- Analysis Paralysis
- Triple Your Yield
- Rule #1: Bigger Isn’t Always Better
- Rule #2: Can They, Or Should They Be Paying So Much?
- Rule # 3: Check the Debt
- One REIT That Fits All the Criteria: STAG (NYSE: STAG)
- Conclusion
Are you one of those people that make New Year’s resolutions?
Go to the gym every day. Learn a new language. Master the piano. Start painting. Stop swearing. Grow a robust, 1970s-style mustache.
Well, maybe that’s just me…
The problem is the typical New Year’s resolution only lasts about a month. Based on polls I’ve read, that seems charitable, as 68% of Americans have reported giving up their resolutions way sooner than that. I’m talking within a few days or a week (if they start at all). One in seven never truly believe they’ll see their resolution through in the first place.
Most people probably know this from personal experience. I certainly do.
But I believe that the prime culprit here is that we always have so many things we’d like to change to get our lives where we ideally like them to be, that we become intimidated by the sheer amount of work and willpower it would take to radically change, say, six major things all at the same time.
It’s like spinning plates; the more you spin, the more you drop.
Analysis Paralysis
That is the definition of analysis paralysis.
Here’s how the experts explain it…
“Analysis paralysis is an anti-pattern, the state of over-analyzing a situation so that a decision or action is never taken, in effect paralyzing the outcome. A decision can be treated as over-complicated, with too many detailed options, so that a choice is never made, rather than try something and change if a major problem arises.”
In other words: don’t overthink it, just do it. If you are serious about accomplishing a goal, you need to focus completely on that goal and make it your main priority.
As far as investing goes, if you allow all of these dizzying thoughts to consume your thinking completely, you'll never even get to the point where you can make any decisions, much less manage a coherent portfolio.
This year, my financial resolution is to secure what I have and slowly grow my wealth with safe, income-based stocks. Once I have achieved that goal over the first few months of 2023, I will feel confident, fulfilled, and ready to start taking on other financial goals, like investing in riskier growth stocks and taking a few more chances knowing that I have a solid anchor.
That time will also allow me to gauge what is currently a very mysterious market. I’m perfectly happy to keep my eye on my goal while some of the fog dissipates (while that sweet mustache keeps on a growin').
There are many options: thousands of stocks, boatloads of mutual funds, CDs, bonds, treasuries, precious metals, collectibles…
Now we're subjected to mind-boggling investments like cryptos, SPACs, and NFTs.
Let’s keep it simple today, shall we? As I wrote earlier this week, I’m currently highlighting each area of dividend stocks that I believe will hold steady during what appears to be an upcoming recession. I spoke of consumer staples last time, but today I want to focus on a sector that sports much higher dividend yields: REITs.
Triple Your Yield
A REIT – or real estate investment trust – is a company that owns and typically operates income-producing real estate. That means any space that produces rent and money for the owners—from office and apartment buildings to warehouses, hospitals, shopping centers, malls, and hotels.
The idea is to allow all investors to invest in large-scale, diversified portfolios of income-producing real estate — not just the wealthy who own the buildings.
The most attractive feature of REITs is their large dividend yields. These companies must pay 90% of their taxable income through shareholder dividends. I’m going to introduce you to two of these today – each yielding around 5%, almost triple the average S&P 500 stock.
One thing that makes REITs appealing to me right now – other than the juicy dividend payouts – is that most of them had a rough year in 2020. Once interest rates rise, it becomes more difficult for REITs to borrow money to fund new construction. And when risk-free yields are creeping up, it causes REITs to lose some luster.
But as far as I am concerned, REITs should be a long-term holding in your portfolio, and right now, we can get very steep discounts on some REITs that will provide you income and solid returns for the years ahead.
But before I share my recommendation, and in an effort to keep things as simple as possible, here are three simple rules to consider when evaluating REITs.
Rule #1: Bigger Isn’t Always Better
I’ve seen a ton of online ads recently shouting about 17% dividend yields from REIT stocks. You may see something like that and say, “I want an easy 17%, sign me up!”
But what's that old quote about being bigger? “It's not the size of the boat but the motion of the ocean.” While that may not necessarily be correct in that case, it certainly translates when you're talking about high yields in the REIT market.
When I see a REIT dishing out a 17% or higher yield, all I see is a huge red flag.
The relationship between the dividend yield and the stock’s reliability is intertwined with any stock. If you are producing yields that high, one of two things is happening.
The first rule is rather simple. When a stock’s share price declines, it mathematically pushes that dividend yield higher. So, many of the highest-yield REITs often show a downward price trend.
So instead of getting all giddy about a 20% dividend yield, you should ask yourself, “why is it that high?”
Look at the range and the duration of those share price declines. Is it a cyclical company that so happens to be in a natural downturn? Has the company wildly fluctuated in price based on unsightly earnings or a rare positive announcement? What is the company’s historical dividend level, and how did the stock perform at an average yield?
Or has the stock been dropping like a rock for an extended period, pushing the yield to unsustainable levels?
That brings me to my next rule…
Rule #2: Can They, Or Should They Be Paying So Much?
High yields also beg the question, “Can the company afford to continue paying, or better yet, keep raising that dividend?” You’ll need to check the books and see just how much revenue is coming in to determine if the dividend is sustainable.
Dividend payouts of this magnitude can also potentially hamstring the business from acquiring, optimizing, and expanding the business itself. If the company is laying out all of its extra cash into dividends, it may not have much left over to accomplish its growth goals.
And due to the nature of the REIT structure, these types of companies rarely have much cash on hand – that goes to pay the dividends. So in the event that they have a few bad quarters or want to expand further their real estate empire – which is the goal of every REIT – they need to resort to debt.
This brings me to rule number three.
Rule # 3: Check the Debt
As I mentioned, 90% of a REITs taxable income goes to shareholders, which doesn’t leave much for business operations. Now, of course, debt isn’t always a bad thing. REITs rely on it to fund new acquisitions, leading to greater revenues, cash flows, increased profits, and, in turn, more dividends.
That does assume that the REIT is sustainably leveraged. As we’ve seen in recent years, economic conditions can swing wildly, especially in real estate. Take the Fed’s interest rate hikes, for instance. Higher interest rates hit real estate hard, and if a company has to take on debt at a much higher level, it may not be prepared for it.
A REIT shouldn’t be so leveraged that it can’t handle transitionary periods of high-interest rates, lower property values, lower occupancy rates, and, therefore, lower rent prices.
This is a basic primer on what to look for in investing in REITs. The takeaways here are REITs that produce very high yields can be less reliable. REITs that produce income like clockwork pay more moderate yields. I’m most comfortable aiming for the 4% – 8% range.
I want to share one interesting REIT with you today that fits all of the above criteria and could bring both yield and double-digit stock gains this year and beyond.
STAG Industrial (NYSE: STAG)
STAG Industrial is a REIT focused on acquiring and operating industrial properties throughout the United States. The company owns and operates 563 warehouses – 116 million square feet worth – across 41 states.
They are particularly heavy in e-commerce, which accounts for 40% of their business.
They own and rent the warehouses where some of the biggest e-commerce giants house their wares. Amazon makes up the bulk of Stag’s customers, as you can see in this top ten chart:
As you can see, Stag is also very diversified, which is crucial in the industrial space. They have holdings in over 45 different industries – tires, metal, mattresses, books – and over 60 markets.
But today, I want to talk about their bread-and-butter, e-commerce.
I’m sure I don’t have to tell you how much e-commerce has grown in the past decade. In 2016 only 6% of goods were purchased online. That number has jumped to almost 15% and is expected to double by 2030. That means more warehouses for STAG to acquire and rent, with shareholders reaping the almost 5% dividend yield.
Not only is that a perfectly sized dividend yield, as I mentioned above, but Stag has been able to grow that dividend every year since 2011. They also grow that dividend slowly at a rate of 0.8% annually, which may not sound sexy, but it just sounds sound.
To sweeten the pot, STAG’s dividend is delivered monthly, so you can get income every month of the year.
STAG also has a very reliable revenue stream. Over 98% of their current properties are occupied, 60% of which are tenants that bring in over a billion dollars annually. Those are companies that can afford to pay their rent. Moreover, less than 25% of their current leases expire by 2024.
As far as spending capital wisely and not blindly scooping up properties and plunging themselves into unnecessary debt, STAG’s acquisition pipeline is currently at $2.7 billion. I also discovered an interesting tidbit: of all the transactions in their pipeline, their stringent approval process only greenlit 5% of them. That takes serious self-discipline.
STAG also holds $17.8 million in cash reserves and $877 million in undrawn “revolver” balance.
Editor’s Note: A revolver refers to a borrower – in this case, the company – that carries a balance in a revolving credit line. The borrower is only obligated to make minimum monthly payments, which go toward paying interest and reducing the principal. It helps STAG fund expenses for day-to-day operations like payroll.
Like almost all REITs in 2020, STAG suffered badly:
That’s a 30% drop over the past year, with a 52-week range of $26.56 – $45.73. Right now, you'd be buying at quite a discount, especially if you hold it long-term and reinvest those dividends.
Not only do we have an easy-to-understand REIT in a growing market segment, but with STAG we also have a good steward of capital, monthly 5% dividends that should continue to grow responsibly with some dry powder on hand to continue the acquisition process that has made them one of the largest owners and operators of industrial real estate in the country.
Thanks, three simple rules!
Conclusion
I hope I was able to lay out some of the most basic qualifications for investing in REITs. I in no way expect the sector to blast out of a cannon to start the year, but I expect it to do what it always does best: provide outsized dividend income and steady growth for the long years ahead.
Next time you see a REIT with a dividend that seems too good to be true, it’s because it probably is. Look back at these three rules before you decide to delve deeper with your due diligence.
It will save you some time, and it will certainly save you some money.
Editors Note: If you'd like a sneak peek at my absolute favorite REIT that checks off these boxes and more, you can find it here.
Godspeed,
Jimmy Mengel
The Profit Sector
Follow me on Twitter @mengeled.
