Jefferies Still Likes Top Yielding REITs: 4 to Buy Now With Yields Up to 7%

September 1, 2016 by 247lee

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We have all heard it over and over: the bond proxy arena is way overbought and could be vulnerable to rate increases. The fact of the matter is that while utilities and telecoms are way overbought, and overweighted by many portfolio managers, real estate investment trusts (REITs), according to Jefferies, are not. In fact, the average manager is 3.3% underweight REITs, and each 1% increase in weight represents $46.7 billion in buying pressure. With real estate now its own sector, based on the S&P Global Industry Classification Standard, managers may be forced to buy.

A new Jefferies report, while acknowledging that REITs are pricey, sees continued low rates and the new industry classification as a significant tailwind for the group. It also points out that since 1979 the group has gained a very solid gain of 12.9% annually, based on total return, which is much better than the Russell 3000’s rise of 11.6%, and even better than the small caps.

We screened the stocks rated Buy in the firm’s REIT coverage universe and found four top yielding names that make sense for income accounts.

Digital Realty Trust

This stock may be a solid play for more conservative accounts. Digital Realty Trust Inc. (NYSE: DLR) supports the data center and colocation strategies of more than 600 firms across its secure, network-rich portfolio of data centers located throughout North America, Europe, Asia and Australia.

Digital Realty’s clients include domestic and international companies of all sizes, ranging from financial services, cloud and information technology services, to manufacturing, energy, gaming, life sciences and consumer products. The company rates highly with portfolio managers, as a large part of the market cap of the company is in institutional hands.

The company reported strong second-quarter numbers that were ahead of expectations. Last year, Digital Realty bought Telx, a national provider of data center colocation, interconnection and cloud enablement solutions back in a $1.89 billion deal, and the acquisition is expected to close this month. The combination is expected to double Digital Realty’s footprint in the rapidly growing colocation business, as well as to provide Digital Realty customers access to a leading interconnection platform.

Digital Realty investors are paid a 3.55% distribution. The Jefferies price target for the stock is $104, and the Wall Street consensus target is $108.29. The shares closed Wednesday at $99.09.

Extra Space Storage

This top REIT resides on the analyst’s Top Picks list. Extra Space Storage Inc. (NYSE: EXR) owns or operates 1,088 self-storage properties in 35 states, Washington, D.C., and Puerto Rico. Its properties comprise approximately 725,000 units and approximately 80.4 million square feet of rentable storage space, offering customers conveniently located and secure storage solutions across the country, including boat storage, RV storage and business storage. The company is the second largest owner or operator of self-storage properties in the United States, and it is the largest self-storage management company in the country.

Wall Street analysts note that management teams at the storage REITs see an additional 0.5% to 1.5% of occupancy gains in 2016. While that may seem small, that is an immediate increase to top and bottom line numbers. According to other Wall Street analysts, net rents are up nicely year over year, driven mostly by Extra Space and other sector leaders. This could position the industry well for the upcoming fall leasing season.

Extra Space Storage unitholders receive a 3.87% distribution. The $105 Jefferies price target is well above the consensus target of $93.73. Shares closed most recently at $80.55.

Omega Healthcare

This company is in one of the fastest growing arenas of the REIT industry. Omega Healthcare Investors Inc. (NYSE: OHI) is a skilled nursing REIT that owns over 900 health care properties, principally skilled nursing facilities. These assets are currently leased to 83 third-party operators across 42 states.

In the research report, the analysts cited numerous reasons for liking the company:

1) Omega’s tenants generally have lower exposure to Medicare which is where the funding pressure is; 2) Only 7.6% of revenues come from tenants with rent coverage below 1.0x, 3) The company has some of the highest rent coverage ratios in the SNF-focused Healthcare REIT sector, and 4) The tenant base is well diversified. The current stock price implies that the majority of the $110 million of annual rents from tenants with an EBITDA rent coverage below 1.2x is at risk – and our analysis suggests this is too dire of a scenario.

Shareholders are paid a very strong 6.63% distribution. Jefferies has a $38 price target, and the consensus target is $36.38. Shares closed most recently at $36.20.

Senior Housing Properties

This is another health care REIT paying a big distribution. Senior Housing Properties Trust (NYSE: SNH) is an externally managed trust that has the majority of its assets under management primarily in independent living (29%) and medical office buildings (41%), along with investments in assisted living (24%), skilled nursing facilities (3%) and hospitals/specialty (3%). As of the first quarter this year, the company owned 428 properties in 38 states and Washington, D.C.

Hedge funds have piled into shares of the company since the beginning of the year. In fact, 16 of them owned shares of Senior Housing Properties Trust at the end of the second quarter, up by five funds from the end of the first quarter. Although some analysts are concerned about potential oversupply in the senior living sector, the company’s management has executed very well, and Senior Housing Properties isn’t very leveraged versus its net operating income.

Shareholders are paid a huge 7.0% distribution. The $19 Jefferies price target could be poised to be raised. The consensus target is $20.10. The stock closed above both levels Wednesday at $22.34.

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It is important to remember that REIT distributions can contain return of capital. With the Federal Reserve very reluctant to raise rates, and even if it does the increases will be tiny, these all make good sense for growth and income accounts.