Nontraditional REITs Provide Serious Returns

by Marc Bastow | June 3, 2013 4:03 am

The drive to find sources of portfolio income and yield continues to affect investor behavior. That’s nothing new, but with yields on fixed assets hovering around the 2% level, investors are always looking to find that extra bump to juice returns.

Traditional real estate investment trusts (REITs) have been a haven for those extra yields for years. REITs have a history dating back to the Eisenhower administration, which carved out a piece of the Cigar Excise Tax Extension of 1960 to allow investors the ability to earn returns on portfolios of income-producing real estate.

The amendment set up the REIT rules as we know them today, including the requirement that a REIT pay out no less than 90% of its income as a (taxable) dividend to investors, while avoiding the corporate tax on that same income.

REITs have been winners ever since: The iShares Dow Jones Real Estate ETF (IYR[1]), for which 92% of the portfolio is composed of  REITs, has outperformed the S&P 500 over the past 10 years, providing a 10.3% annualized return compared to 7.76% according to Morningstar. Indeed, the IYR has returned 220% including dividends since early 2009.

That’s great — but REIT investors who take a little bit of time to look can do better!

What’s changing in the industry is the growth in nontraditional REITs. So long as a company can make a credible case to the IRS that 75% of its income is generated in the form of “rent,” they can apply for REIT status. The result is companies with varied interests — we’re talking timber, data centers, billboards, prisons and cellphone towers — dive into the REIT structure pool.

Corporate data centers present a huge growth arena for REIT expansion as companies lease out thousands of square feet of property to house back-office IT centers running both local and “cloud” services. While perhaps not limitless, the need for those back-office centers, in addition to the front-end space for employees, is likely to grow significantly.

Data-storage REITs like Digital Realty (DLR[2]) offer investors the profits from the company’s ownership and management of 122 properties representing nearly 23 million square feet of space in 32 locations in North America, Europe and Asia. DLR trades today nearly 32% off its 52-week high of $82 per share, and the dividend yield is a very juicy 5%.

Even more enticing, DLR has outperformed the S&P 500 by more than 20 percentage points since 2009, and that doesn’t include dividend payments that have increased from 33 cents to 78 cents a share over the same period — an increase of more than 135%. As for the IYR, DLR beats it by an astounding 40 percentage points over the same period.

A key to DLR’s success is the diversification of its tenant base, along with its strength: no one tenant accounts for more than 9% of its rental base, and its client list include Microsoft (MSFT[3]), AT&T (T[4]) and Facebook (FB[5]). Just these names alone suggest future rental revenues and growth will be sustained as they grow users and data needs. DLR looks like a solid REIT winner.

And how’s this for nontraditional — prisons. Corrections Corporation of America (CXW[6]) owns and operates 67 correctional and detention centers in 20 states. CXW is another REIT priced under its 52-week high, this time off by around 15%, and is trading at a low 11x earnings, with a dividend yield just north of 5%.

Just like DLR, CXW has outperformed the S&P 500 over the past 5 years by nearly 20 percentage points, and a whopping 35 points better than the IYR.

Like it or not, prisons are not going away anytime soon, and while no one wants to see “growth” and “prisons” lumped into the same sentence, municipalities and states — not to mention the federal government — are strapped for cash. Finding ways to outsource the ownership and operation of the prison system  is important today, and will in all likelihood continue to be a driver for CXW.

Investors might want to exercise a bit of caution before jumping in here, as CXW has seen a drop in quarterly revenue over the past three consecutive quarters. Operating income is still fairly strong, however, and those dividends should be safe for long-term investors looking to boost those portfolio returns.

Marc Bastow is an Assistant Editor at As of this writing he is long MSFT.

  1. IYR:
  2. DLR:
  3. MSFT:
  4. T:
  5. FB:
  6. CXW:

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