3 REITs for Rising Rates

01/06/2016 9:00 am EST

Focus: REITS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

After a full year of tiresome speculation and endless can kicking, the Federal Reserve finally raised the federal funds rate. So which sector will be helped by rising rates? asks Ian Wyatt, editor of High Yield Wealth.

We expect our real estate recommendations to do well in a rising-rate environment. This might seem counterintuitive. Real estate investment trusts must issue debt or equity to grow. Indeed, REITs are heavy users of debt financing. 

But we've seen data—persuasive data—that show many REITs do fine when rates rise. If rising interest rates correlate with a strong economy, well-run REITs are frequently able to outrun rising capital costs with higher lease rates that strong demand permits.

This is one reason why we like established REITs like Gladstone Capital (GOOD), which has a 98% lease rate, a rate few REITs can match. Keep in mind, too, that Gladstone has never cut its dividend and has raised it three times over the past ten years. Gladstone yields over 10%.

We see similar value in Government Properties Income Trust (GOV). It too has high occupancy rates and nearly all of it is due to its principal tenant: the federal government. Not surprisingly, GOV has a high retention rate with its tenants, which leads to a high dividend coverage rate.

Last quarter, its funds from operation at $0.57 a share easily covered its $0.43 per share dividend payout. GOV shares yield over 10%. 

Digital Realty Trust (DLR), a REIT that specializes in providing the buildings and infrastructure for telecom, IT, and Internet data centers, is that rare breed. It combines higher yield with dividend growth. Digital's $3.40 annual dividend per share produces a 4.5% yield.

Compared to Gladstone and GOV, Digital's yield fails to stand out, but every year the payout is increased 7% to 10%. Over time, a Digital Realty investor will see a yield on his cost basis approaching that of Gladstone and GOV

All three of these sound real estate investments are value-priced. All have underperformed in recent months, which we view as an outgrowth of investor misconception.

Higher interest rates are perceived as a threat, but the threat has never materialized, at least not in the past.

Continued business performance is the antidote and all three continue to perform. We think it's only a matter of time before investors realize that the threat of rising interest rates is much ado about nothing. 

In short, we still like the value proposition of many of these higher-yield investments.

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