3 Reasons Why 50% Of My Portfolio Is Placed In REITs

seekingalpha06-17

Roughly 50% of my portfolio is placed in equity REITs.This goes hand in hand with the dividend investing strategy.In the article, I explain the three key reasons that motivate me to allocate so ...

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P. Carey Inc","O":"Realty Income Corp","BK4181":"酒店及度假村房地产投资信托"},"translate_title":"我的投资组合的50%投资于房地产投资信托基金的3个原因","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"APLE":1,"WPC":1,"VNQ":1,"SPG":1,"O":1,"EPR":1,"CFA.SI":1,"CFA":1,"ADC":1,"US3Y.BOND":0.9,"US7Y.BOND":0.9,"US6M.BOND":0.9,"US5Y.BOND":0.9,"US30Y.BOND":0.9,"US2Y.BOND":0.9,"US12M.BOND":0.9,"US10Y.BOND":0.9,"US912797FS14.BOND":0.6,"US912797GB79.BOND":0.6,"US912797GK78.BOND":0.6,"US912797GL51.BOND":0.6,"US912797GW17.BOND":0.6,"US912797HE00.BOND":0.6},"content_text":"Roughly 50% of my portfolio is placed in equity REITs.This goes hand in hand with the dividend investing strategy.In the article, I explain the three key reasons that motivate me to allocate so heavily in the REIT space.   Dragon Claws By reading the title of this article, I bet that for the majority of the audience, the first immediate thing that comes into their minds is either the concentration or low growth risks, which come along with having 50% of the exposure tilted towards equity REITs. The truth is that I fully agree that these risks are present and most probably by allocating into more growth biased stocks and diversifying more into the other equity segments, the overall risk-adjusted return profile for the portfolio would increase. Having said that, I really do not care about having the portfolio optimized according to the modern portfolio theory, where the objective is to diversify away any idiosyncratic risk. Also, allocating heavy amounts of capital into high-growth names does not fit my underlying investment strategy at all. The investment strategy, which I am applying, is (in broad terms) the following:  Invest in high-quality and defensive businesses, which offer abnormal dividend yields. Do not forget about the dividend growth component, but the primary objective is to make sure that the distribution level that is at the point of entry does not shrink. Reinvest the dividends into portfolio stocks, especially focusing on those that are temporarily depressed, to maximize the dividend income compounding effect. Avoid excessive single security concentration risk.  As you can see, the notion of enjoying returns in the form of price appreciation is irrelevant in my situation, where the only thing that matters is juicy, steadily growing and inherently defensive streams of current income. In this context, equity REITs come into play very nicely. Let me know explain the three most critical aspects that collectively justify my decision to carry so huge concentration in my portfolio to equity REITs. #1 High yielding and durable income The beauty of REITs is that they offer above-average yield, which is underpinned by defensive cash flows. If we look at the broader REIT market (VNQ), we will notice that while the dividend yield has indeed gone up since the Fed initiated its restrictive monetary policy, in absolute terms it is not that attractive, especially compared to fixed income alternatives.   YCharts However, by searching deeper in the REIT space, we can find REITs that have higher yields with the same degree of embedded defense that is necessary to fulfill my investment criteria - i.e., low probability of dividend cut and high probability of further dividend increase. Typically, these names are located in sectors that have fallen out of favor, where the market has assigned a sector-wide discount even for REITs that are able to grow and have the right defense in place. The most common examples stem from retail net lease, lodging and diversified REIT segments. For instance, the Top 3 REITs in terms of their share in my portfolio - EPR Properties (NYSE:EPR), Realty Income Corporation (NYSE:O) and Apple Hospitality REIT, Inc. (NYSE:APLE) provide dividend yields of 5.9%, 8.5%, and 6.6%, respectively. Given that all of them carry robust capital structures with well-laddered debt maturity profiles and have been able to consistently grow their AFFO generation, accessing such yields is very attractive. If we take the case of, say, Realty Income, we will notice that the underlying cash flows are backed by 10+ year weighted average lease agreements, which are significantly diversified across multiple sectors and different tenants. In addition, O is one of the few REITs out there that has an upper investment grade credit rating, which in combination of ~ 26% of FFO retention (after dividends) injects a great degree of safety, while allowing the Management to grow the portfolio in a de-risked fashion. #2 Growing income As I already briefly touched on this in the previous section, high yielding REITs do not necessary have to come with no or limited income growth prospects. In my REIT dividend investing strategy, one of the key components that have to be present is the relatively accommodative FFO payout ratio, which is not only important from the risk management perspective, but also to enable a REIT to stimulate FFO growth. In a nutshell, except for increasing the FFO payout, there are 5 avenues of how REITs can grow their distributions:  Issuing new shares to fund incremental investments (this can be done in an accretive manner, but, for example, in times like this when the equity valuations are down, the cost of equity is just too high for the cap rates that can be found in the M&A markets). Doing buybacks (this happens very infrequently as in the REIT business size matters, where a more diversified and larger portfolio creates better conditions for achieving strong credit rating). Taking fresh debt to venture into M&A or develop projects organically (there is a limit here as to how much debt a REIT can take) Collecting higher NOI from favorable lease rollovers and the embedded rent / lease escalators (this is a fairly sustainable process, but usually is limited by ~ 2 - 4% growth level). Combining the undistributed FFO with additional debt to do the M&A or facilitate organic development projects.  In reality, the combination of the last two points is necessary to maximize the FFO growth potential. Luckily, it is possible to find high yielding and defensive REITs, which have both favorable FFO payout levels and an embedded element of a like for like growth. Let's take those three same examples even though there are a more way more such as W. P. Carey Inc. (NYSE:WPC), Agree Realty Corporation (NYSE:ADC), Simon Property Group, Inc. (NYSE:SPG) etc.  Realty Income - FFO payout of 74% and a consensus FFO growth estimate of 3.6% for 2024. EPR Properties - FFO payout of 70% and a consensus FFO growth estimate of 3.3% for 2025 (taking 2025 because 2024 is measured against a year, where COVID-19 related repayments artificially inflate the comp). Apple Hospitality REIT - FFO payout of 63% and a consensus FFO growth estimate of 2.2% for 2024.  #3 The embedded upside optionality While at the start of this article I said that the element of price appreciation does not play a major role in my overall dividend income investing strategy, there is, however, a case to be made for experiencing the notable total returns from the REIT positions. In the case of REIT price surge, there would be an opportunity to trim down the positions, where the reinvestment yields were unacceptably low, allocating the gains into other high and defensive yielding assets. The thing is that since the Fed started to increase the interest rates, most of the REITs suffered. The most pronounced drops in the multiples have taken place for the duration heavy REITs, where the underlying cash flows are based on relatively fixed and long-term lease agreements.   YCharts Interestingly, in the meantime, the FFO results have continued to advance higher as stronger inflation levels have allowed to capture more attractive leasing spreads and the fixed rate borrowings have largely kept the interest expense component down. Now, if we look at the FOMC dot plot chart below, it is clear that sooner or later, we will face some interest rate cuts. Granted, as the history has shown, we cannot know for sure when and to what extent this happens, but the odds are definitely higher for the Fed reducing interest rate levels from here.   FOMC; St. Louis Fed As the interest rates decline, REITs should respond accordingly, experiencing multiple expansion. Plus, decreased SOFR will also bring down the cost of debt, which, in turn, should strengthen the FFO generation and leave more capital that could be put to work. The bottom line In my opinion, this is the right moment when to invest in REITs if the investment objective is to capture juicy and growing dividend yields without assuming unnecessary financial risk. In addition, REITs introduce an additional element of significant upside from the potential normalization (decrease) in the interest rates. Having said that, I would like to emphasize that allocating half of portfolio in REITs is most probably not the optimal strategy that income investors should follow. While REITs definitely deserve a notable presence in the portfolio, investors should combine and diversify their REIT holdings with other asset classes that offer high and relatively defensive yields such as MLPs, BDCs, covered call ETFs and some common equities.  In my case, I have done a very deep due diligence and feel comfortable in having ~50% of my exposure distributed across 9 REIT investments. Plus, from the tax perspective other asset classes such as BDCs and MLPs are less favorable, which quite naturally forces me to deemphasize these alternatives.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2444583041"}