REITs are viewed as bond surrogates. The value of bonds and similar income investments frequently decline as an immediate response to rising interest rates. Higher interest rates reduce the present value of future cash flows, including REIT dividends, explains income expert Ian Wyatt, editor of High Yield Wealth.
Indiscriminate selling offers the opportunity to pick-up additional yield from our current list of REIT recommendations. We’ll exploit the opportunity by adding Easterly Government Properties (DEA) and its 5.1% dividend yield.
Easterly arguably offers the safest dividend on the market. The name reveals the business strategy. Easterly buys, develops, and manages class-A commercial properties. The properties are leased to U.S. government agencies.
Easterly focuses on U.S. government tenants to a degree no other REIT can match. Roughly 97% of Easterly’s real estate portfolio is leased to the U.S. government. No U.S. government agency has ever defaulted on its lease.
Demand for Easterly’s properties is enhanced by occupational demands. Seventy-eight percent of Easterly’s properties are leased to agencies where telecommuting is either impractical or prohibited. The tenants include the Federal Bureau of Investigation (FBI), Drug Enforcement Agency (DEA), courthouses, and government laboratories.
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REITs are pass-through entities. Little earned income is retained. A REIT can grow only by issuing new equity or debt. Debt is a large variable in the capital-structure of most REITs. Tapping debt markets to grow or to refinance maturing debt can crimp cash flows (and dividends) in a rising-interest-rate environment.
Easterly management has proactively mitigated the risk. Management refinanced most of the company’s debt on fixed terms in 2017. A year ago, Easterly’s capital structure consisted of 77% floating-rate debt —debt most susceptible to rising-interest-rate risk. Today, the capital structure consists of 85% fixed-rate debt. Easterly’s outstanding debt has a weighted average maturity of 8.5 years and a weighted average interest rate of 3.6%.
The business and capital structure are sound. These are important considerations, to be sure. But cash flow is king. It’s the overriding variable. As the cash flows, so flows the dividends, and so goes the share price.
Easterly gives us a REIT backed by the highest-credit-rated tenants — the U.S. government. It gives us a high-yield dividend: a 5.1% starting yield that’s also tax efficient. Less than 50% of the dividend is subject to immediate income tax. Perhaps most important, Easterly gives income investors piece of mind.
