It's easy for dividend investors to get caught up in, well, dividends. However, that's just one facet of an investment and, while important, doesn't usually provide enough of the story to make an investment call. That's true even for a Dividend Aristocrat like Essex Property Trust (NYSE: ESS). Here's what you need to understand before jumping aboard here.
A lot to like
Essex Property Trust has increased its dividend every single year for 26 consecutive years. That puts the real estate investment trust (REIT) into the vaunted Dividend Aristocrat space. Notably, it even increased its dividend in 2020 while the coronavirus pandemic was raging -- many other REITs had to cut their dividends. The dividend, meanwhile, has increased at an annualized rate of roughly 7% over the past decade. That's about twice as fast as the historical rate of inflation growth, meaning that investors' buying power actually grew over time.
If you are a dividend investor, those factoids should be pretty interesting. Now, to be fair, the roughly 3.4% yield today isn't huge on an absolute basis. However, when you compare it to the sub 2% yield on offer from the S&P 500 Index, it starts to look a lot more compelling. That's especially true given the solid dividend growth over the past 10 years. Meanwhile, the yield hasn't been as high as it is today since the Great Recession.
Don't smash the "like" button just yet. There's more to understand.
Essex is an apartment REIT. It's a pretty robust sector of the real estate universe because the company is providing a basic necessity of life, namely shelter. Moreover, the dividend yield is sort of in the middle of the range in the apartment peer group, so you won't pick up much yield looking elsewhere. However, the dividend history laid out above is top notch, giving this REIT an edge over other options. So far so good, but there's one notable problem.
Essex's nearly 250-property portfolio is entirely focused on the West Coast, with just three core areas, Southern California, Northern California, and Seattle. These are wealthy and densely populated regions, which is great. However, there's very little diversification in Essex's business model. Diversification is good for your portfolio, and it can be good for a REIT's portfolio, too.
To put some numbers on that, Essex's third-quarter revenues declined in every single city in which it operates. The cause was the coronavirus pandemic, which led many people to move out of big cities. Major metropolitan regions will likely come back in time, but the near-term hit Essex's business is taking, with revenue off by a notable 6.7% in the third quarter, could be a bit disconcerting if you don't understand its highly focused business model.
Some comparisons will help. Peer UDR (NYSE: UDR) has a portfolio that's widely diversified across the United States. It saw revenue growth in its Southeast and Southwest properties, which helped offset the drops in coastal regions. Overall revenue growth was down just 3.3% in the third quarter. At the other end of the spectrum, Mid-America Apartments (NYSE: MAA), which focuses primarily on Sun Belt locations across multiple states, saw its revenues increase 2.1% year over year in the third quarter -- just two of the cities in its portfolio saw revenue declines.
This isn't meant to suggest that Essex is a bad REIT. It's history clearly indicates that is not the case. However, its highly focused approach is a risk that investors need to understand before buying, or it could suddenly become a major issue. And the pandemic is just one factor to consider. The West Coast is also known to experience wildfires and earthquakes. With all of its eggs in basically one basket, there's more risk in Essex's portfolio than you might think.
Go in with your eyes open
Essex Property Trust has a long and successful history behind it. You don't achieve Dividend Aristocrat status by accident. However, investors shouldn't buy this REIT without fully understanding its business, which by design lacks diversification. That's worked out well so far, but there's no guarantee that it will keep doing so. If you decide to step in here, make sure you understand what you're buying. For more conservative dividend investors, though, a more diversified option, like UDR, will probably make more sense.