Real estate investment trusts had a rocky 2013. Rates plummeted as we entered summer, but tapering talks quickly erased big gains in the sector.
With the 10-year Treasury yielding 2.7%, REITs are a solid place to score ongoing income. Here are my two favorite REITs for 2014.
1. The best acquirer in the business
Realty Income Corp. (O +0.53%) is by far my favorite REIT. The company makes routine sale-leaseback transactions wherein it buys properties from retail companies to lease them back to their original owners. Realty Income also makes infrequent portfolio acquisitions in which it buys real estate portfolios from other investors.
Because of the company's scale, Realty Income benefits from having some of the cheapest financing in the business. Historically, Realty Income has been able to acquire properties with yields 1.45% higher than its cost of capital. Smart acquisitions are behind the company's robust average dividend growth of 4.1% since going public.
But what really interests me in Realty Income isn't the dividend; it's the portfolio. The company's average lease has more than 10.9 years remaining, and its occupancy rate of 98.1% as of the third quarter is as impressive as it gets. Because Realty Income writes long-term leases, it's less sensitive to economic changes than other real estate operators.
Perhaps most importantly, Realty Income's real estate portfolio has avoided the general weakness in commercial real estate. The single-tenant, specialized model at Realty Income has served investors well, and there's no reason to believe that will change any time soon.
2. A health care play for the long haul
Health Care REIT (HCN +1.75%) is one of the best health care operators on the market. The company specializes in renting health care properties to private practices, physicians, and hospital companies. Health Care REIT invests primarily in centers where private payers (private health insurance companies) make up the bulk of revenue.
Private pay is believed to be much higher quality than Medicare or Medicaid-funded providers. Private payers are not subject to legislative risks that could affect businesses that accept mostly Medicare and Medicaid.
Much like Realty Income, Health Care REIT is a serial acquirer, using stock issuance and debt to add new properties to its portfolio. Since 1991, consistent dividend increases have propelled the company's quarterly dividend to $0.765 per share, up from $0.46 per share, for compounded growth of 2.3% per year.
The company currently trades for less than 15 times normalized funds from operation, with a current yield of 5.3% annually. Given that the United States and Europe have a quickly aging, baby boomer population, Health Care REIT will have plenty of opportunities to acquire health care properties to build the dividend going forward.
Why buy REITs?
Real estate investment trusts provide consistent income from their dividend yields while providing protection in the form of valuable real estate. Realty Income and Health Care REIT are on top of my list of REITs for 2014 because they are great acquirers and operators. Perhaps more importantly, each fills a very specific, very profitable, niche. Realty Income buys single-tenant buildings that house anything from gyms, to movie theaters and restaurants. Health Care REIT buys properties that are specifically designed and located for health care services.
Health care and single-tenant buildings have held up best in a weak market for commercial real estate. Over time, investors can have confidence that they'll receive consistent dividends that increase with rental rates. Thus, REITs offer some of the best inflation-protected yields on Wall Street.
