Why a Tough Year for REITs Makes These 3 Stocks Great Buys

Source: Flickr / Nicholas Eckhart.

It's a scary world for investors in real estate investment trusts, which face a potentially difficult future due to the looming prospect of rising interest rates. For any stocks whose business models are reliant on debt financing within their capital structures (as REITs are), the onset of higher interest rates likely means higher interest expenses. 

However, despite headwinds in the past year due to rising rates, high-quality REITs like HCP  (NYSE: HCP  ) , Health Care REIT  (NYSE: HCN  ) , and Realty Income  (NYSE: O  )  exhibit long-term visions for their business that should appeal greatly to Foolish investors.

Stable business models
Real estate investment trusts utilize debt to purchase properties, which they then rent out. Using debt to buy property may sound scary. However, the nature of the portfolios can lead to a great deal of stability in the business.

Realty Income owns more than 3,800 properties rented under long-term leases. These properties are primarily rented to retail tenants that come from various industries such as distribution centers, health and fitness facilities, and drugstores. A unique aspect of Realty Income's business model is that it engages in "net" leases, meaning the tenant is responsible not just for paying rent every month, but also for covering the major operating expenses such as taxes, maintenance, and insurance.

HCP and Health Care REIT are both involved in acquiring and leasing health-care related properties, such as senior housing, medical facilities, and hospitals. It goes without saying that the aging population in the United States will serve them well. Tens of millions of people are in or nearing retirement, and will require lots of health care services.

For evidence of their stability, look no further than their tremendous track records of rewarding shareholders. Consider that Realty Income has paid 524 monthly dividends since 1994, and has increased its payout 75 times since then. HCP happens to be the only REIT included in the S&P 500 Dividend Aristocrats index, and recently raised its dividend for the 29th year in a row. Likewise, Health Care REIT recently paid its 171st consecutive quarterly dividend, and earlier this year raised its payout by 4%.

Get to know FFO
The first part of the bull case for REITs like HCP, Health Care REIT, and Realty Income is that they're fairly cheap stocks, especially when compared to the broader market. Despite the rate-related worries, these businesses posted growth last year even as their share prices faltered. The end result is that they're trading at cheap multiples based on the financial metrics most important to them.

To illustrate, consider that HCP and Health Care REIT trade for 13 times and 15 times trailing funds from operations, respectively. This is a non-GAAP equivalent to earnings per share that is a better measure of a REIT's financial performance. Realty Income trades for about 17 times its trailing funds from operations, which isn't quite as cheap, but it's still a notable discount to the broader market.

High-quality REITs like HCP, Health Care REIT, and Realty Income have been sold off over the past year, mostly due to the market worrying over the prospect of higher interest rates. While this would make it difficult to refinance debt at favorable rates, each company has been around long enough to endure previous environments just like this.

Despite this worry over rising rates, it did not actually have as adverse of impact on the businesses as the market would believe, as each company was able to increase funds from operations. Plainly stated, their management teams are capable enough -- and have proven to be able -- to get in front of the rising rate environment and adjust their investment strategies accordingly.

Is this a better dividend option than REITs?
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Read/Post Comments (2) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 27, 2014, at 7:21 PM, corbyco wrote:

    Should we not be worried that HCN has a PE of over 600?

  • Report this Comment On April 27, 2014, at 7:30 PM, LazyCapitalist wrote:


    REITs shouldn't really be valued on their price to earnings. You need to use price to funds from operations (FFO) as the article suggests.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2902172, ~/Articles/ArticleHandler.aspx, 8/27/2015 3:46:23 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Bob Ciura

Bob Ciura, MBA, has written for The Motley Fool since 2012. I focus on energy, consumer goods, and technology. I look for growth at a reasonable price, with a particular fondness for market-beating dividend yields.

Today's Market

updated Moments ago Sponsored by:
DOW 16,486.47 200.96 1.23%
S&P 500 1,971.82 31.31 1.61%
NASD 4,767.89 70.36 1.50%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/27/2015 3:30 PM
HCN $64.86 Up +0.44 +0.68%
Health Care REIT CAPS Rating: *****
HCP $37.58 Up +0.07 +0.19%
Health Care Proper… CAPS Rating: *****
O $46.02 Up +0.55 +1.21%
Realty Income Corp… CAPS Rating: ****