REITs (real estate investment trusts) got hit by a nasty Thursday surprise. Spirit Reality Capital, Inc (New) (NYSE:SRC) spooked the market with some fearful results. Spirit leases real estate to physical retailers. Given the Amazon.com, Inc. (NASDAQ:AMZN)-induced carnage across the American retail space in recent quarters, that market is fraught with risk.
Spirit cut its guidance sharply. Furthermore, it revealed that its largest tenant is facing mounting problems. The market reacted with fury, sending the stock down over 24% Thursday.
Spirit isn’t a particularly large company. However, its plunge sent shivers across the sector. Other retail-exposed REITs got punished. Investor favorite Realty Income Corp (NYSE:O) dropped almost 4%. Another competitor, National Retail Properties, Inc. (NYSE:NNN), declined 4% as well.
More generally, REITs have struggled since the election. Donald Trump’s victory has caused interest rates to surge. The Federal Reserve has lifted its targets for rate hikes. That is terrible news for REITs.
The sector gets hit twice when rates rise. For one, they have to pay more interest to borrow money, and like most real estate players, REITs are generally levered to the gills. Secondly, investors tend to value REITs based on yield. When yields for safe assets like CDs and bonds rise, REITs have to pay a higher dividend to remain attractive. The easiest way for the dividend to rise is for its stock price to go down.
In the wake of both general headwinds and the specific Spirit-induced scare, REITs have tumbled. But buying indiscriminately will lead only to trouble. Let’s sort through four popular REITs for winners and losers.
REITs to Buy: Public Storage (PSA)
Dividend Yield: 3.9%
Public Storage (NYSE:PSA) isn’t the world’s most exciting company, but you’ll get more interested once you see its track record. Americans are prone to hoarding, and PSA stock delivers dividends off that clutter.
Public Storage has, incredibly enough, grown its dividend at a compounded rate of 15% per year since 2007. Even during the financial crisis, people still needed a place to keep their excess stuff.
Just since 2011, the dividend has doubled again, and the company raised it another 11% last October. The company’s business model has plenty of room for further expansion, as self-storage is a highly fragmented industry. Using its high-flying PSA stock, the company can buy out local operators at a few times annual earnings and get instant juice for the stock price.
The company also benefits from an industry-leading balance sheet. Instead of taking on much debt, Public Storage issues preferred stock. These shares, generally paying 5%-6% yields, are fixed-rate and have infinite maturity. Thus, regardless of where interest rates go, Public Storage’s capital is locked in at cheap rates.
As a result, PSA stock is virtually immune to higher interest rates, and the company is one of the few A-rated American REITs out there. This REIT won’t have the most explosive upside of its industry, but it’s arguably the single safest option during a bear market for REITs.
REITs to Buy: Ventas (VTR)
Dividend Yield: 4.9%
Ventas, Inc. (NYSE:VTR) is arguably the leader in its sub-sector within the REIT space. Yet, unlike O or PSA stock, VTR yields a full 5% at the moment. Is the larger yield an opportunity or a trap?
I argue it’s an opportunity, but it must be watched closely, since Ventas is a healthcare REIT. It derives the majority of its income from nursing homes, with a substantial minority of its profits coming off medical office buildings.
Normally, I’d be very bullish on Ventas’ properties. America is aging, and its collective health continues to fail; obesity and diabetes are running rampant.
Yet, VTR stock, along with other healthcare names, has struggled. That’s because no one has any idea what the American healthcare system will look like once the Republicans finally enact a reform bill. It seems likely that Ventas will come out alright; its properties are pivotal to the functioning of the overall medical system. But as healthcare reform has dragged on, shares of biotechs, hospitals, health insurers, etc. have whiplashed depending on the latest proposal.
VTR stock looks attractive here due to political discounting, but be aware it could go lower in the near-term depending on what sort of winds blow out of Washington.
REITs to Hold: Realty Income (O)
Dividend Yield: 4.5%
The management at Realty Income must be credited for quite possibly the REIT sector’s most brilliant marketing ploy. By labeling themselves as the “monthly dividend company,” the company has managed to stand out in a crowded field. And while O stock will continue to deliver a sizable, and modestly growing, yield, it won’t do much else in the near-term.
O stock has become a victim of its success. As it grows, it has to make larger and larger deals to keep its dividend growth on pace. However, an overheating market has caused profitability of new purchases to decline markedly. Realty Income has ramped up its debtload, but it’s generating lower margins on the new money it is putting to work. When interest rates rise, Realty Income’s model will really feel the squeeze.
At this point, the company’s dividend appears quite safe, but it wouldn’t surprise me at all to see the dividend growth rate fall to just 2%-3% per year going forward until the rising interest rate cycle ends. And with O stock yielding roughly 4.5% now — far below its historical median — the stock has a lot of room to decline should investors be able to generate a similar yield from a safer source.
Only buy O stock here if the yield is enough to meet your desired return, since stock upside will be limited or nonexistent in coming quarters.
REITs to Sell: The GEO Group (GEO)
Dividend Yield: 5.9%
Six months ago, The GEO Group Inc (NYSE:GEO) faced imminent wipeout risk. The government appeared ready to crack down on private jails. In the summer of 2016, GEO stock got cut in half virtually overnight following news that the Justice Department was looking into ways to phase out private prisons.
Since the low at $11, however, GEO stock has tripled. What changed? President Donald Trump.
Now investors foresee huge amounts of undocumented immigrants going to jail. Also, the wave of marijuana legislation may slow with a hostile federal government. Since drug users are a huge portion of the country’s prison population, this would be a big plus for GEO stock.
However, at today’s price, GEO stock is now trading 50% above where it did prior to the beginning of last year’s controversy. The business hasn’t improved that much. Trump ensures the status quo will carry on, but GEO was a $20 stock back then. GEO isn’t going out of business anymore, but that hardly means it should trade for all-time highs while other REITs tumble. Private prisons remain highly contentious, and the stock will likely stay volatile as political issues resurface in coming quarters.
At the time of this writing, Ian Bezek owned PSA stock. You can reach him on Twitter at @irbezek.