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Top 5 Ideas For Building A Diversified REIT Portfolio

These REITs collectively create a portfolio of investments with exposure to healthcare, commercial real estate, office buildings, industrials, and mortgages/lending.

How many times have you heard the saying buy land because they're not making any more of it, seen a real estate show on T.V about flipping houses, or heard people discussing real estate investments? I know that investing in physical real estate isn't for me. I don't have the time or energy to put into that type of endeavor, nor do I want to deal with tenants. This is why I invest in Real Estate Investment Trusts (REITs). I know I am not handy, and I don't have the time to properly manage a real estate business, even if it's just renting out one property. By investing in REITs, I get many benefits from investing in real estate without the day-to-day headaches.

To be classified as a REIT, the Internal Revenue Service has specific provisions a company must comply with. To qualify as a REIT, the company must invest at least 75% of its total assets in real estate, cash, or U.S. Treasuries and earn at least 75% of gross income from rents, interest on mortgages on physical property, or real estate sales. REITs are required to pay a minimum of 90% of their taxable income to shareholders in the form of dividends. Therefore many investors plow capital into REITs as the dividend potential exceeds many other investments throughout the market.

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In the world of REITs, it's not one size fits all. There are different types of REITs by asset class then different investable sectors. REITs are generally structured as the following:

Equity REIT

Owns properties then distributes income from leases to shareholders.

Mortgage REIT

Holds mortgage notes on properties and collects principal and interest payments.

Hybrid REIT

Combination of characteristics between an Equity and Mortgage REIT

When you think about real estate, what comes to mind, a house, land, or a shopping mall? These are only some of the different sectors of the investable real estate market that an individual can access from investing in REITs. There are nine main sectors of real estate that investors can choose from:

  • Office
  • Retail
  • Industrial
  • Lodging
  • Residential
  • Healthcare
  • Self-Storage
  • Infrastructure
  • Data centers
  • Specialty

I am a fan of diversification because exposure to different investments can mitigate downside risk. I believe in building a portfolio of investments to generate income over a long period. My Top-5 REITs for building a diversified REIT portfolio are:

  • Realty Income (O)
  • Omega Healthcare Investors (OHI)
  • SL Green Realty (SLG)
  • STAG Industrial, Inc. (STAG)
  • Starwood Property Trust (STWD)

These may not be the largest yielding REITs, but collectively they create a portfolio of investments with exposure to healthcare, commercial real estate, office buildings, industrials, and mortgages/lending. At the close of the market on 6/29/21, collectively buying one share of each company would cost $248.49 and generate $12.52 in dividends before compounding, which is a forward yield of 5.04%. If I were going to start from scratch and pick five solid REITs to either start a REIT portfolio or a REIT section in a dividend portfolio, I would start with O, OHI, SLG, STAG, and STWD.

Realty Income (O)

Realty Income is part of the S&P 500 index and is one of 65 companies in the prestigious S&P 500 dividend aristocrat club. Since 1994 Realty Income has delivered a 15.2% compound annual total shareholder return while rewarding investors with a 4.4% compound annual dividend growth rate.

The bleak period of the pandemic is behind us, and commercial real estate space is still needed. Has anyone seen Walgreens, 7-Eleven, FedEx, Walmart, Speedway, CVS, or Home Depot locations close since the pandemic started? All of the ones I know of are still there, and they make up a large portion of Realty Income's top 20 clients. Overall, Realty Income has a 98% occupancy rate across their 6,600 commercial properties, spanning 56 different industries. Their top 20 clients hold 2,921 leases accounting for 51.2% of their revenue. With 5.5% of realty incomes revenue being generated from 248 leases held by Walgreens, 4.6% of their revenue coming from 7-Eleven across 431 leases, and 3.6% of its revenue coming from 41 leases held by FedEx, I am not surprised Realty Income's revenue stream wasn't dealt a crushing blow during 2020.

(Source: Realty Income)

(Source: Realty Income)

If you like dividends, Realty Income is a company to consider. Realty Income trades around $70 per share, and pre covid had briefly breached the $80 mark leaving some room left in its recovery. Realty Income pays a dividend of $2.82, which is a forward yield of roughly 4%. Realty Income is a top idea because its provided shareholders with 26 consecutive years of dividend increases granting them dividend aristocrat status while granting 94 consecutive quarterly increases. Realty Income is also a monthly dividend payer, while most companies pay quarterly. With Realty Income providing increases quarterly rather than annually and paying its dividend monthly instead of quarterly, this is one of the best investments to utilize the powers of compounding through dividend reinvestment.

(Source: Realty Income)

(Source: Realty Income)

Omega Healthcare Investors (OHI)

Omega finds itself in a unique position as the demand for their product exceeds supply making this extremely interesting. For those of you who are unfamiliar with Omega Healthcare, they are a triple net equity REIT specializing in Skilled Nursing Facilities and Assisted Living Facilities. The aging baby boomer population is expected to create a multi-decade increase in demand for skilled nursing facilities, with a 44% projected increase in adults over 65 in the next 20 years.

Omega has 954 properties across the United States and the U.K., which operates almost 97,000 beds.

Skilled Nursing Facilities provide care for post-acute care at a much higher rate than can be handled in Senior Housing or Home Health settings. This has made hospital discharges to Skilled Nursing Facility's steady, making Omega Healthcare an interesting name as they are the largest Skilled Nursing Facility focused REIT. 20.9% of Medicare fee for service hospital discharges have a Skilled Nursing Facility destination. There is a limited supply of growth in skilled nursing facilities due to regulatory restrictions that can vary state by state, creating a massive moat around the industry. There are 1.65 million certified beds across 15,600 certified facilities in the U.S. 86% of states have a moratorium on new beds or C.O.N restrictions. Of Omega's 954 properties, 78% fall in the skilled nursing segment, with 22% focused on senior living. Omega has one of the best organic tailwinds anyone can ask for, and that's the human aging process. There is a growing aging population in the U.S, which is expected to climb from 56.1 million Americans in 2020 to 80.8 million in 2040. As the year's pass, the demand for the facilities which are operated out of Omegas properties will continue to increase, providing an organic moat.

(Source: Omega Healthcare)

(Source: Omega Healthcare)

Omega Healthcare is one of my top REITs because there is no shortage when it comes to the demand its properties support, creating a great revenue stream for dividends. Omega trades around $37 per share and pays a $2.68 dividend which is a 7.21% forward yield. 7% is a high-yield opportunity compared to many equities and the best part is Omega's track record. For the past 17 years, Omega has provided consecutive dividend increases with a 5-year growth rate of 11.2%. Omega's 2020 adjusted funds from operations payout ratio was 82.4% leaving considerable room for future increases. Omegas dividend leaves little to complain about and combines the best of both worlds with long-term dividend growth and a high-yielding dividend.

(Source: Omega Healthcare)

(Source: Omega Healthcare)

SL Green Realty (SLG)

When you look at a picture of New York City or drive through the Big Apple the skyline is constructed of massive buildings. SL Green Realty is the largest owner of office real estate in New York City. SL Green's share price was decimated during the pandemic as work from home had become a reality for many, and offices either shut their doors or enforced limited capacity. Many questioned what commercial real estate would look like after the pandemic and would as much office space be needed with the rise of Zoom, Teams, and WebEx? The world is getting back to normal, and even the hardest-hit areas such as New York City have reopened for business. When it comes to commercial real estate, my preference is to focus on the largest commercial real estate market in the U.S, and that's New York City, and SL Green is the largest player in town.

SL Green holds interests in 84 buildings encompassing 37.8 million sq feet. SL Green signed 21 office leases totaling 352,752 sq feet in Q1 of 2021. With new leases consisting of Beam Suntory for 99,556 square feet at 11 Madison Avenue, for 15.0 years, a financial service firm for 26,770 square feet at One Vanderbilt Avenue for 15.0 years, and Grand Central Office Suites, LLC for 19,647 square feet at 420 Lexington Avenue, for 16.3 years a clear statement about the relevancy of office space has been made. If you look through SL Greens portfolio, you'll find some of NYC's crown jewels inside, including One Vanderbilt Avenue, One Madison Avenue, and 420 Lexington Avenue. In Q1 of 2021, SL Green collected 95.3% of their gross tenant billings, including rent and other billable expenses. Leadership at SL Green has clearly believed shares have been undervalued. The company has repurchased or redeemed a combined 1.5 million shares of its common stock and operating partnership units. SL Green has repurchased 34.1 million shares/units under it8134s $3.5 billion share repurchase plan.

In 2020 SL Green started paying its dividend monthly rather than quarterly. In Q1 of 2021, $0.3033 was paid in dividends per share, equivalent to a $3.64 annualized dividend. Currently, SL Green yields around 4.5%. I like SL Green as a core holding when building a diversified REIT portfolio because they generate large amounts of funds from operations (FFO) per share ($1.73 in Q1 2021) compared to what is paid out in dividends, and it's a direct play on NYC commercial real estate.

(Source: SL Green Website)

(Source: SL Green Website)

STAG Industrial (STAG)

Lastly, if I was going to build a diversified REIT portfolio, it would need exposure to industrials, and STAG is the REIT I would want to invest in. STAG focuses on single-tenant properties with a portfolio of 494 buildings spanning 39 states. Throughout STAG's portfolio, their properties have amassed 99.1 million square feet of rentable space. Since STAG's IPO their properties have increased from 93 to 494 while the leasable sq feet increased to 99.1 million from 14.2 million.

Industrial real estate space has increased its prestige over the years as e-commerce has increased its relevance in the retail mix. In 2020 e-commerce generated $431.65 billion in revenue and is expected to grow to $563.39 billion in 2025. As both the overall retail market and e-commerce expand, the need for warehouse space will grow with it. Some of STAG Industrials largest customers are Amazon, FedEx, and XPO Logistics. I don't see the trend of e-commerce reversing and believe the pandemic has created a permanent increase in demand as people have become accustomed to ordering items online and directing their time to other aspects of life.

STAG is a cornerstone in my REIT foundation because it has sequentially increased its revenue and FFO YoY over the past decade while benefiting from a continuous trend of increased demand for industrial space. While STAG is at the lower end of the spectrum for dividends in the REIT space, its dividend has increased YoY since its IPO. Over the past decade, STAG has increased its annual dividend from $0.7257 to $1.44. STAG also paid its shareholders a special dividend in 2018. I love being invested in Amazon's landlord and collecting a dividend from it without having to do any of the work.

(Source: STAG)

(Source: STAG)

Starwood Property Trust (STWD)

Mr. Sternlicht eats, sleeps, and breaths real estate as he is the Chairman & CEO of Starwood Capital Group, a private alternative investment firm focused on global real estate, hotel management, and energy. Starwood Property Trust is a hybrid mortgage REIT led by Barry Sternlicht. Mr. Sternlicht is my favorite CEO in the REIT sector and, for the past 29 years, has structured investments with an asset value of over $110 billion. If that wasn't enough, Mr. Sternlicht serves as Chairman of Starwood Property Trust and is a Senior Advisor of Invitation Homes, the largest publicly traded investor, owner, and operator of single-family homes in the U.S.

Starwood Property Trust has deployed over $63 billion of capital since its inception and manages a current portfolio of over $17 billion across its business segments:

  • Commercial and Residential Lending
  • Infrastructure Lending
  • Investing and Servicing
  • Property business segments

Today Starwood Property Trust trades at 5-year highs, and for a good reason. In March and April of 2020, the future was uncertain and panic set in as American's experienced lockdowns for the first time in their lives. Real estate was one of the hardest-hit sectors as the World Health Organization classified COVID-19 as a global pandemic. Senior leadership built Starwood from the ground up to withstand market volatility and to deliver for shareholders throughout various market cycles. Their business model held up through the volatility, and unlike others, Starwood made over $3 billion in accretive investments across its four business segments. In many cases, chaos creates some of the best opportunities. I believe the investments Starwood made throughout its business segments during the chaos of the pandemic will provide significant growth opportunities in the years to come.

Starwood's dividend has been reliable from the financial crisis to the pandemic, providing investors with large amounts of income. Through the volatility of 2020, shareholders of Starwood received their $1.92 dividend per share while other REITs were forced to reduce or cut their dividends in their entirety. This is the 8th consecutive year where Starwood will pay an annual dividend of $1.92 per share. Normally I look for companies that grow their dividend, but Starwood is one of the companies I am happy to make an exception for. Excluding the pandemic dip, Starwood's dividend yield has fluctuated between 7–10%. Starwood's stable, high-yielding dividend has provided significant income for shareholders over the years, and while increases are always nice, it's been large enough to feast on.

(Source: Steven Fiorillo) (Data Source: Starwood Property Trust)

(Source: Steven Fiorillo) (Data Source: Starwood Property Trust)

Generating monthly income from REITs through dividends

Investing in Stag Industrials, Starwood, SL Green, Omega Healthcare, and Realty Income creates a diversified REIT portfolio with exposure across several aspects of real estate. At the market close on 6/29/21 purchasing one share of each company would cost $248.49. This investment would generate $12.52 in annual dividend income while creating an overall yield of 5.04%. The combination of these five companies would generate 44 annual dividends as SL Green, STAG and Realty Income pay monthly dividends.

If you like investing in dividend-producing equitis like I do then you probably have some REITs in your portfolio. There are many types of REITs for investors to choose from small to large caps, low to high yields, by asset class and sectors. These are my top five building blocks for a diversified REIT portfolio, covering numerous sectors and generating sustainable dividend income.

(Source: TD)

(Source: TD)

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