Against a backdrop of falling interest rates, real estate investment trusts can make a lot of sense for income investors, assert analysts at Jefferies.
"With the yield curve flattening, we expect investors to continue flocking to REITs and their attractive dividend yields," according to a report dated Tuesday.
The back story
REITs are yielding an average of 3.9%, compared with 2.48% for the 10-year U.S. Treasury note. The note was yielding above 3.2% last November. But the Federal Reserve has shifted away from a tightening regimen, and there are concerns about the strength of the U.S. economy.
REITs are required to pay out at least 90% of their taxable income as dividends, and they are popular with income investors. The stocks have done well lately. The FTSE Nareit All Equity REITs index has returned 18.4% this year, compared with 15.5% for the S&P 500 (.SPX).
The Jefferies analysts cite a handful of REITs they think are well positioned in the current environment.
The four companies in their top tier are STAG Industrial (STAG), Simon Property Group (SPG), National Storage Affiliates Trust (NSA), and Corporate Office Properties Trust (OFC).
The report points out that "an inverted yield curve typically drive[s] investors to the REIT sector" and significant outperformance for REITs when such scenarios do occur.
The two-year U.S. Treasury note was recently yielding 2.34%, 0.14 percentage point below the 10-year note. The yields of those two securities have not inverted lately, though in December the spread was only about 0.1 percentage point.
Looking ahead. Simon Property Group, a large operator of regional malls and outlets, is one of the four companies on the Jefferies conviction Buy list. With a market capitalization of around $65 billion, it is one of the largest players in its sector.
The report cites the company's "high-quality portfolio" of properties, "development pipeline and fortress balance sheet." The stock, which yields 4.4%, has a one-year return of about 25%.
National Storage Affiliates Trust focuses on self-storage facilities. It yields 4.3%, and it has a one-year return of around 15%. Jefferies expects acquisitions to be the company's main source of growth. The company sports a market cap of about $1.6 billion.
Corporate Office Properties Trust, which yields 4%, focuses on office properties and data centers. The company, according to Jefferies, "is in a unique position as its customer base of defense contractors and the Department of Defense is coming out of a nearly decade-long recession driven by an unusually long period of stagnant government funding for the military." Its one-year return is about 7%.
STAG Industrial has a one-year return of about 30%, and it yields around 5%. It focuses on industrial properties. The company "has a higher concentration of warehouses in secondary markets than most Industrial REIT peers, which is beneficial at this point in the economic cycle as there is ample demand in those markets and little new supply," according to Jefferies.
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