Safest REITs to Buy Right Now [October 2020]
The coronavirus pandemic has created a time of great uncertainty for investors.
That doesn’t mean, however, that real estate isn’t a viable investment opportunity. REIT’s are an excellent way to invest in real estate without physically having to own property.
And since real estate has a low correlation with the rest of the stock market, REITs are an incredibly worthwhile investment during trying times.
What is a REIT?
A real estate investment trust (REIT) is a company that brings together multiple investors or resources to finance or purchase revenue-generating properties across various niches. Many of them are bought and sold on major stock exchanges, exactly like stocks.
This means REITs are highly liquid, unlike regular real estate investments. They’re also required by law to pass on 90% of their taxable onto investors in the form of dividends, which means they generate regular income.
REITs make real estate investment accessible to people that might otherwise be unable to invest in real estate. They’re even one of the ways that people with bad or no credit can invest in real estate. Because REITs can be bought on stock exchanges, you can build a diverse portfolio of assets more quickly than if you were investing in properties outright. This makes you a more resilient investor.
Some of the investment opportunities afforded to you by REITs include:
- Apartment complexes
- Data centers
- Infrastructure (cables, cell towers, etc.)
- Medical facilities
- Retail centers
Are REITs a Good Investment During the Coronavirus Pandemic?
Many investors thought that the coronavirus pandemic would create an abundance of distressed real estate properties that have been foreclosed on or are for sale by owner.
However, most distressed properties that stem from the coronavirus are in the retail, hotel, or office space sectors. Given the uncertainty in these sectors, the investment may be risky.
For now, there isn’t an overabundance of distressed residential property. This is in part because experienced real estate investors are supposed to budget for vacancies and emergencies. There was also rent assistance in the CARES Act.
That soon may change, however, as these funds dry up and eviction moratoriums expire. Statewide moratoriums, like California’s AB 3088 and the CDC’s nationwide eviction moratorium, end February 1, 2021, and December 31, 2020, respectively. The search for new tenants may also be challenging as landlords may use potentially stricter criteria (better credit scores, income minimums, etc.).
Unfortunately, there doesn’t appear to be any federal stimulus or assistance on the horizon any time soon. As a result, distressed residential real estate may become commonplace. However, residential real estate has gone up in price in many areas due to increased demand and diminished supply.
All this adds up to REITs being a particularly appealing route for investing in real estate during the coronavirus pandemic.
How Can I Tell if a REIT is Safe to Invest in During the Coronavirus Pandemic?
There are several ways in which you can determine how safe a REIT is, whether it’s during the coronavirus pandemic or in general. These metrics are meant to be used in conjunction with one another to paint a picture of the REIT’s financial profile and prospects.
1. Debt-to-Earnings (EBITDA)
The amount of debt a company has impacts:
- The ability to pay dividends
- Long-term success
EBITDA refers to earnings before interest, taxes, depreciation (the process of deducting expenses associated with buying and improving real estate), and amortization (the spread of a property’s cost over that property’s useful life).
EBITDA is sometimes used as an alternative profitability metric to net income (sales minus the cost of all operating expenses [this includes everything from the cost of goods sold to taxes]). This may seem complicated, but it’s not.
Simply put, EBITDA is a useful measure of a company’s ability to pay back its debts. Too much debt or debt with high interest creates a significant liability that can prove catastrophic if the economy goes south.
So, when researching REITs, all you have to do is make sure its debt-to-EBITDA is under 6x. 6x, in this case, refers to a company’s price-to-earnings multiple [P/E]. A P/E of 6x means that the stock is trading at a multiple of six times its earnings. A high P/E suggests that the company is overvalued, so the lower the P/E, the safer the bet.
You can calculate the EBITDA yourself because all the information you need is freely available on the company’s income statement and balance sheet.
There are two formulas you can use.
With the first formula, you start with the operating income.
EBITDA=operating income+depreciation and amortization
The second formula starts with the net income and adds back interest, taxes, depreciation, and amortization.
EBITDA=net profit+interest+taxes+depreciation and amortization
The two formulas can yield slightly different results depending on whether or not the companies have one-time adjustments. This can include litigation, unrealized gains or losses, repairs or maintenance, insurance claims, etc.
2. Dividend Yield
A dividend yield is a percentage that expresses the relationship between dividends and the company’s stock price. To get a company’s dividend yield, add up the past four quarterly dividends and divide that sum by the current stock price.
A higher dividend yield means you’ll get more money, but you don’t necessarily want that. A yield that’s too high could mean that the company is giving away too much of its income and might not have enough to support daily operations or strategic growth.
A company could also have a higher dividend yield because it’s distributing a greater than usual percentage of its earnings to attract more investors. Similarly, a low dividend yield could mean capital growth has taken center stage while dividend income distribution sits on the back burner.
4 to 6% is considered a good dividend yield. However, the dividend yield you calculate isn’t necessarily what the dividend yield will be in the future. Very high dividend yields, for example, are not sustainable for extended periods. For this reason, it’s more useful to know if the dividend is secure and that it’ll be paid in the future. How do you find that out? Payout ratios.
3. Payout Ratios
Payout ratios measure the percentage of a company’s earnings passed on to shareholders in the form of dividends. Relative to other stocks, REITs have higher payout ratios. Anything under 100% is considered a good investment opportunity, although REITs can get up to 90%. If you see a REIT in the 60 to 80% range, you’ve found a substantial investment that balances security and a good return. It also means the dividend yield you just calculated is a more secure investment.
Funds from Operations (FFO)
FFO is GAAP net income + depreciation and amortization – gains from property sales
Looking at the FFO will give you a more accurate picture than looking at the earnings because GAAP (generally accepted accounting principles) net income deducts depreciation and amortization. Well run real estate usually appreciates over time, which means that adding depreciation and amortization can artificially inflate the dividend payout ratio.
4. Adjusted Funds from Operations (AFFO)
FFO still isn’t accurate enough because it doesn’t account for capital expenditures (CapEx), which is the cost of maintaining the REIT assets. This includes everything from painting apartments to replacing HVAC units. You can usually find the CapEx on a REITs cash flow statement.
For this reason, you’re better off using AFFO. It gives you the actual residual cash flow. It is a better indicator of a REIT’s ability to keep paying dividends because the cost of actually maintaining the properties is included.
The formula for AFFO is FFO – CapEx.
5. Granular Asset Specifics
The assets owned by REITs aren’t nebulous or opaque; you can look into them if you want to make a more secure investment. You’ll want to examine:
- The real estate markets they’re in.
- The type or quality of their occupants.
- The class of the assets.
- The saturation of the markets in which the properties reside.
Markets can be oversaturated, with little to no demand, or in the sweet spot where demand is evergreen.
6. Credit Rating
A good credit rating is indicative of sound finances. It also lets you know that it’s cheaper for the REIT to borrow money. So, look for REITs with investment-grade credit ratings, which is BBB- or greater on the Standard & Poor’s rating. A higher credit rating can translate into a higher valuation.
What are the safest REITs to invest in during the coronavirus pandemic?
Here are three safe REITs for you to invest in, but, more importantly, for you to put to use the evaluative metrics you just learned.
1. Equity Residential (NYSE: EQR)
Equity Residential focuses on high-density residential communities in cities like New York, Boston, Seattle, and D.C. They’re consistently a safe bet because of their A-credit rate and solid financials, even in the face of coronavirus. Equity’s collection rate, which is the measure of how many tenants pay their rent, was 97% during Q2 2020.
Equity’s debt-to-EBITDA is 4.82x. They have $187 million in cash on hand, so if anything makes the economy go south, Equity will have a significant cushion to weather the storm. Its payout ratio is 66%, which is solid, and its dividend yield is 4.5%.
2. Prologis (NYSE: PLD)
Considered by many to be the top industrial REIT, Prologis owns logistics facilities in 19 countries that add up to over 963 million square feet of real estate. The company has an excellent track record and an A-credit rating. And since industrial space and fulfillment centers are in such high demand, Prologis has enjoyed stable revenues and growth.
Q2 2020 saw Prologis enjoying a 22% net rent increase and a 95.7% occupancy rate. Prologis also has 4.6 billion in liquidity and a debt-to-adjusted EBITDA of 4.17x. Its payout ratio is 52%, which is a very conservative estimate given how good its finances are.
When the stock market dipped in March, Proligis dipped as well. Since then, however, it’s grown beyond its 2020 highs. Its current dividend yield is 2.6%. While below the sweet range, this lower figure is made up of how safe of a bet your investment is.
3. American Tower Corporation (NYSE: AMT)
With annual revenues pushing $1.9 billion, American Tower Corporation (ATC) is the largest publicly traded REIT. Wireless and broadcast towers worldwide provide the company with the space that it leases. Currently, ATC’s portfolio has 181,000 communication sites.
Thanks to the coronavirus pandemic, revenues and net operating income in this sector saw significant growth. In Q2 2020, ATC alone saw a 1.2% increase in revenue, 3.2% more net income, and a 20% growth in dividends relative to the same quarter last year. The company also added 500 towers to its international markets in Q2 2020.
In June 2020, the company’s payout ratio was 53%, and it had $6.5 billion in liquidity. It had a 4.8x debt-to-EBITDA, so its finances are stable. Its dividend return is under 2%, however, which may discourage some investors. Although, security is appealing in a time of uncertainty.
Bottom Line on Investing in REITs
Equity Residential, Prologis, and American Tower Corporation may be prohibitively pricey for some investors.
Luckily, the tools you now have will allow you to study any REIT you find so that you can make investments that fit your budget.