The Right REITs for Healthy Income

10/17/2016 10:00 am EST

Focus: REITS

Charles Carlson

Editor, DRIP Investor

Chuck Carlson is a long-standing expert on dividend reinvestment plans. Here, the editor of DRIP Investor discusses the pros and cons of REITs for income investors and highlights a trio of favorite plays in the healthcare sub-sector.    

Steve Halpern:  Our special guest today is Chuck Carlson, one of the nation's leading experts on Income Investing and editor of DRIP Investor.  How are you doing today, Chuck?

Chuck Carlson:  I'm fine, thank you.

Steve Halpern: Now today we're going to focus on real estate investment trusts or REITs.  Could you share a brief overview of these investment vehicles and their benefits for income investors?  

Chuck Carlson: Sure, real estate investment trusts are, as the name implies trusts, set up to purchase and own a variety of different investment properties.  

You have real estate investment trusts that are devoted to owning health care properties, you have them devoted to owning retail, mall properties.  You also have real estate investment trusts set up to own mortgages.  

Typically, REITs make their money from the leases on their property and the cash flow that comes from those leases, and they in turn distribute a big chunk of that cash flow to individuals.

This is where the biggest pro is -- that these are looked at as nice cash flow investments for investors because REITs, in order to avoid taxation at the REIT level, must distribute at least 90% of the cash flows to the shareholders of the REITs. So, again, from an income standpoint, REITs have a lot to offer for investors if bought properly obviously.  

Steve Halpern: Now interestingly, you point out that there was a recent change that could possibly increase investor attention towards REITs.  Could you explain what happened?

Chuck Carlson: Sure, historically, REITs have been part of the broad financial sector, S&P and MSCI are two prominent index companies and typically when they were looking at their indices and the composition of those indices, there are typically 10 sectors that all the stocks are divided into, and REITs were part of the financial sector.  

That has changed.  Both MSCI and S&P Dow Jones Indices have now carved out a real estate sector as an 11th sector, and in that real estate sector, the lion share of the components are real estate investment trusts,

So the upshot is, you know, the REITs have been kind of carved out of the financial world and now are being focused on as almost their own independent group.

And that type of visibility could increase support for the group as institutional investors and those that like to have coverage across all of the sectors from a diversification standpoint, now are kind of almost forced to put money into the REIT sector.

Steve Halpern: Now as part of your stock selection process, you used one system that's called your 12-Factors Scoring System.  Could you give a brief overview of this strategy and what this system is now saying about the REIT area?

Chuck Carlson:   Sure, we have a broad way of ranking stocks here called our Quadrix Stock Rating System and Quadrix is comprised of 90 plus variables that we look at to evaluate all stocks and score all stocks including REITs.  

However, we also have kind of a scoring system within a scoring system to help us evaluate stocks relative to their peer group.

And one of those scoring systems is our 12-Factors Scoring System which takes the 12, what we believe are the 12 most relevant factors out of the 90 plus factors in our Quadrics model, and score companies on those 12 Factors as they relate to their own industry groups.

So in addition to being able to rank stocks all one versus 5000, we have the ability through the 12 Factor Scoring System to rank stocks relative to their peer group.  

We have found that that is especially useful way to look at the REIT universe in terms of comparing them to their peers.  REITs rarely score very well in the overall Quadrix score because REITs typically are not very high growth investments.  

They pay out a lot in terms of cash flow so certain dividend metrics don't look that great so they just don't fit well in a traditional scoring system which is why I think in the 12-Factor Scoring System when you're looking at REITs, one versus the other, it's very helpful to do that, and we have a tool that can do this.  

Steve Halpern: Now, from your analysis, you have found three REITs in particular that you've chosen to highlight in a recent report.  They all happen to be healthcare REITs.  Could you give a brief overview of what makes this subsector attractive?

Chuck Carlson:  Well you know again I think the primary reason is its demographics for starters.  I mean we have an aging population, and when you look at how many people now are retiring and where the largest, fastest growing portions of the demographic sector are, they tend to be older folks and so obviously as you age, you need more health care.  

You need assisted living centers, nursing facilities.  You need those types of facilities that provide those services so I think there is a pretty good demand for those, which is helping companies in those particular areas, probably do well in terms of the REIT sector.  

I think it is a better bet to bet on growth and demand in those types of properties than say for example kind of brick and mortar retail where you know they're seeing a lot of competition from e-commerce and the internet so that's why we were looking at some of those areas.

Steve Halpern: Now turning to some specific recommendations, one that you like is National Health Investors (NHI).  What's the story here?

Chuck Carlson: Well again, it's a prominent provider and owner of healthcare properties, and you know I think it's a good story that ties into this graying of America.  

I like the dividend yield on the company and it's one that I think -- again — all of these companies allow investors to make even their initial purchase of stock directly through the companies direct purchase plan so there's kind of an added kicker there where they're typically very easy to buy, and I think that's a nice company again because of its health care play.  

Steve Halpern: You also like Omega Healthcare Investors (OHI).  What is the attraction here?  

Chuck Carlson:   That's been kind of a long-term favorite of mine, and it's a stock that has actually done fairly well over the years so it's one where you can get a pretty good dividend yield on that stock.  I believe right now the yield on that stock is right around 7%.  

I normally don't like such high yielders, sometimes high yields like that scare me off.  I am more comfortable in this stock at that yield, and I even think their dividend is going to be growing so in terms of a nice yield play, and if investors want to reach for yield a little bit, I don't often recommend that, but I think this is a REIT that they can feel comfortable doing that in.  

Steve Halpern: Now finally, you like the prospects for Welltower (HCN).  Would you share your thoughts on this company?  

Chuck Carlson: Welltower is based in Ohio, and it's a major provider of, excuse me, senior living centers, and I think that's an area in particular that has especially strong growth prospects in that space.  

The REIT has performed fairly well.  I think the dividend yield of around 5% is attractive.  Again, I think if you're looking at REITs, I think it is a decent play in the group.  

One thing, Steven, I will mention, however, is that one of the downsides of REITs is that they can be interest rate sensitive stocks.  In other words, if you start to see interest rates rise, and rise in a hurry, typically that is a negative for this group so that is something investors need to think about.  

It is not necessarily a free lunch when it comes to investing in these companies.  The stocks can go down, and the other issue that needs to be mentioned is that typically, dividends that are paid by REITs are not qualified dividends receiving the favorable 15% tax treatment.  

Typically, the distributions that you will receive from REITs are going to be taxed at your ordinary tax rates so while the yields may be higher on REITs, you can expect to pay a higher tax rate on the distributions that you receive on REITs, and that's because of the pass-through nature of a REIT.

Steve Halpern: Again, our guest is Chuck Carlson of DRIP Investor.  Thank you so much for your time today.

Chuck Carlson: Thank you.  

By Chuck Carlson, Editor of DRIP Investor

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