My dad is an attorney who’s practiced for over 50 years and has specialized in commercial real estate law on the builder and developer side. Many of my clients are part of successful, multi-generational, family real estate businesses. Being around it for as long as I have, I know enough to be dangerous mainly through osmosis.
Real estate investment trusts (REIT’s) are a bit of a different animal than traditional real estate investing, because the investors only hold a securitization of physical real estate.
However, the idea is the same: a steady income stream derived from rents and leases with capital appreciation thanks to sales and increased property values.
In the current, multi- year, sub-basement interest rate environment, REITs have been a default go to sector for yield hungry investors. Naturally, the sector has performed well.
The other day, I stumbled across (literally) a recent research report from Lazard Ltd’s (LAZ) asset management arm.
Looks like REITs have delivered some strong as rope five year numbers.
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So does it make sense to put new money to work in the sector? I believe so.
Drilling down a bit more into the report, Lazard sees net operating income (NOI) growth for the sector at an annual average of 3.5%. While at first blush that doesn’t seem too terribly exciting, the translation would be average annual dividend growth of 5% to 7% overall. Not too shabby in a world of sub 5% GDP growth for developed nations and, in some cases, negative yields in sovereign bonds.
In looking for REIT opportunities, I started poking around in the closed end fund (CEF) space. CEF’s are a unique animal. While exchange traded funds (ETF’s) are mainly passive investment vehicles, CEF’s are actively managed and often employ leverage internally to boost returns and yields. Like ETF’s, CEF’s offer market liquidity; a distinct advantage over their open ended mutual fund cousins.
Here are three of my favorites:
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Neuberger Berman Real Estate Securities Income Fund (NRO) — According to the fund’s fact sheet, the primary objective of this fund is high current income, with capital appreciation being secondary. With its heaviest weighting in health care and shopping center REIT’s, NRO trades at a 14% discount to its net asset value. Shares are currently priced around $5.45 with an 8.8% yield.
CBRE Clarion Global Real Estate Income Fund (IGR) — For investors seeking global exposure, IGR can fill that particular niche. While 62% of the fund focuses on the United States, the remainder is geographically diversified across developed foreign markets of North America, Europe, and the Pacific Rim. At $8.10, shares trade at an attractive 12% discount to NAV with a 7.4% dividend yield.
Nuveen Real Estate Income Fund (JRS) — Investing in a blend of both real estate debt and equity securities, the fund holds some of the biggest names in the REIT space such as Simon Property Group (SPG) and Equity Residential Properties Group (EQR). Shares trade at $11.33 with an 8.9% dividend yield.
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(Editor’s Note: We’ve owned JRS in the High-Yield Opportunities portfolio of The Daily Paycheck for 6 years, for a total return of 99.7%. Learn more about our Daily Paycheck service and how it has generated returns as high as 360% on dividend paying stocks at this link.)
Risks To Consider: The largest inherent risk is the nature of CEF’s themselves, especially in a potential rising interest rate environment. Historically, CEF’s employ leverage (margin, issued debt, etc.) as part of their investment strategy. When borrowing costs are low and returns are high, it’s all good. When borrowing costs creep up, even slightly, returns, which include distributions, can be squeezed.
The consensus view is that interest rates are more likely to rise than fall. While the three funds discussed do employ leverage, the average percentage based on total assets is around 21%, which is a manageable number. Prior to the turn of the century, some CEF’s were known to leverage over 50% of assets in some cases. After more than a few disasters, the industry wised up. However, expect at least some volatility in the event of rising rates.
Action To Take: While some individual REITs appear pricey, value remains in the CEF space. An equally weighted basket of NRO, IGR and JRS can be purchased at an average discount to NAV of 9.3% with a combined yield of 8.36%. Projected growth in the REIT sector would help boost prices and result in total returns in excess of 14%. That’s pretty attractive in a low yield, low growth environment.
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