Dividend stocks are everywhere, but many just downright stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn't sustainable. In others, the dividend is so low, it's not even worth the paper your dividend check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today, and one day each week for the rest of the year, we're going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn't to say that these stocks don't share the same macro risks that other companies have, but they are a step above your common grade of dividend stock. Check out last week's selection.
This week, I'd like to turn your attention back to the residential real estate investment trust sector and highlight why Equity Residential (NYSE:EQR) is a great income-producing stock you can trust moving forward.
A reason to worry?
Last week was certainly a transformative time for the housing sector. The Federal Reserve has, for years, been using monetary easing -- its latest round includes $85 billion worth of monthly bond purchases, including long-term U.S. Treasuries and mortgage-backed securities -- to drive down long-term lending costs for consumers and enterprises. The Fed's justification was to entice banks, consumers, and businesses to take on debt to expand their businesses and increase consumption. We knew that this easy money wasn't going to last forever, and last week the Fed hinted that its bond-buying program, known as QE3, could be pared back or halted before the year is over.
While this is good news from the perspective that the Fed thinks the market is strong enough to move forward without any additional stimulus, it's terrible news for the housing sector, which has relied on low lending rates to drive loans. It's no surprise that last week was the worst one we've witnessed in the housing sector in more than a year -- especially for homebuilders still on the shakiest of ground, like Beazer Homes (NYSE:BZH). Beazer, which is still losing money on an annualized basis, fell 10% on the week, despite seeing its revenue surge 50% in its most recent quarter.
Everything's peachy for residential REITs!
However, what terrible news exists for homebuilders could turn into fantastic news for the residential-REIT sector. You see, if lending rates begin to rise because the Fed is paring back its bond purchases, then it will remove the consumer incentive to purchase a home and will drive people back into renting -- which is great news for the big three residential REITS: Equity Residential, AvalonBay Communities (NYSE:AVB), and UDR (NYSE:UDR).
In the most recent quarter for all three companies, we saw economic occupancy and rental rates rise noticeably. In the case of Equity Residential, we saw net operating income jump 6.1% as rental rates drove revenue higher by 5%. Equity Residential's portfolio also ended the quarter with a high occupancy rate of 95%. Similarly, AvalonBay delivered a 0.2% increase in economic occupancy in the first quarter, with rental revenue in established communities rising 4.9%. UDR rounded out the strength in this sector with rental revenue growth of 5.4% in the first quarter, even though occupancy rates came in flat at 95.5%. These results speak to one important fact of the residential-REIT sector: All three have incredible pricing power. With so few vacancies on the market and lending rates rising, that's only going to increase the amount of rental pricing power that these three names can wield.
Another important aspect that can't be ignored is just how important the Archstone purchase will be for both AvalonBay and Equity Residential. Equity Residential paid close to $1.5 billion for a minority stake in Archstone, with AvalonBay picking up the tab for the remainder. Normally, residential REITs like Equity Residential and AvalonBay issue shares or take on debt to construct new apartment complexes. A deal like this will allow both companies to absorb Archstone's existing communities and add to their funds from operations almost immediately.
Show me the money, Equity Residential
If it's not enough to spur your interest to know that Equity Residential's occupancy rates are already high and growing, its rental pricing power is increasing, and lending rates are rising -- which should further spur rental demand -- then perhaps the fact that as a REIT it's required to pay out at least 90% of its net income to shareholders as a dividend will!
Although Equity Residential's dividend saw a dip during the recession, it still pays out a yield at 2.8% that will easily top a 10-year U.S. Treasury bond. Another way of thinking about this is that Equity Residential has paid out more than $17 per share in dividends since 2003 on top of the fact that its share price has more than doubled. This is about as steady of a dividend as you can find in the REIT sector.
Even though I featured AvalonBay as a great dividend you can buy right now as well, I think the residential-REIT sector is large enough to fit to two rental behemoths. As the prospect of a Fed bond-buying wind-down becomes a reality, it would only be reasonable to expect apartment demand and rental pricing to improve, playing directly into Equity Residential's favor. With the recent addition of Archstone's portfolio of properties to its rental portfolio, Equity Residential's funds from operation would only be expected to increase from here on out, boding well for income-seeking investors.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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