There are a few sectors and industries that income investors can turn to, virtually without fail, to find above average dividend yields. Real estate investment trusts, commonly referred to as REITs, are one such industry (others include utilities and limited partnerships).

The high dividend payouts in the REIT sector relate to two aspects of these securities. First, REITs, as their name implies, own real estate or real-estate-related securities (in the case of mortgage REITs). This asset type is known for its cash flow generation. Second, REITs are structured as pass through entities for tax purposes. This allows these companies to avoid corporate taxation, but requires that the vast majority of earnings be “passed” on to shareholders as dividends. Note that shareholders must pay taxes on the dividends they receive from a REIT as if it were income.

Just because REITs, in general, have a tendency to pay material dividends, doesn’t mean that all REITs pay material dividends. Just as with other sectors, some REITs are geared toward growth and others toward income. To highlight those that are geared toward income, we used the online screening tools of The Value Line Investment Survey to highlight those REITs with the highest current yields.

This list is a good starting point for investors seeking income, but it is important to keep in mind that an above-average yield can be an indication that the market believes the dividend payment is at risk. That said, a high yield can also present a good buying opportunity if a company is merely misunderstood. The screen turned up several interesting REITs, including Hospitality Properties Trust (HPT), Duke Realty Corporation (DRE), and Mack-Cali Realty (CLI).

Hospitality Properties Trust

Hospitality Properties Trust is a real estate investment trust (REIT), that owns 289 hotels and 185 travel centers throughout the United States and Canada. The company leaves the operation of these properties up to unaffiliated hospitality management companies through 13 combination management or lease agreements. Currently, the largest of these agreements includes 145 travel centers located across 40 states, while the smallest combination has 11 hotels located in eight states. Interests that operate Hospitality’s hotels are some of the largest hotel management companies in the world, including Marriott International (MAR), InterContinental Hotels Group (IHG), Hyatt Corporation (H), and Carlson Hotels Worldwide. The company’s travel centers are operated exclusively by TravelCenters of America.

Operators of hotel and travel center properties agree to a minimum level of rents in order to protect Hospitality’s cash flows, regardless of performance. The effectiveness of these agreements had been in question, as three of the company’s largest lessees, TravelCenters of America, Marriott International, and InterContinental Hotels Group, had faced difficulties meeting their obligations. Over the past year, these agreements have been restructured, reducing guaranteed minimum rents by $47.3 million, and providing a more sustainable road forward.

With a yield of 8.2%, Hospitality pays a fortuitous dividend, and ranks second for payout among all REITs under our review. The conclusion of the aforementioned rent restructuring agreements should reduce cash flow uncertainty, and thus strengthen the payout.

Duke Realty Corporation 

Duke Realty Corporation specializes in office properties for the industrial, suburban office, and medical office markets, concentrated in Midwestern and Southeastern suburban areas. As of June 30, 2011, the company owned or jointly controlled 797 properties with an overall portfolio occupancy of 89.3%. A total of 790 of these were in service, and comprised 138.6 million square feet, while seven properties, totaling 2 million square feet, were under development. Duke operates in three reportable segments, office, industrial, and real estate service operations. 

This REIT is currently focused on repositioning its portfolio toward property types and regions with more favorable prospects. By 2013, Duke looks to increase its industrial and medical office property holdings to 60% and 15%, respectively. This will likely come at the expense of suburban office assets, which are to be limited to 25% of total holdings. Regionally, the REIT is seeking to reduce exposure to the Midwest and Southern markets, while expanding in Eastern and Western states with better economic prospects.

Shares of Duke Realty currently enjoy the sixth-highest yield —6.75%— of any REIT under our review. Although Duke has kept its quarterly disbursement constant at $0.17 a share for the last 10 quarters, stronger cash flows resulting from the adjustments to the portfolio may well support a resumption of growth here over the next three to five years. Indeed, looking to mid-decade, we project 12% growth in the quarterly payout.

Mack-Cali Realty

Mack-Cali Realty owns, develops, leases, and manages office and industrial properties, primarily in the Northeast. Its portfolio consists primarily of Class A office and office/flex properties, but also includes industrial facilities, and warehouses. At the end of 2010, Mack-Cali owned 277 properties totaling 32.2 million square feet. Finally, its yield of 6.79% is currently the fifth-highest among the REITs under our review.

Overall softness in the suburban office market has presented Mack-Cali with challenges, and has pushed down the lease percentage so far this year. Tenant retention has also been an issue, falling to 59.5% at the end of the second quarter. Much of this, though, is a result of broader economic problems, and should not hurt the quality of the portfolio. Indeed, there are reasons for encouragement, including the signing of 162 new and renewed leases in the June interim.

The REIT’s operations are concentrated in high-value markets, so we think the current headwinds will be temporary. A more robust economic recovery over the next three to five years would likely boost occupancy rates, cash flows, and possibly the payout. Indeed, looking out to mid-decade, we expect the quarterly dividend to increase about 11%.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.