Despite the recent gains and rebounds in the housing market, the housing bubble completely changed the way we live.
In the wake of the housing bubble and the recession, more and more Americans are abandoning the traditional goal of owning a white-picket fence in favor of renting. Either through financial hardship or via choice, America is quickly becoming a “renter nation” when it comes to housing. According to real estate group Green Street, of the 5.5 million estimated new households that will form over the next three years, roughly 70% of them will choose to become renters.
That’s a huge number — one that could provide plenty of profits for investors who bet on the right horses. In this case, we’re talking about real estate investment trusts, or REITs.
Enacted in the 1960s by Congress, REITs were created to let average investors make investments in large-scale, income-producing commercial real estate. And I do mean income. REITs are required by law to spit out 90% of their taxable income back to shareholders annually. That results in some huge dividend yields.
Now, these big dividend yields aren’t considered “qualified” for tax purposes — meaning they don’t get taxed as normal income. That makes REITs and their big dividend yields perfect holdings for an IRA or other tax-deferred account.
With that said, here’s five of the best REIT plays for our growing “renter nation”:
When it comes to apartment REITs, AvalonBay Communities (AVB) is one of the largest. The firm has direct or indirect ownership in a massive 273 apartment communities, or roughly 81,500 different apartments or townhomes. The bulk of these buildings are located in markets with a high barrier to entry — Washington D.C., for example — and feature a stable and generally high-income renter’s base.
However, AVB isn’t done growing.
The REIT recently broke ground on another 13 new communities and has an additional 26 optioned for development rights. Aside from that organic construction, AVB partnered to real estate magnate Sam Zell to purchase Archstone from Lehman Brothers out of bankruptcy for $6.5 billion. That move gave AVB a stake in 66 additional properties.
Those new apartments will continue to help boost AVB’s cash flows and its dividend yield. Already, AvalonBay saw its full-year 2013 funds from operations (FFO) rise 14% on the backs of these new units. That windfall helped the REIT raise its dividend 8.4% for the first quarter of this year.
AVB currently has a treasury-beating dividend yield of 3.2%.
While Home Properties (NYSE: HME) isn’t as large as AvalonBay, the two REITs share a similar strategy — namely, focusing on the profitable East Coast. For HME that means owning multifamily properties in Washington D.C., Boston, Baltimore, Philadelphia and New York: places where the average home price is around $340,000 and potentially out of reach for many families.
And like its much larger rival, HME is quickly expanding in these key markets.
Since 2011, Home Properties has spent about $600 million on property acquisitions to expand its umbrella in these markets. That expansion continues today, as Home Properties has unveiled an aggressive plan to spend around $250 million more this year on additional purchases of multifamily communities.
However, the difference in the two REITs is that HME is willing to “flip” properties that don’t necessarily meet its criteria for long-term ownership. That strategy helps boost cash flows and provides HME with additional funds to purchase more properties down the road.
It also results in a plenty of dividends for investors. HME currently yields 4.8%.
Investors Real Estate Trust
Most people wouldn’t be shocked to find out that an average 2-bedroom apartment costs nearly $3,000 per month to rent in places like New York City or San Francisco. However, that is also the going price for a similar apartment in North Dakota.
Why? The boom in Bakken shale drilling. For various REITs it’s a gold mine — and one company that’s definitely taking advantage of this trend is Investors Real Estate Trust (IRET).
IRET specifically focuses on the upper Midwest and North Dakota, putting it right in the center of Bakken shale country. In fact, its corporate office is the next county over from the epicenter of the Bakken boom.
Overall, IRET owns and manages a diversified portfolio properties including 72 apartment buildings in the region. High incomes and housing demand from the Bakken, from both rig workers and landowners, has helped IRET realize plenty of cash flows and rising rents from its stable of properties.
And while IRET has been flowing that cash back to investors since 1971 as dividends, the strong apartment demand in North Dakota should help the firm boost its dividend even higher in the future.
Currently, IRET has a dividend yield of 6.0%.
Associated Estates Realty Corporation
Some of the best bargains can be had in smaller REITs. A prime example is Ohio-based Associated Estates Realty Corporation (AEC).
The firm (which incidentally was the first publicly traded apartment REIT) owns 53 multifamily properties throughout the South, Mid-Atlantic and Midwest. The key for AEC has been the fact that it has been transitioning away from lower-income housing toward higher-valued and more “luxury” apartments. That’s helped AEC see rising community income growth than many of its rival REITs — which gives AEC the ability to charge higher rents.
AEC has also begun expanding its property holdings in these key markets; given its smallish size, the firm should be able to grow its top and bottom line quite easily.
As these projects take hold, analysts expect AEC’s FFO to be flat throughout this year. But it should rise about 6% during 2015. That will help AEC strengthen its 4.4% dividend yield.
iShares Residential Real Estate ETF
Given just how powerful the rental trends are becoming, investors may be better suited in a wide swath of apartment REITs. To that end, the iShares Residential Real Estate ETF (REZ) may actually be the better choice.
The exchange-traded fund (ETF) tracks 36 different REITs … including all of the ones on this list. REZ also includes exposure to the various public storage REITs like Extra Space Storage (EXR). Those firms have also been seeing huge demand as renters need additional space for all of their stuff … especially if they’ve downsized from previous homeownership.
REZ has had pretty good performance, managing to return more than 15% annually over the last five years. The ETF also kicks out a 3.55% dividend yield. Costs for the broad REIT fund clock in at a relatively inexpensive 0.48% — or $48 per $10,000 invested.
Overall, REZ may be the best way to capitalize on the REITs catering to our new “renter nation.”
At the time of publication, Levitt had no positions in the securities mentioned.