The past few years have been challenging for most real estate investment trusts (REITs). Higher interest rates have weighed on real estate values to increase their income yields above those of lower-risk income investments like bonds. In addition, higher rates have made it more expensive for REITs to borrow money to fund development projects and acquisitions.
However, rates likely won’t stay this high for much longer. The Federal Reserve plans to begin cutting them as soon as inflation is under control, which it hopes will be the case before the end of the year. As a result, now looks like a smart time to buy REITs. While many look attractive, Realty Income (O), Prologis (PLD), and Mid-America Apartment Communities (MAA) stand out as some of the top options. They could turn a $1,000 investment into a lucrative income stream while also potentially delivering strong share-price gains.
The income lover’s dream
Realty Income built a real estate business designed to deliver dependable dividend income. It pays a monthly dividend that has steadily grown over the decades. It most recently delivered its 124th increase since its public market listing in 1994 (and 106th consecutive quarterly increase). Realty Income’s dividend yields an attractive 5.6% at its recent share price. It could turn a $1,000 investment into $56 of annual dividend income at that rate.
Elevated interest rates are currently a headwind for the company. Its share price sits about 25% below its high before the Fed started raising rates, which is a big reason why it has such a lofty yield. That has made it less attractive to issue new stock to fund acquisitions. Meanwhile, debt is more expensive. As a result, Realty Income only plans to invest about $2 billion to acquire real estate this year, which is well below its roughly $9 billion annual run rate in recent years.
However, as rates fall, Realty Income’s stock price should rise, enabling it to use shares as a currency to fund more deals. That would boost its growth and enhance its ability to continue increasing its dividend. The company’s combination of income yield, earnings growth, and price appreciation potential positions it to produce strong total returns in the coming years.
A short-term speed bump
Prologis highlighted the impact rates are having on its business in its first-quarter earnings release. CEO Hamid Moghadam noted: “While operating conditions are healthy in the majority of our markets, customers remain focused on controlling costs, which is weighing on decision making and the pace of leasing.
A volatile and persistently high interest rate environment, together with mounting geopolitical concerns, contribute to this indecision and its short-term effect on net absorption.” That issue led the REIT to tweak its guidance, reducing its expectations for occupancy, same-store net operating income (NOI), and funds from operations (FFO).
However, the CEO also stated, “We remain optimistic about the fundamentals of our business.” Management believes things will be slower in the next quarter or two before reaccelerating due to the strong tailwinds driving the industrial real estate sector, including a favorable outlook on new supply. That drives Prologis’ belief its core FFO will increase by an average of 9% to 11% annually through 2026.
That strong growth rate should enable Prologis to continue boosting its dividend at an above-average pace. With its dividend yield up to 3.6% — due to a rising payout and lower stock price — and robust growth ahead, Prologis could generate strong total returns as rates begin to ease.
Dual headwinds should fade over the next year
Mid-America Apartment Communities (MAA) is battling interest rate and supply headwinds. Those issues weighed on its first-quarter results. Its same-store NOI dipped 0.7% in the period due to rising expenses and very modest rent growth.
However, better days lie ahead, especially on the supply side. “With continued solid demand and the resulting steady absorption of the new supply pipeline, we continue to believe that the decline in new supply deliveries expected late this year and into 2025 will fuel a strong and quick rebound in rent performance,” CEO Eric Bolton stated in the first-quarter earnings release. Add in the likely easing of expense headwinds as inflation and rates fall, and the REIT could deliver stronger FFO-per-share growth in the future.
Another growth catalyst is its investment program. MAA had five new communities under development at the end of the first quarter, which it expects to complete over the next two years. Meanwhile, it has a strong balance sheet, giving it plenty of flexibility to capture new growth opportunities. Add in its growth, share price upside as market conditions rebound, and attractive dividend (4.3% yield), and MAA could deliver robust total returns in the coming years.
Income with upside
Falling rates have weighed on REIT stock prices, making their dividends more attractive. However, those high yields might not last much longer given that the Fed appears poised to start lowering rates. Because of that, high-quality REITs like Realty Income, Prologis, and MAA look like really smart investments right now.
— Matt DiLallo
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Source: The Motley Fool