Stocks with high dividend yields can be great, but if a stock has a high dividend yield and also has lots of long-term growth potential and relatively low risk, that's the trifecta. One area of the market where you can find stocks that meet these criteria is in the real estate sector. With that in mind, here are three real estate investment trusts, or REITs, that could be worth a closer look right now.
A hotel REIT with a twist
Hotel REITs tend to be some of the highest-yielding REITs in the sector, and a big reason is that they are more vulnerable to recessions than most types of commercial properties. However, Hospitality Properties Trust (NASDAQ:HPT) isn't just a hotel REIT -- the company also has a large portfolio of interstate travel centers.
Here's why this is important: Hotels are extremely cyclical because they rent to "tenants" on a daily basis. That is, there are no long-term rental agreements that keep space rented out. In tough times, consumers often cut back on travel, and this results in higher vacancies and lower room rates.
On the other hand, travel centers are leased to their operators on a long-term basis, meaning that the income they generate should stay predictable, even if the economy weakens. Additionally, the businesses themselves provide many nondiscretionary services, such as fuel and food, so they tend to be somewhat recession-resistant.
At first glance, Hospitality Property Trust's 8.2% dividend yield may sound too good to be true, and to be fair, it's certainly a good practice to question dividends that are this high. However, the company's payout is well covered by its funds from operations (FFO, the REIT version of "earnings"). In fact, Hospitality Properties Trust's dividend represented just 50% of third-quarter FFO, a rather low payout ratio for a REIT. Plus, a significant portion of the portfolio is being renovated, which should only boost FFO in the future.
Why so cheap, then? In order to improve its properties, the company has taken on significant debt. Plus, recession fears have depressed most hotel REIT stocks, and Hospitality Properties Trust is no exception. To be clear, I wouldn't exactly call this a low-risk stock, but with a well-covered dividend and lots of room for earnings growth in the near future, the risk-reward certainly appears to be in investors' favor.
A defensive REIT with lots of room to grow
Healthcare is one of the most defensive types of real estate you can invest in. Not only do tenants generally sign long-term leases on healthcare properties such as medical offices and life science facilities, but healthcare (for the most part) is a recession-proof business. In other words, sick people still need to go to the doctor, even if there's a recession going on.
My personal favorite healthcare REIT is HCP (NYSE:HCP). HCP is one of the largest healthcare REITs in the industry, but unlike the other big players, the company isn't highly levered to a single type of property. Instead, HCP's portfolio is divided rather evenly between senior housing, medical offices, and life science properties.
All three should benefit from demographic tailwinds. Specifically, the senior citizen population in the U.S. is expected to roughly double over the next 35 years. Simply put, older people tend to use healthcare services more often than the general population, and also spend more on healthcare services when they do.
Senior housing should be the biggest type of property to benefit from this, but it's also the most economically sensitive. There should be plenty of long-term demand growth, but the industry is currently facing oversupply issues, which can lead to vacancies and loss of pricing power.
Over the past few years, HCP has transformed its portfolio by spinning off and selling noncore assets, such as its skilled nursing portfolio, and has significantly reduced its leverage in the process. The hard work was recently rewarded with a credit rating upgrade, which should further reduce the company's borrowing costs, but as part of the process of improving its financial condition, HCP ended its long streak of dividend increases.
However, with a strong balance sheet and a portfolio of high-quality properties, plus a target development spending rate of $300 million per year or more for the next few years, HCP's 5.1% dividend yield should not only be safe, but I'd be surprised if the company didn't resume dividend increases in the near future.
Invest for the long run
As a final thought, these (and most other) REITs are best suited for long-term investment strategies. There are factors -- particularly rising interest rates -- that have nothing to do with the company's business, that can cause REIT stock prices to temporarily fall. Over time, the effects of interest rates should even out, and the underlying business fundamentals should drive returns, so I'd only suggest investing in these stocks if you plan on holding them for a long time -- say, five years or more.