5 High-Yielding REITs for Dividend Investors

If you're a small-time landlord, real estate can be a ton of work, with an uncertain payoff. But stick with real estate investment trusts and you're likely to be rewarded. Over the past 15 years, property-owning REITs have generated an average annual total return of 11.2% a year, doubling the 5.5% annualized gain of Standard & Poor's 500-stock index.

As giant landlords, REITs (rhymes with treats) own everything from apartment buildings to offices, malls, warehouses and hotels. Regardless of what they hold, they're required to shell out at least 90% of taxable income to shareholders. That makes them gravy trains for dividends. REIT stocks today yield 3.8%, on average, well above the 2.2% yield of the S&P 500.

REITs could get a lift, too, from a new buying wave by mutual funds. Until now, S&P has classified REITs as financial stocks, along with banks, brokers and other such firms. That was always an odd fit for real estate developers and landlords. But starting in September, two big index providers--MSCI and S&P Dow Jones Indices--plan to carve out REITs and real estate operating companies into a stand-alone sector. Real estate will be the eighth-largest group in the S&P 500--bigger than materials, telecommunications and utilities. Many mutual funds ignore REITs, and the change could prompt more interest in the stocks, propping up the sector.

Of course, REITs could take some lumps, too. After returning 10.6% in the past year, the stocks have edged into pricey territory, trading, on average, at 103% of their net asset values, slightly above their historical average. REIT stocks could face pressure, moreover, if long-term interest rates climb. That would make REIT yields less attractive than bonds and other fixed-income investments.

Yet Kiplinger's doesn't expect big rate hikes over the coming year, partly because inflation expectations remain muted. REITs continue to offer yields that are greater than those of investment-grade bonds. And their payouts are likely to climb more than those of utilities or other income investments, making them a better bet long term.

Below are five REITs we like for their dividend yields, growth prospects and reasonable share prices. Note that price-earnings ratios are based on estimated year-ahead funds from operations, a common REIT measure that represents net income plus depreciation expenses. (Returns, prices and related data are through June 10).

Gaming and Leisure Properties

Visit a casino and you'll probably lose money at the slot machines or table games. A better bet: Gaming and Leisure Properties (symbol GLPI, $34.07, P/E ratio 11, yield 6.4%). The REIT recently bought 14 casinos from Pinnacle Entertainment in a deal worth about $5 billion. Gaming issued $1.1 billion worth of stock to help finance the acquisition, and it now carries a hefty $4.9 billion in long-term debt on its balance sheet.

Overall, though, the purchase is a good deal for shareholders. With revenue now flowing from 35 casino and hotel properties in 14 states, Gaming and Leisure should generate ample cash to fund its dividend and raise it as rental income climbs gradually. Jeffrey Kolitch, manager of Baron Real Estate Fund (BREFX), figures that within a year the firm will bump its annual payout from $2.24 per share to $2.45. At 11 times estimated FFO, the stock trades well below the average of 18 for all property-owning REITs. The shares look "mispriced," says Kolitch, who sees the stock hitting $41 over the next year.

Host Hotels & Resorts

Lodging REITs such as Host Hotels (HST, $15.40, P/E 9, yield 5.2%) have hit the bargain bin. Investors worry that hotel revenues, after climbing for years, appear to be peaking, and they fear that competition from Airbnb and other home-rental websites will cut into occupancy rates and hotel profits. All this has taken a toll on Host's stock, which has sunk 17% over the past year. Yet at just 9 times projected FFO, the shares look compelling.

The largest U.S. lodging REIT, Host owns 92 upscale hotels and resorts, including luxury properties such as the Hyatt Regency Maui Resort and Spa, and the W Hotel in New York City's Union Square. Demand for its hotels, which other companies manage, appears to be healthy, with average revenue per available room (a common lodging REIT measure) climbing 3.6% in the first quarter compared with the same period in 2015. For Host's core clientele--upscale business and leisure travelers--competition from the likes of Airbnb isn't likely to pose a major threat.

Granted, Host's revenues would slump if the economy weakens and business travelers spend less on lodging. Yet that would likely be a temporary setback. Host's balance sheet looks strong, with a manageable debt level relative to its income. Its dividend should be secure, too, says Mike Underhill, manager of RidgeWorth Capital Innovations Global Resources and Infrastructure =Fund (INNNX). Over the next year, he expects the stock to hit $19.

Realty Income

Most REITs pay quarterly dividends, but Realty (O, $64.30, P/E 22, 3.5%) shells out cash monthly, paying about 20 cents per share like clockwork. That income arises from Realty's vast collection of properties: 4,615 buildings, leased mainly to big retailers such as Walgreens and Dollar General. These firms sign long-term triple-net, or NNN, leases with Realty, requiring them to pay for all property taxes, maintenance and insurance.

Although Realty isn't a high-growth REIT, it's a solid earner. The firm has paid dividends for a stunning 550 consecutive months. Its 98% property occupancy rate has never slipped below 96%, and revenues are climbing thanks to rent increases built into leases and a steady stream of property acquisitions. Realty expects FFO to rise by as much as 4.3% this year. That should support more growth in the dividend, which Realty has increased at an annualized rate of 4.7% since going public in 1994.

At 22 times FFO, Realty is one of the pricier REITs, and its stock may stay flat in the near term. But stick with it: You can scoop up steady monthly dividends while waiting for the shares to edge higher over the long run.

Sovran Self Storage

Sales are going strong for Sovran (SSS, $101.91, P/E 18, 3.1%), a self-storage REIT that owns more than 550 properties in 26 states under the Uncle Bob's brand. The firm is landing customers with its modernized, climate-controlled facilities, many of which are located in high-traffic urban and suburban areas. Occupancy hit 90.5% in the first quarter, up one percentage point from a year earlier. Sovran is also expanding with a $1.3 billion deal, announced in April, to acquire 84 properties from LifeStorage, a privately held firm whose buildings generate higher average rents per square foot than Sovran's real estate.

Sovran issued 6.9 million shares of stock to finance the LifeStorage deal. That could dilute FFO per share in the near term and lower the REIT's net asset value per share (the estimated market value of Sovran's properties, less outstanding debt). Still, analysts see Sovran's revenue jumping a healthy 17% this year, to $430 million. Sovran recently hiked its annual dividend rate by 11.8%, to $3.80 per share, and it ramped up its 2016 FFO forecast to as much as $5.55 per share, up 14.4% from 2015. Although the stock looks pricey at 18 times FFO, it has room to climb. Bank of America Merrill Lynch, which rates the stock a buy, expects the shares to hit $120 a year from now.

STAG Industrial

Leasing warehouses to auto-parts makers and other industrial firms, STAG (STAG, $22.72, P/E 14, 6%) has been snapping up properties since going public in 2011, amassing 223 buildings with more than 40 million square feet of space. Demand for warehouses should stay healthy as long as the economy keeps expanding. And STAG aims to keep up its growth, planning to acquire or develop $1.7 billion worth of properties over the next few years.

Spending heavily to buy warehouses has pushed STAG's debt load to 36% of its property values, according to brokerage firm Baird. That's slightly above average for industrial REITs. But it isn't excessive relative to STAG's income, and it shouldn't prevent the firm from acquiring more real estate. Meanwhile, rental income is rolling in. First-quarter FFO rose by 11.4% from the same period a year earlier, and STAG generates plenty of cash to support its dividend, which, Baird says, it should be able to hike at an annual clip of 7% to 8%. Trading about 20% below STAG's net asset value of $28.30 a share, the stock looks like a good value, says Baird, which expects it to hit $24 over the next year.

Top funds for real estate stocks

If you prefer to buy real estate investment trusts through a fund, you have plenty of choices. One good one is Manning & Napier Real Estate S (symbol MNREX), which holds 56 real estate stocks--mainly REITs such as mall owner Simon Property Group and storage firm Prologis. Over the past five years through June 10, the fund returned 12.4% annualized, beating 93% of its peers. One drawback: annual fees, at 1.09%, are above average.

Fidelity Real Estate Investment (FRESX) returned 12.5% annualized over the past five years. Veteran manager Steve Buller looks for REITs that offer growth at a reasonable price and says he's emphasizing health care and triple-net-lease REITs these days. The fund yields 2.5% and costs 0.78% in annual expenses.

If you simply want to track the REIT market, buy Schwab U.S. REIT ETF (SCHH), an exchange-traded fund that follows the Dow Jones U.S. Select REIT index, a basket of 96 stocks weighted by market value. Yielding 3.1%, the ETF pays out more than most mutual funds, thanks to a rock-bottom expense ratio of 0.07%.

For ultra-high income, consider iShares Mortgage Real Estate Capped ETF (REM). The fund, which yields 11.0%, invests in mortgage REITs--firms that own real-estate-backed loans. Mortgage REITs could tumble if short-term interest rates climb sharply while long-term rates stay flat or decline (squeezing the REIT's profit margins). But that looks unlikely over the next year. Annual expenses are 0.48%.

Daren Fonda is an associate editor at Kiplinger.