REITs And Covid-19, What You Need To Know…

Real estate investment trusts (REITs) have long offered a great way for investors of any means to participate in the wealth-generating appeal of real estate.

These publicly traded vehicles offer many different options for income-oriented investors: apartment REITs, office REITs, industrial warehouse REITs, retail REITs, storage REITs, healthcare REITs… Some even own cell-phone towers or highway billboards – any asset that generates rental income.

If you’ve ever bought and sold a house, then you understand that most properties appreciate in value over time. But the primary appeal of these securities is their income-producing potential. Even better: Real estate trusts are exempt from federal income taxes, provided they distribute at least 90% of their taxable income to stockholders. This helps explain why REITs pay dividend yields that far exceed market averages.

Even better, those dividends aren’t exposed to disruptive influences that other businesses must deal with… such as spiking raw material costs or changing consumer fads.

That was all before Covid-19, of course.

How Covid-19 Has Impacted REITs

Fast-forward to today, and let’s just say that this isn’t a great time to be a retail property owner. Business across the country have been forced to operate at reduced capacity (or remain in full shut-down mode), which isn’t exactly compatible with timely rent payments.

Some retail REITs collected just 50% of their expected rental income in April, May, and June. Others even less. Nobody wants to lose a tenant, so property owners have willingly agreed to temporary rent deferments, and in some cases, outright lease restructuring.

All this probably makes the prospect of putting your hard-earned money into REITs a little daunting in the minds of most investors.

But I’ll just say this… not all REITs were created equal before Covid-19. And the same is true today. Just as investors needed to be choosy before all this mess hit the market, it’s even more true today.

Over at High-Yield Investing, we’re still believers in the long-term potential of REITs. But we’ve been carefully evaluating the REIT exposure in our portfolio, culling some from the herd – while holding tight to others.

Case in point, consider two REITs we had in our portfolio up until recently.

I’ll start by telling you about the one we cut from our portfolio a few weeks ago.

Colony Capital (Nasdaq: CLNY)

I stuck with Colony during the downturn, in part because the company is divesting properties and monetizing its undervalued assets. I also liked that it was pivoting into data centers, cell towers, and other digital infrastructure (among the most promising real estate niches).

There have been other encouraging developments, including a board shakeup that brought in fresh leadership. But my original attraction to Colony was the coveted industrial warehouse unit, which had become ever more important for e-commerce fulfillment. It was sold to Blackstone Group last September – fetching $5.9 billion.

Unfortunately, that catalyst was fleeting, and Colony has continued to bleed cash during this transition period. And Covid certainly isn’t helping.

You wouldn’t know it from the share price, but Colony has $50 billion in real estate assets under management. It owns $12 billion, while the other $38 billion is managed on behalf of institutional clients.

The company is going on “digital offense”, a great strategy for the long-term. But that also means it must de-emphasize dividends in favor of capital appreciation and total returns. In fact, we likely won’t see another payment for the next couple of quarters as the company preserves cash.

I think Colony will eventually right the ship, but it no longer fits the profile for investors who are interested in income.

CLNY chart

Realty Income (NYSE: O)

Realty Income owns approximately 6,500 income-producing properties across the country. But it’s the strength and composition of the tenant base that are paying dividends (literally and figuratively) right now.

Once again, Realty Income is showing its best-in-class stripes. The portfolio is tilted in favor of convenience stores, pharmacies and grocers. Unlike other retail-focused REITs, these are all essential businesses that have been shielded from the impact of Covid-related restrictions – and in many cases, benefiting from them.

During the second quarter, the company received 85.4% of its contractual rent payments. Even in May, a worst-case scenario with most of the country in lockdown, it still collected 83 cents from every dollar in rent due. Meanwhile, rent collections from stout investment-grade tenants (which comprise about half of the portfolio) have ranged between 98% and 100% the past three months.

That’s why it pays to court well-heeled tenants.

Most of the unpaid rent is tied to lessees that have been granted short-term (often 3-6 months) rent deferrals. So that money will arrive in due course once businesses re-open. Still, short-sighted investors have driven this extremely dependable income producer from $80 per share below to below $60, elevating the yield to 4.8%.

O chart

Action To Take

It’s a case of contrasting REITs… Both looked like suitable portfolio candidates before Covid-19 for their own respective reasons.

One as a viable high-yielding rebound candidate, the other a best-in-class operator. But when it comes down to it, during uncertain times like this, only one is worth holding on to right now — and that’s Realty Income.

I consider Realty Income to be a “buy” at these levels. Over the years, Realty Income has delivered hefty returns to us over at High-Yield Investing. And I believe the REIT will return to its ways before too long.

But the larger lesson here is that income investors shouldn’t abandon REITs completely. But they do need to be very choosy in the REIT space right now. Know the composition of the portfolio, don’t chase yield, and have a bias for best-in-class.

In the meantime, if want to know about my absolute favorite high-yield picks, then I invite you to check out my latest report right here.