If you're looking to bolster your income with high-quality dividend-paying stocks, then real estate investment trusts, a.k.a. REITs, can offer some of the best opportunities. Openly traded on the stock market, equity REITs are companies that acquire commercial properties -- malls, hotels, apartment buildings, you name it -- and create earnings by leasing space to tenants.
Best of all, because these companies receive favorable tax breaks, they're required to pay out 90% of their income to shareholders in the form of dividends. This helps generate yields that more than double the 10-year Treasury rate of 2.1%.
But REITs aren't just about yield. Here are five more reasons why every income investor should consider REITs.
Realty Income (NYSE:O) is a $10.4 billion company that owns 4,284 properties, predominantly retail, in 49 U.S. states and Puerto Rico. However, what makes Realty Income impressive is not the fact that it's big; it's that the company is a prime example of the incredibly consistent income REITs can offer.
Historically, Realty Income has focused on using sale leasebacks to acquire properties. This means it buys properties and leases them back to the seller. The former owner, now a tenant, can either pay off the mortgage or free up capital. Realty Income gets a property with an existing tenant. Most importantly, Realty Income locks these tenants into long-term leases of 10 to 20 years.
During the company's 45-year history, this business model has helped Realty Income keep its total portfolio occupancy above 96%. And as of the third quarter of this year, that number is up to 98.3%.
Equally important is the quality of Realty Income's tenants, which include Walgreens, Dollar General, LA Fitness, and more than 200 others. Ultimately, this combination of a straightforward model, strong occupancy, and high-quality tenants creates a reliable income stream and a consistent dividend for investors.
Operating in nearly every industry, REITs have proven to be resilient investments through even the worst recessions. HCP (NYSE:HCP) is a great example of this: By paying and increasing its dividend for 29 consecutive years, through economic ups and downs, the company has distinguished itself as a Dividend Aristocrat.
The company has a market cap of $20.5 billion and owns 1,191 healthcare-related properties that are not only spread across the U.S., but split among senior housing, nursing homes, life sciences, medical offices, and hospitals. Thanks to this vast diversity, a downturn in one particular region or property type won't have a drastic impact on HCP's business.
Moreover, the necessity of healthcare and the importance of HCP's properties to its tenants adds an extra layer of durability that is unlikely to be affected by the strength or weakness of the overall economy.
3. Disciplined management
As mentioned earlier, REITs pay out at least 90% of their taxable income as dividends. While this is great for income investors, it can make managing operations extremely difficult.
Most companies have the luxury of retained earnings to help protect and grow their businesses, but REIT management needs to be excellent at raising capital, managing debt and expenses, and allocating capital, because REITs lack this retained-earnings cushion.
Because a few wrong steps could mean a dividend cut, companies like Realty Income and HCP that have increased their dividends for decades -- and there are dozens more REITs like them -- prove management's ability to be disciplined with expenses and acquisitions.
Because inflation and stock price depreciation can quickly wash away your dividends, finding companies that can grow over time is an often overlooked yet important consideration for income investors. Luckily, we don't have to look far to find these winning investments. By growing their total properties and paying substantial dividends, Realty Income and HCP have generated total returns of more than 100% over the last five years.
While past results don't always predict future returns, the aging of the U.S. population should continue to create long-term opportunities for HCP. As for Realty Income, the retail market is extremely competitive, but low-cost businesses like convenience stores, drug stores, and dollar stores have been durable over time. I expect Realty Income to have more than its fair share of opportunities to grow.
1. Portfolio diversity
In his book Investing in REITs, Ralph Block explains that REITs have historically had a low correlation with the S&P 500, small-cap stocks, and bonds. This suggests that REITs will often perform in the opposite direction of the broad market. While this means REITs may be a drag on your returns when the market is hot, they will outperform when the market goes cold.
This is the beauty of REITs. Their ability to create value and stabilize your returns over time is the reason they belong in every income investor's portfolio.
Dave Koppenheffer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.