Real Estate
Why to Consider Listed REITs When Searching for Income
Article
Mar 01, 2021
As investors search for income in an environment of record low interest rates, real estate securities may offer a solution.
We believe listed real estate investment trusts (REITs) currently offer attractive yields relative to other income-focused investments, especially considering the improving economic backdrop. Looking forward, we think a global economic recovery will lead to real estate securities offering stable, growing dividend income.
Attractive Current Income
Real estate securities’ yield was nearly twice that of both global equities and U.S. corporate bonds heading into 2021. See the chart below. We attribute this historically high yield premium partly to real estate’s relative underperformance in 2020 amid economic shutdowns and social distancing.
Over the longer term, global real estate securities have delivered higher annual income returns than both global equities and global bonds. This is largely thanks to the real estate business model, which is focused on generating stable, recurring cash flows derived from leases. Current yields are attractive, in our view; but more importantly, we see growing and stable dividends on the horizon as the global recovery unfolds.
The Outlook for Dividends
At the outset of 2020 economic downturn, a slew of listed real estate companies reduced or suspended dividends as profitability declined and liquidity needs increased. Reductions were most prevalent in property types most impacted by economic shutdowns and social distancing requirements, like hotels and retail. See the chart below. We believe the cuts are now behind us, and increasing dividends are likely ahead.
Dividend cuts are inherently tied to the business cycle, so it’s no surprise that we saw an uptick in reductions last year when the global economy plunged into the worst recession since World War II. The last time we saw this steep of a decline in dividends paid by U.S. REITs was the Great Financial Crisis (GFC). However, history shows that as the economy and real estate fundamentals rebound, a prolonged period of dividend growth (and positive total returns) typically ensues. This is what happened after the GFC, as evident in the chart below.
Dividends per share among U.S. REITs grew 15% annually in the five-year period following the GFC. We expect to see a similar trend starting this year, though likely at a lower magnitude given that 2020 dividend cuts were less significant than those during the GFC.
Over time, we believe more and more people will return to offices, resume business and leisure travel, and visit high-quality, desirable stores, restaurants, and entertainment locations. As life returns to normal, we think real estate cash flows will improve as well, resulting in a multi-year dividend expansion.
We believe dividend reductions are done and the sector is poised to grow from here as payout ratios increase and cash flow recovers. In fact, we have already begun to see more companies raising dividends recently, and we expect this trend will persist as the global economy reopens and consumers become more confident in the recovery.
Active Management is Key
We do not advocate chasing yield in lieu of price considerations. Rather, we are focused on identifying companies we think are best positioned to grow dividends over time and benefit from price appreciation as the economy recovers, resulting in attractive total returns. We believe finding these attractive opportunities requires a deep understanding of a REIT’s underlying assets, management expertise and valuation.
We see the greatest opportunities in some of the highest yielding sectors—those listed real estate property types particularly hard hit by economic shutdowns and related social distancing rules. We believe many stocks in these unloved sectors are undervalued and will regain their worth as our lives return to normal.
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Index Definitions
The FTSE EPRA Nareit Developed Index is an unmanaged market-capitalization-weighted total-return index, which consists of publicly traded equity REITs and listed property companies from developed markets.
The ICE BofA BBB U.S. Corporate Index is a subset of ICE BofA U.S. Corporate Index including all securities rated BBB1 through BBB3, inclusive. The ICE BofA U.S. Corporate Index tracks the performance of U.S.-dollar-denominated investment-grade corporate debt publicly issued in the U.S. domestic market.
The MSCI U.S. REIT Index is a free float-adjusted market capitalization weighted index that is comprised of equity Real Estate Investment Trusts (REITs). With 153 constituents (large, mid, and small cap) it represents about 99% of the U.S. REIT universe.
The MSCI World Index is a free float-adjusted market-capitalization-weighted index that is designed to measure the equity market performance of developed markets.