Most investors view a real estate investment trust, or REIT, as a safe investment. These companies typically generate stable rental income, enabling them to pay out attractive dividends.
However, not all REIT stocks are safe investments. Many have had to reduce or suspend their dividend payments during market downturns because they didn't have enough financial flexibility to maintain them. Some have put themselves in such poor financial positions that they've struggled to survive.
Because of that, an investor needs to carefully consider the safety of a REIT before buying shares. Here's a look at the hallmarks of the safest REITs as well as three top ones to buy right now.
What makes a REIT safe?
The safest REITs share many common characteristics. Three factors stand out as being important to dividend safety:
- An investment-grade credit rating backed by low leverage metrics. Debt financing is crucial in real estate. It's much easier to access funding with lower interest rates if a REIT has an investment-grade credit rating backed by low leverage, such as a debt-to-EBITDA ratio of less than 6.0 times. The higher the credit rating, and lower the leverage ratio, the safer the REIT.
- A conservative dividend payout ratio. REITs must distribute at least 90% of their net income to remain compliant with IRS regulations. However, many pay more than 100% of their taxable income because they generate more cash flow -- measured by metrics like funds from operations, or FFO -- than net income because of depreciation. REITs still need to keep their FFO payout ratio to a conservative level, ideally less than 80%.
- A high-quality commercial real estate portfolio leased to credit-worthy tenants. Rental payments are the lifeblood of REIT dividends. Because of that, REITs need to own properties with high rental demand and lease their space to tenants that can afford to pay their rents.
REITs that boast having all three of these characteristics will be much safer than rivals lacking one or more of these traits. Because of that, they should pay a secure dividend yield while also offering consistent dividend growth.
Safe REITs to buy now
This year has demonstrated the importance of investing in safe REITs. Many riskier REITs had to reduce or suspend their dividends this year because of the impact of COVID-19, while safer ones were able to maintain their payouts. Three of these standout REITs are Equity Residential (NYSE: EQR), Prologis (NYSE: PLD), and Public Storage (NYSE: PSA).
Residential REIT Equity Residential stands out as one of the safest REITs in the sector for several reasons. Topping that list is that it has one of the strongest balance sheets in the industry thanks to its A-rated credit and a conservative leverage ratio of 5.1 times debt-to-EBITDAre, which also includes things like gains or losses on asset sales and any asset impairment charges. The company also had more than $2.2 billion of liquidity -- cash and available credit -- giving it lots of financial flexibility.
Equity Residential complements its rock-solid balance sheet with a conservative dividend payout ratio that typically averages around 65% of its FFO. Meanwhile, it boasts an excellent portfolio of multifamily properties, focused in high-demand urban and high-density suburban locations in gateway cities like Seattle, San Francisco, Boston, New York, Washington, D.C., and Los Angeles. Because of that, the company has enjoyed strong rental collection and renewal rates this year despite the impact of COVID-19.
Industrial REIT Prologis has an exceptional balance sheet. The company has A-rated credit backed by a low 4.2 times debt-to-EBITDA ratio. It also boasts having $4.6 billion of liquidity. It complements that top-notch balance sheet with a conservative dividend payout ratio of 65%.
The company also owns an excellent portfolio of industrial properties leased to tenants in high growth markets like e-commerce. Many of these properties are in locations with high barriers to entry. Because of that, Prologis has enjoyed strong rental collection rates -- 97.6% in April and 95% in May -- despite the pandemic.
Self-storage REIT Public Storage also boasts a top-notch balance sheet. It has A-rated credit to go along with a minuscule leverage ratio of slightly more than 1.0 times debt-to-EBITDA. It also has loads of liquidity, ending the first quarter with more than $700 million in cash. Add that to a reasonably conservative 75% dividend payout ratio, and the REIT has a safe financial profile.
That financial flexibility provides the company with lots of cushion as it navigates through the COVID-19 outbreak. The company noted that the pandemic had some impact on demand for self-storage space while also increasing its costs. However, these should prove to be temporary issues since self-storage demand tends to be relatively recession-resistant. Further, the company believes that acquisition opportunities could arise from this downturn as financially strapped peers find themselves forced to sell. With loads of cash and excellent credit, it should come out ahead.
The safest REITs around
Equity Residential, Prologis, and Public Storage all boast top-notch credit ratings and conservative dividend payout ratios. On top of that, they each own in-demand real estate portfolios, which is why their rent collections have held up during the pandemic. These factors make them top investment options for those who want to stock their portfolio with the safest REITs.