The stock market appears to be headed for another sell-off, leaving many investors on the hunt for new investment opportunities -- ones that can offer slightly less volatility or possibly diversify their holdings.
Historically, real estate has been a fantastic investment avenue that offers diversification and protection from the swings of the stock market. But with the real estate market showing signs of wavering, investing in physical real estate may not offer much relief for the time being.
That doesn't mean real estate investing is off the table -- it just means you need to invest in real estate strategically. Here's why I'll be loading up on high-quality real estate investment trusts (REITs) in the next market sell-off and why you may want to follow suit.
High-quality companies will be on sale
Even the highest-quality companies with strong balance sheets and fantastic growth opportunities aren't immune to the impacts of a bear market. Take Digital Realty Trust (DLR -0.43%), for example. This REIT is one of the leading global data-center providers, leasing its nearly 300 data center facilities to tenants in 26 countries.
Data centers play a vital role in the processing and storage of information for virtually everything we do with technology. This is why the industry is experiencing robust demand while still having long-term growth opportunities. The stock has a stellar track record, providing a total return double that of the S&P 500 over the past 18 years. But the shares are down about 30% this year and could fall further if the sell-off continues.
It's hardly the only high-quality REIT that's on sale, either. Prologis (PLD 0.11%), the second-largest REIT by market capitalization and the largest industrial operator in the world, is down 27% this year. This slump came despite the fact that its latest earnings showed outstanding growth on all measures, with ample growth opportunities ahead.
Dividend yields increase when the market is down
REITs are required to pay at least 90% of taxable income in the form of dividends in order to benefit from certain tax advantages. This has made REITs some of the most attractive dividend stocks out there. But thanks to the inverse relationship between share price and dividend yield, sell-offs are among the best times to achieve ultra-high dividend yields.
Dividend Aristocrat Realty Income (O -0.23%) is a perfect example of why this is. Realty Income's dividend yield normally sits between 3% and 4% historically; today, it's at 4.4%. But in the March 2020 market crash, its dividend yield went over 6% before rebounding back to more historic levels.
Since then, Realty Income raised its dividend by 6.45% and grew its portfolio by 4,544 properties, spending a record $6.4 billion in 2021 while still maintaining a debt ratio within the normal range for REITs. This monthly paying net-lease REIT has raised its dividend 116 consecutive times, making it one of the most reliable dividend stocks in the industry. It also generated a 13% annualized return for the past 25 years, outperforming the S&P 500.
Investing in dividend stocks like REITs also has the added benefit of dividend increases when the market recovers. Since REITs are required to pay dividends, dividend growth when shares are held for the long term is likely.
High dividend yields can partially offset inflation
While not always the case, some ultra-high dividend yields can offset today's high inflation rate. Mortgage REIT (mREIT) Annaly Capital (NLY 1.41%), for example, pays a dividend yield of more than 13% currently. There is considerable risk associated with a yield that high and with the company. It's business model doesn't benefit from high inflation or rising interest rates. Since it uses short term debt to fund long-term loans, its revenues come from the spread between the two. Fluctuating rates can squeeze margins and if sustained or coupled with a recession it could lead to financial trouble down the road. So Annaly Capital may not be the right investment for you. But there are more conservative yields in the 4% to 8% range that offer more safety and security while still combating money lost to inflation today. Diversified REIT, W.P. Carey (WPC 4.29%), for example, pays just over 5% dividend yield today with a tremendous dividend paying track record and healthy balance sheet.
Sell-offs don't last forever, so buying REITs when the market is down is the best way to take advantage of higher yields and discounted pricing, all while gaining favorable exposure to the different real estate industries.