Return of the REITs in 2014

 | Jan 23, 2014 | 11:00 AM EST
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Like most high-yielding sectors, real estate investment trusts (REITs), significantly underperformed the overall market in the back half of 2013. The main culprit was the rise in interest rates as the Federal Reserve started to discuss seriously the need to eventually 'taper' in late May.

Yields on the 10-year Treasury rose from about 1.6% at the time of those initial Fed comments to almost 3% by the end of 2013. The 3% level has proven to be tough resistance and rates have pulled back several times over the last month upon touching that resistance point.

REITs and other high yield sectors have performed much better so far in 2014. I believe this better performance will continue as 2014 should be a very different year for investors than 2013. As the Federal Reserve starts to remove liquidity from the market, a more tame 5% to 10% annual return in the market seems much more probable than 2013's return of around 30% for equities.

REITs with reasonable valuations and 5% to 6% yields are looking more attractive in this sort of an environment. I would stay away from REITs focusing on retail properties as I believe the United States is 'overstored' and retail looks increasingly vulnerable to being 'Amazoned'. I do see value, however, in REITs owning other property types.

Here are two I own that have value.

Summit Hotel Properties (INN) is a REIT that focuses primarily on upscale and upper midscale select service hotels on a national basis. It has about 90 hotels throughout the country with over 11,000 rooms. The company came public in February 2011.

Summit yields just over 5%. The company has grown its room base by over 50% since coming public early in 2011. More importantly, through prudent purchases and divestures, its portfolio now has almost three-quarters of its properties in top 50 lodging markets. That compares to less than one-half its properties in those markets when it began life as a public company.

Combined with a well-executed renovation program, this portfolio transformation has had several positive impacts. Occupancy has increased from just below 63% in 2011 to a current 75%. Revenue per average room (RevPAR) has increased over 50% and its average daily room rate has risen by more than 25 percent.

The company believes RevPAR growth will post 6% to 8% gains in 2014. Summit has a conservative capital structure and well-staggered debt maturities. The REIT sells at just over 9x forward funds from operations and is priced at just under book value. Summit goes for just less than $9 a share. I look for the REIT to provide at least $1 a share in capital appreciation in 2014, along with a 5% yield for a healthy overall return.

I also continue to like Healthcare Trust of America (HTA), which focuses on medical office buildings and healthcare-related facilities. Around two-thirds of its overall portfolio was acquired during the depths of the financial crisis in 2008  to 2010, leaving its true book value probably understated.

The REIT came public in mid-2012 and pays a healthy yield of 5.4%. The company should be a secondary beneficiary of the Affordable Care Act as more people are provided insurance, which should increase visits to medical facilities. I look for similar overall returns in 2014 as from Summit. It's not spectacular, but very solid.

I recently added to both of these positions by selling just out-of-the-money covered calls on some of my biotech positions that have rocketed up over the last few months. I used the premium income to buy more shares of these REITs. That was just a bit of creative rebalancing in the front part of the New Year that is likely to see a very different market than 2013.

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