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3 of the Best REITs for Dividend Stock Investors

With solid dividends and growth potential, these real estate investment trusts are good investments.

3 of the Best REITs for Dividend Stock Investors

The following is an excerpt from the video series Dividend-Stock Deep Dive, hosted by Morningstar DividendInvestor editor David Harrell. David spoke with Morningstar analyst Kevin Brown, who focuses on real estate investment trusts, or REITs. Watch the full interview.

Key Takeaways

  • Two of the best REITs have increased their dividends through the COVID-19 pandemic.
  • Our outlook remains positive for the REIT that cut its dividend.


How Our Analyst Rated the Best Dividend REITs

David Harrell: In your report, you did some great stuff. And one is you basically ranked all of the REITs under coverage by their historical dividends. You created a 1 to 5 rating based on multiple factors and rated all of the REITs and ranked them. And then, you did the same looking forward in terms of sustaining and growing their dividends. So, then you have this ranking based on future dividends. You took two of those rankings, added in the Morningstar star rating, I believe, and current yield to create an overall ranking of your REIT universe. And you came up with your three top picks, I believe, currently, and I was wondering if you could share those with us.

3 of the Best REITs for Dividend Stock Investors

Two of the REITs are considered undervalued. Data as of Aug. 1.

  1. Federal Realty Trust (FRT)
  2. Realty Income (O)
  3. Ventas (VTR)

Kevin Brown: Sure. The first company I want to recommend is Federal Realty Trust (FRT). It's a shopping center REIT. It is one of the three members in our coverage list that is in the S&P 500 Dividend Aristocrats Index. It's a very strict standard to adhere to. You have to not only not have any dividend cuts, you have to raise your dividend each and every year for 25 straight years. It's very difficult for many companies to adhere to that strict list. Again, only three of the 27 companies we cover actually manage that standard, and Federal Realty stands out. It's a retail REIT, and many other retail REITs have had dividend cuts because of the pressures that they have faced from declining brick-and-mortar sales. However, Federal Realty has found a way to continue to raise it, and it's their top priority. They want to make sure that they are able to continue to pay a strong, consistent dividend. And even during the pandemic, when you had the payout ratio go above 100% for a couple of quarters, they stuck through it and have emerged out the other side back to their historic level of around 85% of AFFO is where they pay out their dividend, and they raise it each and every single year. And so, they've had a great track record. And going forward, we think that they should be one of the top retail REITs in terms of overall growth because they are focusing on some major development projects of mixed-use retail. So, you not only have ground level of retail shops and big boxes, but on top of that, you're building office buildings, apartments, and hotels, which should give those retail shops a captured audience of somebody who's always going to be there shopping at your stores because, frankly, one way that it's easier than online shopping is to go shopping in person if you just have to go down to the ground floor to go to the store. So, you've got some very large projects. They've completed some that have been really well-reviewed, and we think that Federal Realty is just a great opportunity for not only for income-oriented investors but anybody looking for a REIT investment.

The next company is Realty Income (O). This is a triple-net lease REIT, which means that they basically are not responsible for the vast majority of expenses toward maintaining their properties. They have retail tenants who lease their portfolio of assets that are all the corner store, say--imagine Walgreens and CVS on the corner of major, busy intersections. They own those buildings, but the tenant is responsible for all the operating expenses and also responsible for all the maintenance of the property itself. They have to pay for the maintenance. And so, Realty Income just sits back and collects a simple rent payment from them without having any major expenses, and it makes it a very safe, stable business, and even in recessions, their cash flows are not changed very much because they have such a wide cushion between what the operator, the tenants', cash flows are versus the rent payments, that their rent payments are never at risk of being potentially cut. And so, because they have stable revenue growth, they're able to promote a stable income of dividend to shareholders. And this is another member of the S&P 500 Dividend Aristocrats Index, and they dubbed themselves the "monthly dividend company," because, again, their top priority is paying out a dividend to shareholders.

Harrell: On a monthly basis, as they say?

Brown: Yes, they pay out a monthly dividend. Yes.

Harrell: Is that common within the industry? Or is that fairly rare?

Brown: No, that is fairly rare. They're the only ones in our coverage who pay out a monthly dividend. All the rest pay out a quarterly dividend.

Harrell: OK.

Brown: But they give themselves their own name of the "monthly dividend company." I mean, they say "dividend company," because paying a dividend is, again, one of the top priorities for this company. That's why they also are at the top of our overall rankings.

Why Ventas Is Among the Best REITs Despite Its Dividend Cut

Harrell: And, Kevin, your third pick was a firm that its cash flow was definitely impacted during the pandemic, correct?

Brown: That's correct. So, our third recommendation is Ventas (VTR), which is a healthcare REIT. They focus on three separate healthcare sectors: senior housing, which saw a very big impact from the pandemic, but also they own medical office and life science. And one of the things that we like about them is that they do have their life science and their medical office portfolios, which were not impacted by the pandemic and generally should be relatively defensive during most recessions. Medical office is a portfolio that just should continue to grow at 2%, 3% every year and is insulated from most economic impacts. Life science is a sector that should have a significant growth ahead of it, as many pharmaceuticals continue to invest in their overall research capabilities and many universities are expanding their research campuses. And so, Ventas is the partner that can provide the clusters of life science buildings necessary to continue to fuel that growth. And they're seeing significant growth in the 4%, 5%, 6% overall growth every single year from that segment.

Those two segments were not impacted by the pandemic. However, their largest, which represents about 40% of the overall company's cash flows, senior housing was impacted by the pandemic, but we think this provides a significant opportunity for growth going forward. Now, senior housing was one of the biggest things impacted by the pandemic, because seniors were very sensitive to the virus. It wasn't that there was any major outbreak at the facilities of Ventas. It was more so that there were issues with the facilities being quarantined if there was any contact tracing that led to the facility. So, if a visitor had the virus or if somebody who worked there may have had the virus, they would have to shut down the entire facility for an extended period of time. And that meant that you were not bringing in new residents. And so, doing that several times throughout the pandemic led to occupancies falling from the mid-80% range to the mid-70% range in about a year's time.

Now, since the vaccine has been developed and started rolling out among the senior population, we've seen a significant recovery in occupancy, with occupancy growing month over month, every single month over the past year since about March 2021. And it's even continued to see positive growth through the delta and the omicron variants. Now, it's not back up to its prior levels, but it's encouraging to see occupancy start to get back up close to where it previously was. However, we think that occupancies are going to continue to reach that level and then push through as we see the overall 80-plus population continued to grow. The baby boomers are just starting to age into the target age for these facilities. And so, while the past decade, we saw the 80-plus population grow at an average rate of about 1.5%, we're at about 3% right now. And that rate of growth is only going to continue to accelerate up to around 7% by 2027. So, that's a huge amount of demand growth.

Meanwhile, supply growth, which had been above historical average prior to the pandemic, construction starts went to about zero during the height of the pandemic, and even today is still well below historical average. And since these facilities take anywhere from two to three years to build, we see out several years that we're going to have very low supply growth. So, with rapidly expanding demand growth and low supply growth, we think that occupancy is going to continue to push northward into around the 90% range, which is where we were at back in the 2010-11 time frame. And back then, we saw rent growth of 4%, 5%, 6%, 7% on an annual basis. And I think with that you're going to see some very strong growth from senior housing. And that should therefore, you know, fuel strong cash flow growth, which should also fuel strong dividend growth. And so, we think that this is going to be a company that's going to see lots of growth going forward and should be a good investment for all investors--for both those looking for strong growing dividends but also for investors looking for a company just growing its cash flows.

Harrell: It's one of the firms that did have a dividend cut during the pandemic, but your outlook is very positive for the firm right now?

Brown: Correct. And historically, over the past 20-plus years, that pandemic cut, just because of the uncertainty of senior housing cash flows, that's the only time that they have cut their dividend. They made it through the 2008-09 time frame without cutting their dividend. Even though the majority of companies we cover did cut their dividend during that time period, Ventas did not. So this is the one exception to Ventas' history.

Watch "Should Dividend Investors Buy No-Moat REITs?" and "Dividend Investors: Avoid These REITs" for more insights from Kevin Brown about real estate investment trusts.

David Harrell does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.