NEW YORK (Real Money Pro) -- The significant rise in interest rates this year is helping buoy the financial sector, as banks' net interest margins improve and returns on insurers' portfolios get a boost.
It's possible to view the flip side of that move and consider the negative headwind that higher interest rates have had on a variety of high-yield sectors. Some decent bargains are emerging for investors searching for yield.
First off, interest rates won't spike much from here. The yield on the 10-year Treasury bond will have a difficult time crossing and maintaining the 2.5% level in the near term. European and Japanese central banks are still fully engaged in providing additional liquidity and it's hard to see another leg up being triggered by robust global economic growth.
Utilities, after performing well in 2014, have pulled back about 10% thus far in 2015. There aren't, however, see many bargains in the sector, which already looked extended on a valuation basis before its rise in 2014. (I am heavily underweight in utilities.)
Real estate investment trusts (or REITs) have also been under pressure, but their prospects are better. They should do fine once interest rates stabilize at or nearly at current levels. In particular, the lodging space is desirable as demand continues to grow faster than supply, producing solid mid- to single-digit revenue per available room (RevPAR) as well as improved occupancy levels.
Summit has recently posted double-digit growth in annual RevPar and will see RevPar gains of 6% to 8% going forward. The Texas-based REIT also announced today it is selling 26 of its lower-performing hotels, representing about 20% of its overall rooms.
It will reinvest the proceeds to add more lucrative properties and renovate better-performing hotels. This seems achievable given Summit's recent track record and the fact the hotels to be sold had a collective RevPAR 20% below that of the overall portfolio.
Summit should continue to be able to produce annual growth in funds from operations (or FFO) of 10% to 15% over the next few years. The stock recently traded at 12 times this year's projected FFO per share and yields 3.5%.
Shares of Chatham have doubled since I first purchased a stake in this well-run lodging REIT three years ago -- even after a recent 10% pullback. The REIT, based in Florida, just continues to deliver mid to high single-digit RevPAR growth.
Thanks to a large acquisition in 2014, Chatham's FFO growth is impressive. After posting funds from operations of $1.91 per share in 2014, the trust looks set to deliver more than $2.40 per share in 2015 and projections call for higher than $2.80 in 2016. The stock recently changed hands at 11 times this year's expected FFO and yields 4.3%.
Both REITs are squarely situated in the mid tier of the market making them less vulnerable to the strong dollar, which has curtailed tourism somewhat in major destination cities, especially at the high end of the scale.
Investors looking to use the recent declines triggered by higher interest rates to add to their income portfolio certainly could to do worse than selecting these two lodging REITs.