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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. Potential investors should note that dividends shareholders receive from a REIT are taxed as ordinary income.

Just because REITs, in general, have a tendency to pay material dividends, doesn’t mean that all REITs do. Just as with other sectors, some REITs are geared toward growth and others toward income. To highlight those that fall into the latter category, we used the online screening tools of The Value Line Investment Survey to highlight those REITs with yields above the current median of 4.15% (see list below).
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 could also present a good buying opportunity if a company is merely misunderstood. The screen turned up several interesting REITs, including Realty Income Corporation (O).

Realty Income Corporation

Realty Income Corporation, founded in 1969, is a real estate investment trust engaged in the ownership and active management of freestanding commercial properties. As of June 30th, the company’s portfolio consisted of 4,263 properties, or 69.1 million square feet of leasable space, located throughout 49 states and Puerto Rico. To wit, the portfolio is primarily comprised of retail properties, with convenience stores serving as its largest industry. Notable tenants include Walgreens (WAG), FedEx (FDX), Dollar General (DG), LA Fitness, and Family Dollar (FDO), among many others. Overall, Realty Income generates rental revenue under long-term (10- to 20-year) net lease agreements, which, in turn, support the payment of monthly dividends (discussed below).

The company has maintained a healthy growth profile through active portfolio management as well as acquisitions. During the first six months of 2014, the company acquired 402 properties (or more than 6.9 million leasable square feet) for a record $1.1 billion. This included the purchase of 84 single-tenant properties, for $502.9 million, from Inland Diversified Real Estate Trust. To wit, 83% of these investments were retail properties. We believe Realty Income’s aggressive buying behavior will persist in the year ahead, as acquisitions are expected to total a hefty $1.4 billion in 2014. However, this activity may begin to moderate in 2015. Nevertheless, these asset purchases should continue to support earnings and dividend growth over the short and long terms.

The company has made some financial moves of late. During the second quarter, it issued $350 million of 3.875% senior unsecured notes, 13.8 million shares of common stock, and approximately 1.2 million common shares via its direct stock purchase and dividend reinvestment plan. In total, $929.6 million in net proceeds were generated. This was used to repay a portion of the outstanding borrowings under its $1.5 billion acquisition credit facility. Indeed, there is still approximately $1.4 billion available to fund future purchases. Dispositions, an additional source of capital, are expected to total approximately $75 million this year.

Overall, the company’s portfolio has performed well. Year to date, rental revenue has risen more than 25%, to $436 million, which was primarily supported by acquisition activity as well as year-over-year same-store rent increases. Moreover, occupancy levels, which have reached pre-recession highs, are anticipated to remain stable going forward. Funds from operations (FFO), a universal stand-in for earnings, have increased on a year-over-year basis since 2010. We expect Realty Income to continue on this growth path in the years ahead. In fact, FFO-per-share is expected to increase in the 11%-12% range in 2014. 

Under the REIT umbrella, companies are required to distribute at least 90% of their taxable income (excluding net capital gains) to shareholders in the form of dividends. The majority allocate these payouts on a quarterly basis; however, Realty Income uses a monthly structure. On June 30th, the board of directors raised the monthly distribution slightly, to $0.1827917 per share (payable August 15th), which equates to an annualized rate of $2.194. This is the 76th consecutive increase since the company’s IPO on the New York Stock Exchange in 1994. Realty Income has paid more than $3 billion in dividends over the past 45 years. 

Income-oriented investors may want to take a closer look here. The dividend has increased at a compounded average annual rate of approximately 5% since 1994, and we look for additional hikes over the 3- to 5-year horizon. The dividend is well covered. Moreover, the yield rests well above the REIT industry median. All told, Realty Income is a well-run company, in our view, and will likely continue to outperform.

 

Company Ticker Yield
Kimco Realty                   KIM 4.2
Penn. R.E.I.T.                 PEI 4.5
Washington R.E.I.T.            WRE 4.55
Ventas, Inc.                   VTR 4.62
Ryman Hospitality              RHP 4.74
Healthcare R'lty Trust         HR 4.89
Realty Income Corp.            O 5.05
Health Care REIT               HCN 5.23
Digital Realty Trust           DLR 5.28
HCP Inc.                       HCP 5.43
W.P. Carey Inc.                WPC 5.47
Liberty Property               LPT 5.5
Corrections Corp. Amer.        CXW 5.95
Geo Group (The)                GEO 6.12
Hospitality Properties         HPT 7
Annaly Capital Mgmt.           NLY 10.49

 

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