REIT Investing: Necessity is the Mother of Invention

NEW YORK (TheStreet) -- Investors know that companies that provide sharper product differentiation enjoy a greater advantage and, in turn, provide a higher degree of sustainability. Of course there are plenty of alternative income products on the market today and the most successful companies have been able to achieve consistency by utilizing the most innovative forms of risk-control.

But what does innovation have to do with consistent income? After all, we have all seen (AAPL) Apple's ( AAPL) highly innovative platform bounce around and drop by 36% wiping out around $225 billion in market. Ahh, but wait. Apple's volatility doesn't make up for the meager 2.4% dividend yield -- hardly a dividend champion.

And of course Facebook ( FB) with its highly innovative platform pays no dividend at all. Ouch! So how does a fixed-income investor find an alternative that provides durable dividends that are driven by innovatively crafted products?

REITs Provide a True Measure of Dividend Repeatability

There are plenty of alternative income options today and the real estate investment trusts provide a uniquely sustainable platform where consistency is measured by extraordinary risk control. Accordingly, the success or failure of a REIT is directly correlated to providing strong sources of differentiation yielding greater strategic advantage. Chris Zook, co-author of "Repeatability: Building Enduring Businesses for a World of Constant Change," explains:
Differentiation is the essence of strategy, the prime source of competitive advantage. You earn money not just by performing a valuable task but by being different from your competitors in a manner that lets you serve your core customers better and more profitably.

We all know REITs are a unique asset class. The primary attraction being the fact that there are no options for companies to pay, or not to pay, a dividend, since by law, REITs are forced to pay out at least 90% of their otherwise taxable income. The dividends that REIT investors receive out of earnings haven't been reduced by taxes at the corporate level, making REITs tax-efficient conduits for real estate income. Simply said, REITs are forced to do so to retain their REIT status.

Find a REIT that has a Highly Innovative Operating Platform

Today we are seeing an evolution in REITs in which companies that were once just landlords are now becoming more than that. We have found that to remain truly competitive REITs must be strategically-aligned risk-managers where the companies demonstrate both sound shareholder value and tenant value. In other words, REITs today must make innovation a core attribute.

I just returned from a data center conference in New York City. While there, I learned a lot about the demand for "cloud" space and the durability of the highly innovative data sector industry. It was there that I discovered the extraordinary demand for cloud storage and the fundamentals that make the asset sector so desirable.

One of my favorite data sector REITs is Digital Realty ( DLR). With a market cap of around $8.67 billion, Digital is the largest data sector in a class that includes CyrusOne ( CONE), CoreSite Realty ( COR) and DuPont Fabros ( DFT). Digital's current price is $67.66 and the REIT has the highest dividend yield (4.61%) in the sector. Innovation pays off! Digital has increased its dividend by 37% in 2010, 35% in 2011 and 7% in 2012.

Digital is trading around 20% below its 52-week high of $80.59 and the P/FFO of 13.3 makes the San Francisco-based REIT an attractive buy.

Another innovative REIT I really like is Extra Space Storage ( EXR). The Salt-Lake City REIT is second in size to Public Storage ( PSA); however, the innovation is best to none. For the $4.2 billion (market cap) REIT, "innovation is anything, but business as usual."

Guiding the 900 property self-storage chain is Spencer Kirk, a veteran of innovation. The former chairman and CEO of Megahertz grew his previous business from a basement operation to become the leading supplier of solution-oriented mobile data communications products. Kirk has since been a visionary leader in building out a highly innovative self-storage brand.

Extra Space's innovative management team recently announced FFO of 43 cents per diluted share, resulting in 23% FFO growth compared to the fourth quarter of 2011. In addition, the company reported that it has increased same-store revenue and net operating income by 6.5% and 8.5%, respectively, compared to the same period in 2011. Also, the company increased same-store occupancy by 170 basis points to 88.6% at Dec. 31, 2012, compared to 86.9% as of Dec. 31, 2011

Shares are somewhat expensive today so I would wait on a dip -- my target $32.00. The current dividend yield is 2.67% and the moderately high P/FFO multiple is 22.5.

Finally, one of my favorite REIT innovator is Tanger Factory Outlets ( SKT). What makes Tanger especially unique is the supported desktop/tablet site and the mobile site developed by the "pure-play" outlet REIT.

Google predicts that at some point in 2013, more people will access websites from mobile devices than from desktops. Almost everyone these days wants a mobile version of their website. It's practically essential after all: one design for the BlackBerry, another for the iPhone, the iPad, netbook, Kindle -- and all screen resolutions must be compatible, too.

In the field of Web design and development, Tanger has quickly arrived to the point of being unable to keep up with the endless new resolutions and devices. For many websites, creating a website version for each resolution and new device would be impossible, or at least impractical.

As the user switches from their laptop to iPad, the website should automatically switch to accommodate for resolution, image size and scripting abilities. In other words, the website should have the technology to automatically respond to the user's preferences. This eliminates the need for a different design and development phase for each new gadget on the market.

Tanger, with a market cap of around $3.33 billion, is headquartered in Greensboro, N.C., and the outlet REIT currently operates and owns, or has an ownership interest in, a portfolio of 43 upscale outlet shopping centers in 26 states coast to coast and in Canada (12.9 million square feet).

Tanger pays a current dividend yield of 2.37% and has managed to pay and increase dividends for 19 years in a row. Clearly, Tanger has a talent for innovation and more importantly the company has a track record for rewarding shareholders -- 22.79% year-over-year total return.

Plato said, "Necessity is the mother of invention." For REITs, that necessity is the forced dividends that provide investors with the most consistent and durable forms of income. Conversely, REIT investors today are demanding high-quality income and the best REITs will provide the most enduring differentiation. That sums it up in a word: Innovation.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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