The financial markets are focusing on the implications of a possible Greek default and the prospect of slower economic growth. Given that less-than-positive outlook, it could be time to reconsider real estate investment trusts (REITs) if you’re not using them already in client portfolios.
Philip J. Martin, a REIT strategist with Morningstar Inc., in Chicago, says REITs have outperformed other asset classes in previous slowdowns and he believes they are poised to repeat that performance.
“Right now equity REIT FFO (funds from operations) dividend-payout ratios are averaging about 69%,” said Martin, in an interview. “That’s near the historical low of 66%. So even in a slow economic growth environment, they have enough cushion in their cash flows to provide some pretty significant dividend growth.
"We believe they have the ability to maintain their historical average dividend growth of 5% even in a slow economic environment. There are some good things here about REITs where they’re well positioned fundamentally from a cash flow and balance sheet standpoint," the strategist explained. "We’re seeing some fundamental improvement, as well, so they should be pretty competitive investments over the next several years.”
Martin believes that investors concerned with a slowing economy or other headwinds such as rising interest rates and inflation should focus on REIT-sectors that are less cyclical and “cater to need-driven industries.”
He cites retail shopping centers anchored by stores that serve everyday consumer needs as an example. Examples of these anchors include Publix supermarkets and mid-sized tenants, such as a T.J. Maxx, Marshalls and Target.
The retail REITs Martin suggests focusing on include Realty Income (O) and Federal Realty Trust (FRT). “Many of FRT’s shopping centers are anchored by either the leading grocer in a market or a value retailer,” he said. “That, again, is serving everyday consumer needs and focused on value. They benefit from some very, very strong locations in urban infill markets. So, there’s very little competition from new development projects.”
REITs with health-care companies and labs as tenants are another defensive sector, because health care is less tied to the economic cycle. Health-care and lab-space REITs cater to the large biotech and pharma companies like GlaxoSmithKline, Novartis and Johnson & Johnson.