to earn a higher dividend yield to meet passive income needs. Unfortunately, because REIT ETFs are so heavily invested in richly valued, low-yielding REITs, they fail to provide high income. In today’s market, high income is only achieved by selective investors.
At High Yield Landlord, we target a safe and growing 6-8% dividend yield, and we achieve this by investing in smaller and lesser-known REITs that are deeply undervalued. Right now, our average portfolio yield is 6.2%, and it is backed by a low payout ratio that leaves sufficient retained cash flow to grow the dividend over time:
Our Portfolio is composed of what we believe to be the 25-best-REIT opportunities in today’s market. Today, we discuss two of them that are worth buying this Cyber Monday.
These are great examples of the type of opportunities that we like to target. They are deeply undervalued, and you get paid significant income while you wait for long-term appreciation:
RioCan: Monthly 8% Dividend Yield
Last week, we added RioCan (OTCPK:RIOCF) to our portfolio, and it is already up by 5%. Even then, it remains deeply discounted relative to most other REITs.
RioCan is one of the largest shopping center REITs in Canada:
Source: Company website
Retail is hated because of the pandemic, and as a result, RioCan now trades at a 40% discount to NAV and an ~8% dividend yield, which we believe to be sustainable, but more on that later.
We think that this is a great opportunity for sophisticated real estate investors who understand that not all retail is created equal.
RioCan owns the kind of retail that we expect to perform well in the long run:
- These are mainly open-air strip centers and urban mixed-use properties.
- They are anchored by grocery stores, pharmacies, and other essentials.
- The other shops are mostly internet-resistant businesses, such as gyms, barbershops, restaurants, dollar stores, and home improvement stores.
- The exposure to apparel, electronics, and department stores is manageable at just ~10%.
- And importantly, over half of the assets are located in Toronto, which is one of the best real estate markets in the world:
Source: Company IR
These properties are resilient to recessions, but they are not immune to pandemics and economic shutdowns. Early into the crisis, rent collection rates dropped significantly, and it caused a lot of uncertainty.
However, by now, rent collection rates have already recovered to 93%, which is even better than that of its peers in the US. Moreover, its properties have kept enjoying high retention rates and strong leasing spreads even despite the crisis:
Source: Company IR
Today, RioCan screens as a value investment because retail is out of favor, but its long-term growth prospects remain mostly intact.
The company owns well-located properties in high-growth markets, and it is in the process of densifying its assets to maximize value. It has by far the largest pipeline of development opportunities in its peer group. This includes 42 million square feet of mixed-use residential developments, and over a third of that has zoning approved:
Source: Company IR
Today, 10% of RioCan’s cash flow already comes from non-retail uses, and as it keeps building more residential units, its cash flow will only become more diverse. The beauty of these projects is that they build assets at nearly 6% yields, but in reality, they are worth closer to 4% cap rates.The company estimates that each dollar invested turns into $1.57 of value.
Moreover, when you add a residential tower on top of your retail property, you also improve the economics of the retail shops below it.
Here you have three examples:
Source: Company IR
We think that the market focuses too much on the near-term results and forgets about the big picture.
Investors who can look past the “retail apocalypse” headlines can today buy shares of RioCan at 60 cents on the dollar and earn a monthly 8% yield while they wait for the shares to appreciate by ~50% as they return to previous highs in the recovery.
Is the dividend sustainable?
We believe so. The dividend has never been cut since the company went public in 1993, and the most recent payout ratio was 86%. The payout ratio is high but manageable, and the CEO has made it clear that the company doesn’t plan to cut it:
The reason we are giving this guidance at this time is not only to counter some of the fear and anxiety that is clearly out there, but also to reassure our investors of our continued commitment and ability to maintain our current level of distributions. As we have said in the past, we consider our distributions a promise to our unitholders. And while the board of RioCan, are of course, the decision-makers on this matter, management currently sees no reason to recommend any changes to our current distribution.
Everybody was telling me to cut the distribution, including some members of my own board in 2009, when we only earned $1.22 in funds from operations and we distributed $1.38. Taking into account capital expenditures, the shortfall was more dramatic. I made a deal with the board because I knew a lot of shareholders relied on distributions. It would have been easy to cut the distribution or just give it to people in stock. I just felt a lot of people were relying on it. I felt we have this covenant with those people.
Source: Company news
It is nice to have a management team that is so committed to the dividend. Receiving a monthly 8% yield will help us to remain patient while we wait for the long-term recovery.
W.P. Carey: Rock-Solid 6% Dividend Yield
W.P. Carey (WPC) might be the safest ~6% yielding REIT that you can buy today.
It is a blue-chip net lease REIT with an industrial-heavy portfolio that continues to generate steady cash flow even in today’s crisis. Its rent collection rate has stayed at near 100%, and it has 11-year long leases with very limited maturities in the coming years.
The demand for industrial real estate is booming right now because of the growth of e-commerce, which has only accelerated because of the COVID-19 crisis. Companies like Amazon (AMZN) need a lot of industrial space for warehouses and distribution centers.
WPC is leasing it to them, and not surprisingly, it has kept doing very well in 2020. Here is an example of a distribution center that the company leases to Advance Auto Parts (AAP):
What is unique about WPC is that 99% of its leases have contractual rent increases, and 2/3rd of these increases are tied to an inflation index. Therefore, it is a very defensive investment even if inflation got out of control.
With 11-year long leases, strong tenants, automatic rent increases, and high demand for its properties, WPC is well-positioned to deliver steadily growing cash flow to investors, which then results in steadily rising dividends.
What is its track record?
Well… It is better than that of 95% of REITs. WPC has a 20+ year track record of consecutive dividend growth. This includes the 2000 crash, 2008-2009 financial crisis, and even the 2020 COVID-19 crisis. The dividend payments never stop and only keep getting larger:
Even despite being such a high-quality REIT, WPC is today offered at a nearly 6% dividend yield. This is especially surprising when you consider that we live in a yield-less world with the 10-year treasury offering only a 0.8% yield.
Historically, WPC has traded at a 200-basis point spread relative to the 10-year treasury, but today, you can buy it at a 500-basis point spread.
As we put this crisis behind, and income-starved investors rush back to the REIT market, we expect WPC to reprice at a ~4% yield, unlocking ~50% upside to investors who buy it today.
Disclosure: I am/we are long RIOCF; WPC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.