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Diversified REITs: Where to Hide?

REITs of all kinds are getting hammered in the third quarter leaving investors with few choices

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Given Sternlicht invested $150 million in TriPointe Homes (TPH) in 2010, it’s clear he feels the housing market will eventually recover to where it was before the housing crisis began in 2007. And when it does, he’ll have two investment vehicles benefiting from a reinvigorated housing market. It might take some time, but it will happen.

Starwood’s 7.2% yield is about as safe as you’re going to find in the diversified REIT industry. And with Sternlicht at the controls, you’ve got one of the best real estate lenders at the helm.

Public Storage

There’s no such big yield in this pick. Public Storage’s (PSA) dividend yield over the past decade has averaged 2.9%. It’s a steady payout, but that yield is well below General Electric (GE) and many other large-cap industrials.

So why would you even waste your time?

Because investing is about total return and not just dividends. Over the past decade, PSA has achieved a total return of 17.6% — almost 10 percentage points greater than the S&P 500 and 5.8 percentage points ahead of its peers — and has beaten the index in seven out of the past 10 years.

With turmoil expected when interest rates increase, PSA will be the ship safely tucked in port. That’s especially important when overall markets have advanced as far as they have in 2013. Anything could set off a decent-sized correction over the coming months, and when that happens, quality is even more important.

The storage business is much like running parking lots or grass farms. Once you’ve got the property up and running, it doesn’t take a lot to keep it functioning properly. In Public Storage’s 2012 annual report, it points out that it spends about the same amount ($70 million) on maintenance capital expenditures annually for its 132 million-square-foot storage portfolio as PS Business Parks (Public Storage owns 41%) does on a 30 million-square-foot business-park portfolio.

This leads to tremendous free cash flow generation — a critical component for sustaining its 2.9% dividend yield while providing enough cash to expand its business.

It’s not sexy, but over time as the neighborhoods around PSA’s storage locations become more densely populated, the real estate becomes more valuable. Eventually, it will sell the property and locate elsewhere to start the process all over again. It’s a brilliant business if you have patience, and Public Storage has plenty. Its concept is simple: providing storage units for those experiencing downsizing, divorce, death and dislocation. With the strongest brand in storage, it simply needs to keep the doors open and the cash will flow.

However, for those who value yield over capital appreciation, Public Storage has issued $2.4 billion in preferred shares over the past 15 months through March 2013 at an average coupon rate of 5.5%. You lose some capital appreciation, but gain a little more income.

Either way, this is one of the most stable real estate investments anywhere.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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