Today we’re going to discuss the secret to double-digit annual returns every year, forever, with secure real estate investment trusts (REITs).
We income-seekers love REITs for a simple reason: high dividends! The typical REIT yields twice as much as the average S&P 500 stock. That’s mainly because these trusts receive reliable recurring revenue—they simply collect the checks that roll in every month, take out enough to maintain the buildings and then send the rest to us.
And some REIT dividends are true standouts in today’s low-yield world, like the 5.5% thrown off by warehouse landlord W.P. Carey (NYSE:WPC). WPC is a two-time winner in our Contrarian Income Report service’s portfolio, having returned a tidy 28% in dividends and gains in 12 months in its first tour and a steady 16% return in 14 months (and counting) in its second.
Recurring Revenue—A Killer Edge In Uncertain Times
It’s tough to overstate the advantage REITs’ recurring revenue gives them (and us!): where firms like Ford Motor Company (NYSE:F) have to start from scratch every quarter, keeping current customers happy while winning others over one by one from nimble competitors like Tesla (NASDAQ:TSLA), our REITs sit back and pocket rent checks that roll in like clockwork, mostly from tenants who signed on years earlier.
It’s a proven model we can rely on. And that’s why WPC’s dividend has a lovely upward arc (with special dividends thrown in for good measure), while Ford’s volatile sales translate into a jittery payout that finally conked out in 2020.
WPC’s “Recurring” Payout Dusts Ford’s Clunker
And if you buy REITs with two other advantages—long-term leases (ideally with yearly escalator clauses) and high occupancy rates—you get a dividend that’s largely insulated from competitive pressures (not to mention rising interest rates).
There’s one more factor that powers our REIT dividends: these trusts pay zero corporate taxes. With no taxes to pay (as long as they hand out 90% of their taxable income to us as dividends), REITs are left with more money to fuel their payouts.
But even with these advantages, we still need to be selective. We’ll lock in our forever cash flows by zeroing in on REITs with three strengths (besides top-quality properties tenants can’t live without):
- Growing dividends, which tend to pull a company’s share price higher. We’ll see this “set-your-watch-to-it” phenomenon play out in dramatic fashion a little further on.
- Rising funds from operations (FFO for short). This is the main REIT performance figure, and we want to see growing FFO (powered by increasing rents and in-demand properties) to back our rising dividend—and our upside.
- A safe payout ratio: With most stocks, I demand that no more than 50% of cash flow be used to support the payout. But REITs are different—due to their predictable recurring revenue, ratios up to 90% can be sustainable.
WPC ticks those boxes: its payout growth is supported by rising FFO (up 5% year-over-year in the second quarter) that’s backstopped by its 98% occupancy rate and rent escalators: of its total leases, 99% include contractual rent hikes, with 60% linked to the consumer price index, giving WPC a nice inflation hedge.
WPC is far from alone: there are plenty of other REITs successfully transforming recurring—and rising—FFO into rising dividends (and share prices!).
Consider self-storage REIT Extra Space Storage (NYSE:EXR), which is raking in cash as people load up on consumer goods. ExtraSpace yields 2.7%, which is already 100% more than the average S&P 500 stock pays, but has boosted its payout a phenomenal 792% in the last decade. In other words, if you bought back then, you’d be raking in an incredible 22.4% yield on your original buy now.
We can clearly see EXR’s rising payout pulling its share price higher—the pattern is unmistakable:
EXR’s Recurring Revenue Drives Explosive Payout (And Price) Growth
ExtraSpace can easily keep this roll going, with its high 97% occupancy rate and its dividend accounting for a reasonable 76% of forecast 2021 FFO. Plus, management expects the REIT’s FFO to surge 24% this year.
The kicker: the stock is perfectly positioned to gain as supply chain kinks get worked out, giving consumers more products to buy—and store.
Disclosure: Brett Owens and Michael Foster are contrarian income investors who look for undervalued stocks/funds across the U.S. markets. Click here to learn how to profit from their strategies in the latest report, "7 Great Dividend Growth Stocks for a Secure Retirement."