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Cash In on Big Dividends by Becoming Uncle Sam’s Landlord

December 12, 2018

Property pays. And it will continue to pay—even with some of the nation’s real estate challenges—if you own the right properties at the right prices. I’ll show you in a moment how to profit from becoming the landlord to the most dependable tenant in the US market.

But let’s start by getting a lay of the land of property investing. Right now, there are plenty of real estate plays out there that are making the most of the market’s opportunities by acquiring better property and other real estate assets, which in turn are generating a surge of rising revenues that result in market-beating dividends for investors.

The combination of strong demand for underlying land and property assets as well as the steady stream of dividend flows continues to put REITs at the forefront of market success since the recent bottom for the segment on February 8 of 2018.

Just take a look at the general market for REITs tracked by the Bloomberg REIT Index below:

As you can see, since February, the REIT market has soared by some 17.15% in total return, continuing an upward trend that’s remained on track even as the general stock market has run into challenges.

But just because a market is outperforming doesn’t mean that you should throw your money at it. Investing in real estate and REITs is just like any other business. You need to understand what you’re buying and why.

When buying into REITs, it’s not just about the real estate, but the dividend yields. And that’s arguably been one of the biggest reasons for the run-up in demand for many of the major real estate trusts.

But with the demand by the market for dividend income, finding higher dividend yields is getting harder, especially from underlying quality companies.

With the market prices for the average REIT soaring, as noted in the Bloomberg REIT Index, average dividend yield has fallen to a still attractive 3.99%.

Of course, there’s still plenty of real estate trusts with bigger dividend yields, as well as the strong potential for further gains from underlying property assets. But as I said before, you need to know what you’re buying and why—you can’t just say “it’s got a good dividend.” You have to understand what’s a value and what’s a risk.

Let’s start with some yardsticks for measuring REITs, starting with the underlying value of their net assets. That’s book value, the net measure of the properties and other assets net of liabilities, and it has continued to rise across the market.

The market has bid up much of the stock prices of the overall REIT market. This has in effect ramped up how much of a premium investors will pay for the average REIT.

Right now, the US average for REITs is sitting at over 2.50 times the underlying net assets. That’s a hefty premium—a decade ago, that measure was sitting at a discount and not a premium.

The first step, then is to find a REIT that’s still valued below the average for the general market, with a higher level of revenue growth. Starting from there gets us on the way to finding a great stock that you and I want to own. And as I hinted at above, that search led me to an area of the REIT market where you can lease to one of the best tenants in the world—the US federal government.

The US government is a reliable property customer for its landlords. After all, Uncle Sam can always write a check to cover his chits even if his Secretary of the Treasury has to issue a few more I.O.U.s in the form of Treasury securities to make up the balances.

This is why one of my favorite segments in the REIT space is those that own properties that are on long-term leases to the government.

Government Properties Income REIT (GOV) has been in this space for some time, and it’s been doing well. The latest earnings show a return on its funds from operation (FFO) of 18.00%. It’s frugal in its administrative costs, with that expense running at a very low 7.20% of its operating costs. The stock is currently trading at the elusive discount to book value I discussed above—it’s a steal, at 32% under its net asset value.

Debts are higher, with a debt to assets ratio at 62.40%. But the dividend is currently at a whopping 20.19%, making it an attractive punt in smaller bites for dividend-hungry investors.

The company is working to merge with another REIT, Select Income REIT (SIR), with a focus on sale-and-lease-back properties (similar to another favorite REIT of mine, WP Carey (WPC)), in order to streamline management costs for more efficiency. The merger will also work to shore-up the stock and market capitalization of Government Properties and cut back on its cash burn rate.

Buying into Government Properties on the way towards the merger does bring in a greater level of risk to garner that big dividend. This means, again, that this should be bought in smaller sums than some of the other dividend REITs and stocks that I’ve been discussing in Dividend Digest.