Looking for Income? Look to REITs

 | Jul 12, 2016 | 2:00 PM EDT
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It feels like the movie Groundhog Day around here today. Once again, we have the melodious sounds of jackhammers as the plumbers continue to try to locate and fix the leak. I hope today is the day we hit water, but I am not going to fall over in shock if Bill Murray comes in and tells me we couldn't find it, be back tomorrow.

I was asked last night what in the investing process keeps me up at night. The answer is not very much. I have been doing this for about 30 years, so there is not much I haven't seen. Right now I have some safe and cheap stocks as well as a bunch of community banks that are benefiting from continued consolidation. If the market goes down, I have a bunch of cash to put to work. My account balance may bounce up and down in either direction in the short term, but I am highly confident that five years from now it will be a lot higher than it is today. I am still very much in the accumulation phase of my life, and because I think in very long time frames, not much of the day-to-day news and gyrations bother me very much.

If I was an investor coming to the markets today with a pile of cash from my retirement plan and savings looking to invest and live off the income, I suspect the staples of my diet would be Xanax and Maalox. We live in a very low-yielding world and that is unlikely to change any time soon. Even if we get a sudden pickup in the economy and the Fed is able to raise rates a couple of times this year, long-term rates will still be well below long-term averages. It will take years of steadily increasing rates before we see Treasuries and bank products back to levels that can provide anything close to an adequate income. Of course, anyone buying bonds today would see their principle value decimated under that scenario.

Part of the answer involves real estate investment trusts. REITs as an asset class have provided equity-like returns over the years and over many time frames have outperformed stocks as a long-term holding. A recent study with the scintillating title of "Asset Allocation and Fund Performance of Defined Benefit Plans 1998-2014" by Alexander D. Beath, Ph.D, and Chris Flynn, CFA of CEM Benchmarking Forum, says REITs have been the best-performing asset class over the time frame considered. The study found that listed equity REITs had the highest average net return over the period with an average annual return of 12%.

Looking at the spreadsheet that the National Association of REITs has on its website, REITs have averaged 11.89% since they were first introduced in 1972. Equity REITs have done even better with an average annual return of 13.59% over the 44-year period. In comparison, the S&P 500 has averaged 7.02% over the same time frame. Although REITs got hit hard in the carnage of 2007 and 2008, in other bad market periods REITs held up much better than the overall market. In the Internet bust, REITs actually had positive returns and in 1987 they were down just over 3% for the year. It appears that well over half of the return was in the form of dividends, making them a solid choice for income-hungry investors.

While the REIT sector has been driven higher by yield-seeking buying, much of the buying has been done using ETFs and there are still some bargains to be had in the sector. I like Colony Capital (CLNY) , and while shareholders of NorthStar Asset Management (NSAM) are not pleased with the terms of the proposed merger of the two companies, I think they are very favorable to Colony shareholders and am thrilled by the deal. If it fails to close, I am still a big fan of Colony as a stand-alone REIT at current prices. The current yield is 9.85% and will remain over 9% after the merger closes.

I still like Ashford Hospitality Trust (AHT) a lot as well. The asset disposition process is going well and Ashford just completed its previously announced sale of a five-hotel, 1,396-room portfolio of select-service hotels for $142 million in cash and expects more sales to close in the third quarter of the year. This will bolster the balance sheet and allow management to focus on the portfolio of upscale full-service hotels. The shares are yielding 8.41% at the current price.

Income-seeking investors need to look more toward REITs purchased at discounted valuations to provide their income needs. Tomorrow I will look at some other ways to gain exposure to income-producing real estate at attractive prices.

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