Investors should reassess their portfolio at least once a year, and anyone looking at the markets at the end of 2020 will see a vastly different picture than a year ago.
Interest rates hit record lows this year, and overseas government yields are negative for much of Europe. So investors who need income cannot afford to leave any stone unturned. Real estate investment trusts (REITs) are worth considering as some of the highest-yielding stocks out there.
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Interest rates are at record lows, which means income is depressed
Income investors are entering the year with much lower interest rates, and the latest projections out of the Fed indicate that the Fed funds rate will be stuck at the lower bound for at least two years. While mortgage rates have continued to fall, corporate bond yields have fallen as well. The chart below shows corporate bond yields are below 2%.
U.S. corporate 7-to-10-year effective yield data by YCharts.
The bottom line is that higher yields will be difficult to come by over the near term, and income investors will be challenged to generate income. That is why they should look at REITs.
Most REITs are really nothing more than professional landlords. Office REITs build and operate office buildings, charging the tenants rent. Retail REITs own and operate malls, strip malls, and outlet centers. They charge the retailers rent. Apartment REITs do the same thing with residential space.
Lastly, there are less common types, including mortgage REITs.
Retail REITs should improve as the coronavirus crisis fades
Retail REITs have struggled this year as the coronavirus shut down most malls and nonessential retailers. Mall REITs like Simon Property Group (SPG 0.10%) were hit particularly hard as most mall tenants are considered nonessential businesses. Simon's stock got hammered this year, falling as much as 43%.
That doesn't mean that all retail REITs were down that much. Realty Income (O +0.15%) focuses more on essential businesses: convenience stores, dollar stores, and drugstores. These retailers were generally permitted to operate throughout the year. As a result, Realty Income was down only 17% at its low point for the year. Both stocks are the top performers in their niche, and both pay a decent dividend yield. Simon yields 6.2%, while Realty Income pays 4.6%.
The eulogy on office buildings is premature
Office REITs have been hit by the worker flight out of the cities. Those with heavy exposure to Manhattan like SL Green Realty (SLG 0.96%) have been out of favor primarily due to fears of companies leaving this expensive city or moving to a work-from-home model. While employees are huge fans of working from home, corporate executives are less so.
The obituary for New York City has been written many times over the past 100 years, and it usually turns out to be wrong. SL Green trades with a dividend yield of 6.4%, although the stock is down 38% year to date. Part of SL Green's issues is the retailers that operate in its office buildings. Rent collections are down, and that is a function of a drop in tourism and a lack of foot traffic in these stores. As more people get vaccinated and COVID-19 fades into the background, these retailers should return as well.
Collecting interest guaranteed by the U.S. government
Mortgage REITs have a different model. Instead of investing in properties, they invest in property debt (i.e., mortgages). Instead of collecting rent, they collect interest. These stocks had a rough start to the year as volatility in the bond market caused a wave of margin calls. Those issues have been worked out, and the mortgage REIT sector provides some of the best yields out there.
Companies like AGNC Investment (AGNC +0.56%) and Annaly Capital Management (NLY +0.36%) invest almost exclusively in mortgage-backed securities guaranteed by the U.S. government. In other words, if the economy takes another move down and more homeowners get in trouble, these companies will still get their principal and interest. AGNC Investment trades with a dividend yield of 9.2%, and Annaly yields 10.4%. Finding that sort of income is difficult these days.
The next few years will probably be difficult for retirees looking for income. Treasury bond yields are close to record lows, and as we saw in the chart above, corporate bonds are definitely at record lows. REIT stocks don't have the security of a bond, but they do have pretty respectable yields. Mall REITs will invariably react well to any good news on the virus, as will office REITs. Investors are getting paid to wait with REIT stocks, and these investments are worth taking the time to understand.
