Higher interest rates in recent years have had a meaningful effect on the commercial real estate sector. They have increased borrowing costs and weighed on property values. Those headwinds have caused shares of many real estate investment trusts (REITs) to decline in value.
With the Federal Reserve recently starting to cut rates (and signaling that more reductions are forthcoming), interest rates are shifting from a headwind to a tailwind for the REIT sector. Because of that, buying REITs looks like a no-brainer right now. Three top ones to buy are Realty Income(NYSE: O), W. P. Carey(NYSE: WPC), and Extra Space Storage(NYSE: EXR).
A consistent grower
Realty Income is as consistent as they come. The REIT has increased its dividend every year since it came public three decades ago. It has raised its payment 127 times during that period, including for the last 108 quarters in a row.
The company's monthly dividend currently yields nearly 5%, which is several times higher than the S&P 500's dividend yield (less than 1.5%). One factor driving its high yield is that its stock price currently sits about 15% below its peak price from a few years ago, before interest rates started rising. At its current rate, the REIT could produce almost $50 of annual dividend income from a $1,000 investment.
That income stream should rise steadily in the future. Realty Income expects its adjusted funds from operations (FFO) to grow at a 4% to 5% annual rate, driven by rising rental income and accretive acquisitions. That should support a similar growth rate in its dividend. Add its current yield to its growth rate, and Realty Income could produce a double-digit annual total return, with additional upside potential as its stock price continues to recover.
Rebuilding even stronger
W. P. Carey had delivered a quarter-century of annual dividend growth until last year. However, the diversified REIT opted to accelerate its exit from the office sector by spinning off the bulk of its office portfolio while selling the remaining properties. In doing so, it also decided to reset its dividend to reflect its lower income and desire for a more conservative dividend payout ratio.
Even with that strategic reset, W. P. Carey still offers a very enticing dividend that currently yields nearly 6% (due largely to the more than 30% slide in the stock price from its peak before rates began rising). The REIT has already started rebuilding that payout, increasing it every quarter this year.
W. P. Carey has also started rebuilding its portfolio. It's focusing on properties with better long-term growth fundamentals than the office sector, like industrial real estate. It has acquired several industrial properties this year, which will help grow its adjusted FFO. As its cash flow grows, the REIT will be able to continue increasing its high-yielding dividend. That growth, along with an appreciating stock price as the real estate market recovers, could enable W. P. Carey to produce robust returns from here.
A leader in its space
Extra Space Storage is a leading self-storage REIT. It has grown steadily over the years by consolidating the self-storage sector while benefiting from steady demand growth as more people store their extra stuff. That combination of factors has helped drive outsized total returns over the past decade. Extra Space has delivered the third-best returns in the REIT sector at over 300%.
Extra Space's industry-leading third-party management platform is a big driver of its outsized performance. The REIT manages a growing portfolio of self-storage properties for other owners, which generates management and insurance income. It also supplies the REIT with a steady stream of low-risk acquisition opportunities when those owners are ready to sell.
The company is in an excellent position to continue growing shareholder value in the future. Extra Space pays a high-yielding (nearly 4%) and growing dividend. That payout should continue to rise. Demand for self-storage space is growing, which should continue increasing its rental income. In addition, the REIT has a very strong balance sheet, which gives it lots of flexibility to continue expanding its self-storage portfolio. With shares currently down more than 25% from their peak before interest rates started rising, Extra Space could deliver extra-large returns as the REIT sector recovers.
REITs are no-brainer investments right now
Shares of top-quality REITs like Realty Income, W. P. Carey, and Extra Space Storage have lost value since the Fed started raising rates a few years ago. With that headwind shifting to a tailwind, their stock prices should begin recovering. Add in their growing dividends, and these REITs look like smart buys right now.
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Matt DiLallo has positions in Realty Income and W.P. Carey. The Motley Fool has positions in and recommends Realty Income. The Motley Fool recommends Extra Space Storage. The Motley Fool has a disclosure policy.
