One of the best attributes for REITs is that they must pay out at least 90% of taxable income in the form of dividends. It’s that forced distribution characteristic that makes these high-yielding alternatives so attractive.
But it’s not just the high dividends that are so appealing, it’s the predictable dividend increases because they provide the best evidence of dividend safety. When I see REITs that are continuously boosting their dividends it tells me that management is strongly committed to maintaining and increasing it.
Remember, REITs provide a much better dividend forecasting model (than non-REITs) because the sources of income (for REITs) are lease contracts. Accordingly, it’s the dividend increases - even more than current earnings projections (or Funds from Operations for REITs) – that provide the best possible forward-looking indicators of growth and total return prospects.
So, by far, a dividend payment is the ultimate indication that management is committed and when you examine a REIT’s dividend-paying characteristics you can get a fairly good gauge on future performance.
Examine These Inflation-Hedged Lease Contracts
When inflation rises, many corporations raise prices and for some REITs that can be problematic. Unlike Hotels of Self-Storage REITs, the Triple Net REITs have fixed lease contracts and they can’t adjust their rental rates during inflationary cycles.
Triple Net stands for “Net-Net-Net” and it’s a common lease structure in which the tenant (or lessee) is responsible for all expenses, including taxes, insurance, and maintenance (hence the name “triple net”). The attraction to these lease arrangements are the bond-like characteristics in which the landlord has limited expenses.
However, there are several Triple Net REITs that have much less exposure to operating expenses due to their increased quantity of CPI-based lease contracts. While the most common Triple Net Lease is around 15 years with modest rental increases every 5 or 10 years, the CPI-based leases have more frequent rent bumps that add value to the lease and protects the Landlord (or the REIT) against inflation.
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3 REITs That Enjoy CPI-Based Lease Contracts
In my monthly REIT newsletter I have BUY recommendations on 3 REITs with CPI-based lease contracts. As mentioned above, the Landlord has enhanced inflation protection when owning properties leased under this CPI structure.
One REIT, W.P. Carey (WPC) has around 94% of its rental stream distinguished by CPI or percentage rent (78% of the portfolio is CPI-based). Carey has a long history of raising its dividend and the success of the company’s performance can be tracked back to its strategically-enhanced CPI lease model.
Over the last 30 days Carey’s share price has fallen from around $73.32 to a recent close of $68.58. That’s below my FAIR Value price (of $70.00) and the current valuation of 16.8x validates the attractive share price being offered. As noted, Carey has a long history of increasing its dividend (the company has paid and increased its dividend for over 15 years in a row) and the yield today is 5.5%.
Another REIT, albeit new to the publicly-traded sector, is STORE Capital (STOR). This Scottsdale-based REIT listed shares last year but prior to listing the company aggregated 947 free-standing properties in 46 states.
STORE is also like W.P. Carey in that the company’s lease contracts have a built-in inflation hedge mechanism in the form of CPI-based lease contracts. With around 73.7% CPI-based leases STORE can grow organically at a steady clip (around 3% per year assuming 1.5% rent growth and ~50% leverage).
STORE had a solid fourth quarter (the first as a public company) however I’m holding back until I see shares pullback to $20. Currently STORE is yielding 4.5% with a P/FFO multiple of 17.1x. Shares are trading at $22.64 so it won’t take much of a discount in which I can take advantage of my Graham-inspired “margin of safety” price.
The last REIT on my “inflation protection” list is CorEnergy (CORR), an Infrastructure REIT that has a focused niche of financing assets in the energy sector. By structuring Net Lease contracts, CorEnergy has minimal operational and/or maintenance risks and the benefits offer tremendous value for the capital-constrained energy owner/operators. The majority of lease structures are Base Rent agreements with CPI escalators and % rent over the base line (cap 25%).
CorEnergy was previously a BDC (or Business Development Company) and the energy-based asset class enjoys a resilient inflation hedge - the distribution that you get with CorEnergy includes underlying contractual features that give visibility over the long run to inflation-based returns (1% to 3% is a reasonable expectation).
There are added risks involved with CorEnergy such as high tenant concentration (
Disclosure: I own shares in W.P. Carey.
Brad Thomas is editor of Forbes Real Estate Investor.
