Real estate investment trusts (REITs) are rate-sensitive investments, so the rising interest rate environment has been a severe headwind with regard to investor sentiment. The entire sector is in the dumps.
But as usual, Wall Street is treating every REIT pretty much the same. That's why industry-leading names like Realty Income (O -0.17%), Prologis (PLD 0.69%), and American Tower (AMT -0.70%) are top REITs that investors should be examining carefully today.
Let's take a closer look at why these three top REITs are buys in October.
1. Realty Income thinks high rates will lead to growth
Realty Income is the bellwether name in the net-lease sector. Net leases require tenants to pay most property-level operating costs. For the most part, net-lease REITs are a mixture of landlord and financing partner to their tenants, with many deals structured as sale/leasebacks. Rising rates and a falling share price make it harder for Realty Income to raise capital to buy new properties. But it has been increasing its dividend annually for nearly three decades, so it has lived through hard times before. And it has an investment-grade-rated balance sheet, so its finances are strong.
Basically, it should muddle through this period just fine. But worried investors have pushed the dividend yield up to 6.3%. That's near its highest levels in a decade. Here's the really interesting thing: Higher rates also require Realty Income's tenants and potential tenants to adjust. The REIT highlights that in the S&P 500 alone, companies operating in industries it serves face $1.2 trillion worth of debt maturities (that will have to be rolled over at higher rates) between 2024 and 2027. These same companies own $1.6 trillion worth of real estate that could be used for sale/leasebacks, which would likely be a more attractive capital source than a new bond with a higher yield. In other words, Realty Income thinks there's strong growth opportunities ahead.
2. Prologis is in all the right places and has room to grow (internally)
Prologis is the largest player in the warehouse sector, which is boring but vital to the world economy. The key for the company is really a combination of scale and reach. The REIT owns 1.2 billion square feet of space across North America, South America, Europe, and Asia. It is, basically, in all of the most important transportation hubs, which is exactly where its tenants and potential tenants want to be located.
The dour mood on Wall Street has pushed Prologis' dividend yield up to 3.2%. While not huge on an absolute basis, it is a fairly attractive yield for Prologis, even if it isn't at the high end of the company's historical range. That said, this is really more of a growth story.
On one hand, demand for warehouses has been strong, and that has allowed Prologis to rapidly increase rents. On the other hand, the company owns vacant land on which it believes it can build $38 billion worth of assets. For growth and income investors, Prologis is a stock that's worth a deep dive today because of all of the internal opportunities it has to expand its business.
3. American Tower is connecting the increasingly connected world
American Tower's dividend yield is currently 4%. That's near the highest level in the REIT's entire history. To be fair, there are more negatives than just rising rates here. The cellular tower owner is also dealing with a potential slowdown in capital spending from its telecom customers after a big spending spree on new technology (5G). And American Tower invested in data centers, which didn't work out as well as planned. And yet the world is only expected to get more connected.
In developed nations, cellular data use is going up because people are streaming more. In emerging markets demand for cellular technology is still growing. And around the world, the internet of things revolution is just in its early stages. So it seems like there's plenty of demand ahead for this globally diversified cell tower landlord. But here's the interesting part of the equation: A cell tower with one tenant has a return on investment of 3%. A tower with three tenants, which is not at all unusual, has a return of 24%. In other words, there's a lot of potential here for positively leveraged growth.
It's hard to buy when others are selling
When Wall Street decides to sell an entire sector, like it is doing with REITs today, it can be particularly hard to step in and buy. But if you have the fortitude to look at the sector, Realty Income, Prologis, and American Tower are industry-leading companies with strong operating histories. And their yields are attractive right now. If you think in decades and not days, you might want to grit your teeth and take a closer look at all three.
