Four REIT stocks pass a strict quality screen, with dividend yields up to 6.19%

By Philip van Doorn

Income-seeking investors will soon lose their easy access to yields of over 5% in bank accounts

Investors can never predict the exact timing of interest-rate cuts, but many expect the Federal Open Market Committee to begin reducing the target range for the federal-funds rate on Sept. 18, following its next policy meeting.

The federal-funds rate has been in a range of 5.25% to 5.50% since July of last year. This has made it easy for some income-seeking investors to avoid difficult decisions, with 5% bank CDs available. An investor who questions why an adviser would recommend a bond investment when attractive CD rates (in accounts protected by the Federal Deposit Insurance Corp.) are easy to come by may not understand that "banks' short-term yields go away," according to Lewis Altfest, CEO of Altfest Personal Wealth Management, which he founded in 1983 and which manages $1.7 billion in client assets.

Evidence that some investors agree with Altfest is provided by the inverted yield curve for U.S. Treasury securities. The Federal Reserve has kept short-term rates high in an effort to reduce inflation. The yield on three-month Treasury bills BX:TMUBMUSD03M was 5.22% early Monday, while the yield on 10-year Treasury notes BX:TMUBMUSD10Y was only 3.89%. In a lower-inflation environment, it would be typical for long-term interest rates to be higher than short-term rates.

The long-term rates are already low because demand for long-term bonds is high - investors have been loading up on longer-term bonds, which might indicate they expect the U.S. to enter a recession, or at least that they expect short-term rates to decline. When bond prices rise, their market yields fall.

Share prices of real-estate investment trusts can move in a manner similar to bonds (in the opposite direction of interest rates), because these companies are required to pass at least 90% of their profits to shareholders in the form of dividends, in return for tax advantages. REITs fall into two broad categories. Equity REITs own and rent out properties or sell them for a profit after acquiring, developing or improving them. Mortgage REITs are primarily lenders or investors in mortgage-backed securities.

So far this year, excluding dividends, the real-estate sector of the S&P 500 SPX has increased only 4.3%, for the second-worst performance among the 11 sectors of the U.S. large-cap benchmark stock index. This might reflect concern over high vacancy and declining property values for office buildings. That is one reason you should do your own research to form your own opinion when considering any investment.

Related coverage from Joy Wiltermuth:

Real-estate stocks are bouncing back. Is the commercial property rout over?Office REITs find an open door in the bond marketPimco sees no recession, despite bond-market signal

Screening REIT stocks

For a broad screen of the REIT space, we started with the Russell 3000 Index RUA, which is designed to represent about 98% of companies that are publicly listed in the U.S. The index includes 172 REITs of various types.

Investors will of course be interested in REITs with high dividend yields. So the screen centers on companies' ability to raise their payouts or at least avoid lowering them.

Within the REIT industry, the metric called funds from operations, or FFO, is typically used to gauge a company's cash flow that is available for dividends. FFO adds depreciation and amortization (noncash figures) back to earnings while netting out gains on the sale of property. Going further, adjusted funds from operations, or AFFO, nets out the costs to maintain properties that REITs rent out.

So an obvious way to screen REITs for dividend coverage would be to look at consensus AFFO estimates. But we went further to take a conservative approach.

During an interview with MarketWatch, Altfest said that REITs with high dividend yields "can be appealing" but cautioned investors not to expect growth for their share prices. "It is going to be difficult for these companies to grow, because they are paying out the greatest percentage of cash flow," he said.

When making our first cut for the REIT screen, we reduced the list of 172 companies to the 108 covered by at least five analysts polled by FactSet and for which consensus 2025 AFFO estimates were available. Dividing the AFFO-per-share estimates by the current share prices gave us estimated AFFO yields. Comparing the AFFO yields to the current dividend yields showed whether or not there was headroom to pay higher dividends, based on the estimates.

There were 87 REITs remaining for which the indicated 2025 headroom was at least 1%. And when we sorted this list by current dividend yield, there were four REITs with yields in excess of 10%, with two above 13%.

"There are people who get caught up in the yields on REITs," Altfest told MarketWatch. "The 13% you are talking about is clearly not a high-quality yield. There is something going on there." In other words, the high dividend yield means investors have been shying away from these stocks.

For additional screens for quality, Altfest suggested looking at revenue. "If you see their revenues are going down, it could indicate difficulties - for example, in a REIT of office buildings, in which leases are up and they are having difficulties re-signing or getting someone new in there," or for which the REIT must lower what it charges per square foot upon renewal.

So we pared our REIT list further by removing any company whose quarterly revenue per share had declined from the previous quarter or from the year-earlier quarter. We used per-share numbers rather than raw revenue numbers because the per-share numbers reflect any dilution to shareholders from the issuance of new stock-raise money. This left us with 38 REITs.

Then, because depreciation and amortization are added back to earnings as part of the AFFO calculation, we took our screen a step further. Altfest asked, "Is the highest proportion of the dividend not coming from depreciation?"

It turned out that among our 38 remaining REITs, only four passed this last part of the enhanced screen. All are equity REITs. Here they are, sorted by dividend yield:

   REIT                               Ticker   Current dividend yield  Estimated 2025 AFFO yield  Estimated headroomInvestment concentration 
   Gaming & Leisure Properties Inc.    GLPI                     6.19%                      7.98%               1.80%Casinos/casino hotels 
   VICI Properties Inc.                VICI                     5.25%                      7.35%               2.09%Casinos/casino hotels 
   National Health Investors Inc.      NHI                      4.85%                      6.37%               1.52%Senior housing and medical 
   CubeSmart                           CUBE                     4.20%                      5.38%               1.18%Self-storage properties 
                                                                                                                                 Source: FactSet 

Click on the tickers for more about each company.

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-Philip van Doorn

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08-24-24 0759ET

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