Retire Calendar

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I believe that real estate investment trusts (REITs) belong in the portfolios of everyone who is investing for retirement. Not only do these stocks tend to pay high dividends, but they also have strong potential for market-beating growth.

If you invest in solid REITs with smart business models, you can limit your downside risk during recessions and market crashes. With that in mind, here are three excellent REITs that you should put on your retirement radar.

O Total Return Price Chart

Public storage: Strong demand and a great business model
Most Americans know of Public Storage (NYSE:PSA) from its more than 2,200 storage facilities, but many don't realize what an attractive business self-storage is. As people accumulate more "stuff," they need places to put it.

As a result, one in 10 Americans rent storage space today, a sharp increase from one in 17 just 20 years ago. Self-storage facilities have about half the maintenance expense of most other forms of real estate -- Public Storage's properties can break even with just 30% occupancy.

For these reasons, self-storage REITs have outperformed other types of commercial real estate over long time periods. Not only that, but returns tend to fluctuate less from year to year, as you can see in the chart below.

Type of real estate

15-year average total return (1997-2011)

Standard deviation

Office

10.4%

23.8%

Industrial

8.7%

24.5%

Retail

13.5%

24.1%

Apartment

13.8%

21.8%

Self-storage

15.4%

19.9%

Source: National Association of Real Estate Investment Trusts.

Further, the self-storage industry is highly fragmented, with the top six companies accounting for just 12% of the market -- meaning that there's plenty of room for consolidation. And Public Storage is the biggest and best-known brand in the industry. In fact, the company is larger than the next four largest public self-storage REITs combined. The industry-best brand recognition gives Public Storage the ability to attract more customers, and gives the company pricing power over rivals.

Realty Income: The best way to invest in retail
You may be thinking something along the lines of "isn't retail risky?" If you are, it's completely understandable; after all, there have been some high-profile retail bankruptcies during the past few years, and online competition is cutting into the profits of many others.

However, Realty Income (NYSE:O) is different because of the type of retail properties the company invests in. Specifically, the vast majority of Realty Income's investments fit into one of three categories.

  • Non-discretionary retail: These businesses sell things people need, not things they want. Think of grocery stores and drug stores. There is minimal threat of online competitors putting these types of retailers out of business.
  • Service businesses: Think of movie theaters and fitness centers. These businesses provide a service that must be experienced in person.
  • Low price points: Dollar stores are a perfect example of this, and are a top holding of Realty Income. Not only are dollar stores the fastest-growing type of physical retail, but these businesses sell goods that are either non-discretionary (like groceries), or offer deals that cannot be readily found online.

A glance at the company's top tenants shows how the majority can be grouped in to one or more of these categories.

Realty Income Tenants

Source: Realty Income Corporation.

The proof is in the performance. Realty Income has a 98.3% occupancy rate, and has never dropped below 96% no matter what the market was doing. The company pays an attractive 4.4% dividend yield on a monthly basis, and has increased the payout 83 times since going public in 1994 -- a fact that's almost as impressive as the average total return of 16.6% since then.

Welltower: Strong demographic trends
Formerly known as Health Care REIT, Welltower (NYSE:HCN) is the largest REIT specializing in healthcare properties. The majority of the company's properties are senior housing, long-term care, and outpatient medical facilities.

The main reason I like Welltower (and healthcare real estate, in general) as a retirement investment is the extremely favorable demographic trends. According to data from the U.S. Census bureau, the population is expecting to age rapidly during the coming decades, with the 85-and-over population expected to triple by 2050.

Welltower Demographics

Source: Welltower.

Welltower is also aggressively expanding into the U.K. and Canada, whose 75+ age groups are growing at five and seven times, respectively, the rate of the overall populations.

Plus, the U.S. market for healthcare real estate is highly fragmented: It's currently a $1 trillion market, and no company has a larger share than Welltower's 2.5%. This, combined with the aging population, means that there will be no shortage of opportunities for expansion going forward.

Welltower pays a generous 4.85% yield, and has a strong track record of dividend increases – a 4.2% increase for 2016 has already been announced. Not only do I believe that the growth will continue, but thanks to the trends I mentioned, I think it could actually increase in the years ahead.

Just a starting point
This is not meant to be an exhaustive list of the REITs that make great retirement investments, but the principles discussed here can be applied to others.

To give you an idea of what the right REITs can do for your retirement, consider that all three of these stocks have averaged total returns of at least 14.8% over the past two decades. If you had invested $10,000 into each of these three REITs 20 years ago ($30,000 total), and reinvested your dividends, your investment would be worth about $590,000 today.

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Matthew Frankel owns shares of Realty Income and Welltower. The Motley Fool recommends Welltower. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.