3 Top Stocks for Risk-Averse Investors

By Markets Fool.com

The right kind of stocks can allow you to relax and watch your money grow. Image source: Getty Images.

Continue Reading Below

There are many good reasons investors may want to avoid excessive risk. Maybe you'll need to use your investment capital in the not-too-distant future -- to send a child to college, for example. Or maybe you're retired and rely on your nest egg to produce consistent income.

Whatever the reason, risk-averse investors don't necessarily need to sacrifice growth. Here's why REITs like Public Storage (NYSE: PSA), Realty Income (NYSE: O), and Equity Residential (NYSE: EQR) can give you growing income and the potential for share-price growth while still allowing you to sleep at night.

Low maintenance cost and profitability in any market

Americans like "stuff" and need a place to store it, which is why self-storage, and Public Storage in particular, is such a successful business.

The leading self-storage operator, by far, Public Storage has a total of 2,593 properties with nearly 188 million rentable square feet and is larger than its three closest competitors combined. And, since the industry is extremely fragmented, there are plenty of opportunities for growth going forward.

Continue Reading Below

Growth has been impressive. For the second quarter of 2016, Public Storage reported year-over-year core funds from operations (FFO) growth of 10.6%, same-store rental income growth of 6.1%, and slightly improved gross margins. Over the long term, the company's growth rate has been even more impressive:

Metric

5-Year Annual Growth Rate

10-Year Annual Growth Rate

Free cash flow

12%

9%

Dividends

16%

13%

Net income

21%

12%

Core FFO

11%

9%

Data source: Public Storage 2015 Annual Report.

What makes this REIT suitable for a risk-averse investor? Consider that self-storage buildings have significantly lower maintenance expenses and lower turnover costs than other types of rental properties. In fact, Public Storage has said that it can break even with just 30% of its storage units occupied. With a current occupancy rate in excess of 95%, to say that there is a big margin of safety here would be an understatement.

Recession- and competition-resistant retail

One of the most risk-averse REITs in the market is Realty Income, which specializes in freestanding retail properties. And, although many subsectors of the retail industry are struggling right now, Realty Income's tenants are not.

As of this writing, Realty Income has more than 4,600 properties leased to 246 commercial tenants operating in 47 different industries. The properties are located in 49 states and Puerto Rico, and most of the company's retail properties operate in one or more of three recession- and competition-resistant forms of retail.

  • Service-based: Businesses people actually have to go to, such as movie theaters. These are inherently immune to online competitors.
  • Non-discretionary: Businesses that sell things people need, like gas stations and drugstores. They are resistant or immune to online competition, and resistant to recessions and market crashes as well.
  • Low price point: Businesses that sell items in bulk, or at deep discounts. Warehouse clubs and dollar stores are in this category, and they actually tend to do better in poor economies.

In addition, Realty Income has actively been diversifying its portfolio beyond retail. More than 20% of Realty Income's portfolio is now made up of industrial, office, and agricultural properties, the vast majority of which are occupied by investment-grade tenants.

Realty Income's lease structure also serves to mitigate risk. Tenants sign long-term leases, with an average initial term of nearly 15 years, and the leases require the tenants to pay the property taxes, insurance, and maintenance on the properties, shifting the variable expenses away from Realty Income. And, there are rent increases built right in.

This strategy has resulted in an occupancy rate that has never dipped below 96%, and has allowed the company to increase its dividend for 76 consecutive quarters.

Source: Realty Income investor presentation.

It's tough to become a homeowner, but it's nice to be a landlord

The United States is becoming a nation of renters, and the current homeownership rate of 62.9% is the lowest since 1965. During the five-year period from 2010 to 2014, the number of renter households grew at an average pace of 900,000 per year. There are several factors that could be responsible for this shift, such as rising home prices, higher levels of student debt among younger Americans, and sluggish income growth. These are all issues for another conversation, but the point here is that the result is no shortage in demand for rental properties like those in Equity Residential's portfolio.

Other trends favor renting as well. Corporations are actively moving from suburban locations into cities, and the U.S. urban population is projected to grow at a much faster rate than the rural population through at least 2050.

Source: Equity Residential investor presentation

Equity Residential's strategy is to capitalize on these trends by acquiring, developing, and operating apartment properties in high-growth, high-barrier markets. Examples of Equity's core markets include San Francisco, Los Angeles, New York City, and Boston, where homeownership is expensive, job growth is strong, and barriers to new apartment construction are high. These markets have lower-than-average vacancy rates, and an abundance of high-income rental households.

The company owns or has an ownership interest in 315 apartment properties with a total of more than 79,000 units. Equity Residential grows by acquiring existing properties, but prefers to grow by development, as doing so creates instant value and results in higher margins. In 2015 alone, Equity completed seven new developments at a cost of $835 million, and created an estimate of $300 million in value in the process, and there are still some major development projects in the pipeline. In fact, with about $3 billion worth of projects either under construction or in the pipeline, it's safe to say that Equity has no plans to slow down its development program.

In a nutshell, all of the demographic trends point to higher demand for rentals and limited new supply in Equity's core markets. This should translate into consistently growing rental income and low vacancy rates for years to come.

Risk-averse doesn't mean risk-free

As a final thought, it's important to mention that risk-averse doesn't mean the same thing as risk-free. None of the three REITs mentioned here is without risk. A recession could certainly cause people to lease fewer storage units and hurt Public Storage's profitability; it's entirely possible for one of Realty Income's major tenants to go bankrupt; and the housing market could crash again, leading to lower rent for Equity's apartments. On a broader scale, if interest rates rise faster than expected, it could hurt all REITs.

The point is that, while these stocks have an excellent risk-reward ratio, they won't be without volatility, especially if you hold them over long time periods. However, as long as you keep your eye on the big picture and ride out the ups and downs, these stocks should deliver consistent income and excellent long-term results.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

Matthew Frankel owns shares of Realty Income. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.