Which REIT Sectors Will Stand Out in 2016?

This article is republished with permission from REITCafe.

Now that winners of the $1.6 billion Powerball lottery have been identified, those of us who did not win are considering investments with less risk but strong returns. With traditionally strong dividend yields, real estate investment trusts (REITs) could be a viable option.

REITs are required to distribute at least 90 percent of their earnings to shareholders, and investors have flocked to the sector in recent years for its attractive returns in the current low-interest-rate environment. Equity REIT yields measured 3.85 percent at the end of 2015, up from 3.56 percent one year earlier. Mortgage REIT dividend yields stood even higher, at 12.15 percent, according to the National Association of Real Estate Investment Trusts (NAREIT). Dividend yield can reflect strong profitability, but falling stock values can also boost the yield, so it is important for investors to carefully evaluate stocks.

For REITs, strong real estate market fundamentals have led to better profitability, enabling them to distribute greater earnings to shareholders. At the same time, REIT share values pulled back during 2015, largely because of investor concern about the impact of higher interest rates. REITs whose ongoing profitability enabled them to maintain or increase their dividend (at a time when share prices were falling) posted higher dividend yields.

Among the various REIT sectors, specialty REITs posted the strongest yields in 2015, measuring 6.72 percent. Iron Mountain, the largest specialty REIT, has a 7.57 percent dividend yield. The company increased its dividend in November, but its yield, at least in part, was pushed up by a 26 percent decrease in IRM’s stock price during 2015.

Divided yields for health care and lodging REITs were also very strong, at more than 5.0 percent. Strong yields in these sectors were also, at least partially, the result of falling stock values. Despite their strong dividends, both of these sectors reported negative total returns for 2015.

Other REIT sectors with dividend yields above 4.0 percent include freestanding retail REITs, diversified REITs, and timber REITs.

Use of leverage enables mortgage REITs to amplify their returns and pay strong divided yields. Mortgage REITs make money on the spreads between short- and long-term interest rates. Despite strong dividends, mortgage REIT total returns declined about 9.0 percent during 2015, reflecting investor concern about the impact of higher interest rates on this sector.

This year has gotten off to a rocky start, and REITs could benefit from stock market volatility. Dividend stocks tend to perform better than other stocks in volatile markets, making REITs comparatively more attractive. REITs are also attractive compared with energy stocks, another strong dividend sector that has crashed as oil prices keep falling. To date during 2016, the FTSE NAREIT All REIT Index has fallen less than the Dow Jones Industrial Average, NASDAQ, and the Russell 2000.

REIT share values have been beaten down, but real estate market fundamentals are strong with few clouds on the horizon. Profitability and dividend yields are high, making it an attractive time for careful investment in this sector.

* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.

** - 10 yr. Treasury Yield as of 1/15/2016.