Once relegated to alternative-investment status, REITs have hit the mainstream. Indeed, REITs have become a staple of most well-rounded portfolios, providing the average investor with access to the world of institutional real estate and the wide-ranging benefits of property ownership. Still, although their appeal has gradually become more broad-based, the core audience for REITs remains the income-focused investor. Their sizable dividend yields, high payout ratios, and relatively steady operating performance have made REITs a highly effective cash-flow vehicle.
There is, however, a subset of the industry that bucks the standard; REIT stocks with relatively modest yields and below-average payout ratios. Moreover, yields can sometimes vary significantly within one niche of the REIT universe, with shopping center operators serving as a prime example. Of the 30, or so, REIT stocks covered in The Value Line Investment Survey, there are seven companies within the shopping center segment: Developers Diversified (DDR), Federal Realty (FRT), Kimco Realty (KIM), Penn REIT (PEI), Realty Income (O), Simon Property Group (SPG), and Weingarten Realty (WRI). These companies range in size from relatively small operators—Penn REIT, with a market cap of about $650 million—to industry heavyweights—Simon, just under $38 billion. And their assets run the gamut from strip malls, to regional centers, to big-box retail properties.
It’s no coincidence that of the seven REITs included here, the larger operators—such as Simon and Federal—typically feature more-modest yields than their smaller brethren. Case in point: In our most recent full-page reports, Simon and Federal had yields of 2.8% and 3.0%, respectively, compared with Penn and Weingarten and their respective yields of 5.6% and 5.0%. That’s to be expected, since growth-oriented companies dedicate a greater proportion of cash flow to development and acquisitions, activities designed to set the table for the future. As a result, less capital flows through the bottom line and into the hands of shareholders in the form of dividends. This represents an implicit tradeoff; investors committing funds to expansion-minded REITs are willing to accept lower payout ratios today for the promise of greater upside down the road.
REITs are usually measured against their segment-specific peers, as well as the broader industry across property types. But oftentimes, they’re also pegged against hybrid securities, such as preferred shares, since REITs blur the line between debt instruments and equities. Further, they’re sometimes compared with utility stocks, because of the yield-oriented nature of both investments. But from the perspective of the typical income-focused account, real estate investment trusts are most closely linked with U.S. Treasuries, widely regarded as the benchmark of REIT performance. However, due to their particular strengths and respective weaknesses, REITs and Treasuries are each more suitable for a specific type of investor.
The yield on 10-year Treasuries is currently just over 2.0%, but has historically been in the 4%-6% range, or in line with the long-term historical average for REITs. On the one hand, REITs also offer the prospect of growth—however modest, supplementing the dividend to offer decent total return potential. But on the other hand, 10-year Treasuries are backed by the full faith and credit of the United States government and come with the promise of repayment of principal at maturity, an advantage that REITs cannot match.
But the question remains: Should low-yield REITs merit consideration? For accounts focused on total return potential, Simon Property Group or Federal Realty certainly garner a look, since these stocks generate current income while offering the prospect of higher-than-average growth for the industry. However, investors with a one-track mind on yield would likely be better served choosing Penn REIT or Weingarten Realty, two companies that return a greater proportion of funds to shareholders in the form of a dividend. Moreover, if capital preservation is critical, the 10-year U.S. Treasury wins decisively.
At the time of this article’s writing, the author did not have any positions in any of the companies mentioned.