Look To REITs For Reliable Yield Even In Recessionary Environment

Key Points

• An attractive feature of REITs is dividend income and yield. By law, REITs are required to pay out at least 90% of taxable profit to shareholders as dividends. 
• Prologis, the largest REIT by market cap, has a 10-year track record of dividend increases.
• While office building REITs may be underperforming, tailwinds are helping REITs in categories including self-storage, entertainment, apartments, industrial spaces, and cell towers.

Investors who want exposure to real estate, but who don’t want to deal with clogged toilets, leaky roofs, and late rental payments often turn to real estate investment trusts, or REITs, which are reliable sources of income. 

The largest publicly traded REIT, by market cap, is Prologis Inc. NYSE: PLD, which owns and operates industrial real estate properties throughout the world. The stock has been rallying this year, but was slammed along with the broader market during the week ended March 10. 

An attractive feature of REITs is dividend income and yield. By law, REITs are required to pay out at least 90% of taxable profit to shareholders as dividends.

Prologis’ yield is 2.65%, and it has a track record of increasing its dividend for the past 10 years. 

That’s not bad at all, but there is a select group of REITs with better yields combined with good price appreciation. Those include:

• Gaming and Leisure Properties Inc. NASDAQ: GLPI: 5.6%
• Getty Realty Corp. NYSE: GTY:  4.9%
• Vici Properties Inc. NYSE: VICI: 4.8%
• Essential Properties Realty Trust, Inc. NYSE: EPRT: 4.68%
• CubeSmart (NYSE CUBE):  3.58%
• Life Storage, Inc. NYSE: LSI: 3.44%

Be aware: These do not represent the highest-yielding REITs; the highest-payers may not be the best securities to purchase. The highest yields have been clustered in office REITs. Because yield is a ratio comprising the dividend payout per share with the stock’s price, a downward-trending price will result in a high yield, as the payout remains relatively static. Lower prices and lower revenue could result in a dividend cut. 

That tends not to happen much with REITs, which like to keep dividends steady, but in a recessionary environment, combined with a faltering “back-to-the-office” thesis, it wouldn’t be a surprise to see office REIT prices drop. 

Some analysts believe REITs in general, are undervalued. An easy way to gauge that thesis is by using the Schwab U.S. REIT ETF NYSEARCA: SCHH, which tracks the Dow Jones U.S. Select REIT index.  

As you can see on the SCHH ETF’s chart, shares have had a tough time gaining traction since the beginning of 2022, just ahead of the Federal Reserve’s first in a string of recent interest-rate hikes. 

Despite economic uncertainties and higher interest rates, REITs as an asset class have seen a year-over-year increase in funds from operations and net operating income, according to industry trade organization Nareit. 

In its 2023 REIT outlook, the group made several key points about the industry:

• REITs, on average, outperformed both private real estate and the broader stock market during and after the last six recessions.
• REITs are entering this period of slower economic growth with strong operational performance and are well-positioned for economic uncertainty in 2023.
• REIT and private real estate valuations will continue to reflect higher interest rates and a slower-growing economy in 2023.

The SCHH ETF’s underlying index fell more than the broader market in 2022. 

Securities from all asset classes tend to get carried by the industry tide. That means plenty of REIT stocks are currently undervalued, relative to their earnings potential. While office buildings may not deliver the kind of returns they did in the past, categories being helped by tailwinds include self-storage, entertainment (other than movie theaters), apartments, industrial spaces, and cell towers. 

“The industrial, retail, and apartment property types maintained elevated occupancy rates that were higher than their respective pre-pandemic levels,” Nareit said in its 2023 outlook. “Office occupancy continued its downward trajectory, dropping nearly 3% from its 2019 average. Four-quarter rent growth rates remained healthy for the industrial, retail, and apartment sectors; office continued work toward maintaining positive rent gains.”

The bottom line is: REITS can provide reliable yield throughout various market and economic cycles, but investors should use caution, and realize that various segments of real estate don’t all behave the same. In addition, a reliable yield is often preferable to a high yield, which can be affected by a dividend cut due to reduced revenue and earnings.