Real estate investment trusts, or REITs, make excellent investments for income-seekers as well as investors who are looking for long-term growth. However, not all REITs are the same. Here are three that are some of the best in the sector and make excellent additions to any long-term investor's stock portfolio.
What is a REIT?
If you're not familiar with real estate investment trusts, or REITs, they're companies that invest in real estate assets -- either properties or mortgages -- with the intention of generating income from those assets to distribute to shareholders. If a REIT distributes at least 90% of its taxable income as dividends, it won't be taxed at the corporate level, which is why REITs are generally some of the highest-paying dividend stocks in the market.
There are REITs that specialize in all kinds of property types, including warehouses like featured REIT Prologis does. Image source: Getty Images.
What to look for
There are hundreds of publicly traded REITs, but I tend to stick to the larger, more established players in the sector when looking for long-term investments. I like to see a well-established track record of value creation, dividend growth, and responsible risk management. In addition, I prefer equity REITs (those that own property), instead of mortgage REITs, because they tend to have more predictable growth and income.
To name some of my favorite REITs for long-term investors:
- Realty Income (O +0.53%) invests primarily in freestanding retail properties and has raised its dividend 93 times since 1994.
- Welltower (HCN +1.75%) is the largest healthcare-focused REIT in the market and has a record of market-beating returns dating to 1971.
- Prologis (PLD +0.33%) is an industrial REIT that's well positioned to capitalize on the e-commerce-fueled need for warehouse space.
Here's a closer look at each of these REITs and why you should take a closer look at each.
1. The right kind of retail
Many investors are hesitant to invest in retail, and who could blame them? As of this writing, there have been more than 20 high-profile retail bankruptcies in 2017 alone, and many retailers who haven't declared bankruptcy are struggling to survive.
However, even though Realty Income invests primarily in retail real estate, the vast majority of its tenants are unaffected by the retail-sector headwinds. Specifically, Realty Income invests in properties occupied by tenants with a service-based component (think movie theaters or restaurants), a discount-oriented business (dollar stores, warehouse clubs), or a focus on non-discretionary products (drugstores, convenience stores). When you think about it, most retail bankruptcies have affected companies that were selling full-price products that people didn't need.
What's more, Realty Income's tenants are all on long-term net leases, which generally have 15-year-plus initial terms, minimizing turnover and vacancy risk. These leases generally have annual rent increases, or escalators, built right in and require the tenants to cover property taxes, building insurance, and most maintenance expenses. In other words, Realty Income simply puts a tenant in place and enjoys over a decade of steadily growing, predictable income.
Realty Income pays a 4.6% dividend yield in monthly installments and has achieved annualized total returns of more than 16% since its 1994 NYSE listing, handily beating the S&P 500.
2. A play on the aging U.S. population
The ongoing retirement of the baby boomer generation means that the older age groups of the U.S. population are going to get much larger over the coming decades. This will create tremendous demand for healthcare, particularly senior housing and other types of healthcare that disproportionately serve older individuals. In fact, the 85-and-older population is expected to double in just 20 years, and this is the target demographic for senior housing.
Image source: Welltower investor presentation.
Welltower is the largest REIT that focuses on healthcare properties, and with 70% of its portfolio in senior housing, it's also one of the most well positioned to benefit by the industry's growth.
Most of Welltower's tenants derive their income from private-pay revenue sources, which are far more consistent and predictable than government reimbursements. To add to the opportunity, many of Welltower's senior housing properties are structured as operating partnerships, as opposed to traditional real estate leases. In fact, Welltower's top revenue source is fees and services paid by its properties' residents, not rental income.
Welltower has maintained a stunning track record of performance for more than 45 years, and with favorable demographic tailwinds, there's no reason to believe it won't continue to do so.
3. E-commerce creates a massive need for logistics properties
Prologis is an industrial REIT that specializes in distribution space, or what it refers to as "logistics real estate."
Essentially, the rise of e-commerce and the growth in global consumption has led to a massive increase in the need for fulfillment space. E-commerce fulfillment requires triple the square footage of brick-and-mortar retail, and global consumption has tripled. Prologis is the leader in helping companies meet this growing need.
And there's no expectation that the opportunity will slow down anytime soon -- Prologis estimates that the market could absorb an additional 3 billion square feet of logistics real estate based on the current demand, and e-commerce sales are expected to grow by 162% during the five-year period ending in 2020.
As you might expect, Amazon.com is a major Prologis tenant, as are DHL, Wal-Mart, and The Home Depot, just to name a few. However, the portfolio is rather diverse. On average, Prologis' top 25 tenants each account for less than 1% of the company's rental revenue.
Invest with the long term in mind
To be perfectly clear, I'm not saying that the three REIT stocks I discussed here will perform well in the next few months, or even over the next year. Over short periods of time, these stocks can be rather unpredictable and often move for reasons having little to do with the health of the business.
For example, while the S&P 500 has gained 15% for 2017 through mid-November, Realty Income is down by 1.8% thanks to a combination of rising interest rates, which tend to put downward pressure on REITs, and headwinds in the retail sector, although they've had virtually no effect on Realty Income's business. In fact, Realty Income's funds from operations are up significantly year over year, occupancy hasn't fallen at all from the third quarter of last year, and the balance sheet is as strong as ever.
The point is that these are great businesses that should produce excellent returns over long time periods, but the path to get there won't be straight up. So if you're considering one or more of these REITs for your portfolio, be sure that you're investing with the long term in mind.
