As millions of Americans approach retirement age, many are concerned about how they'll be able to fund their existing lifestyles during their golden years. Dividend growth stocks can help you achieve financial independence, but what if you're looking for a purer income play?
For those seeking secure, high-yield investments that still offer moderate income-growth opportunities, I'd like to introduce you to three of my favorite high-yield investments.
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The glory of triple net lease REITSReal estate investment trusts, or REITs, are businesses that generate income from leasing space in real estate properties. REITs pay no taxes so long as they pay 90% of their income as dividends. Thus these securities are beloved by income investors for their high yields.
Among REITs, the triple net lease business model is my favorite. That's because the customer pays not only rent, but also the taxes, insurance, and maintenance for the properties. This means triple net lease REITs like Realty Income , National Retail Properties , and W.P. Careyoften have lower overhead costs.
Lower costs mean more money for dividends and, better yet, hopefully faster dividend growth. That not only helps you boost your retirement income today but also helps your income grow, hopefully fast enough to offset inflation.
Why these three REITs?When it comes to choosing income investments, the three most important things retired investors must consider are: dividend security, yield, and dividend growth prospects. The adjusted funds from operations, or AFFO, payout ratio tells us what percentage of the cash left over after covering expenses and business costs is consumed by the dividend. In general, I feel comfortable with a payout ratio of under 90% with equity REITs.
You should also compare a REIT's historical dividend growth rate to analysts' projected dividend growth rate to maximize the chances that your income will grow at least as fast as inflation, which has been 2.26% on a compound annual basis over the last decade.
Sources: Yahoo Finance, Fastgraphs, investor presentations, S&P Capital IQ, company 10Qs.
As this table shows, all three REITs have yields far higher than the market's. More importantly, these dividends are well covered by each REIT's funds from operations. In addition, they have good track records of growing their payouts over time, and Wall Street currently expects each to continue growing its dividend by rates that far exceed inflation. In the case of Realty Income and W.P Carey, the expected dividend growth rate appears set to beat the market's median dividend growth rate since 1990.
Industry-leading occupancy rates further provide income securityThe key to these REITs' ability to provide high, steady, and growing income is their industry-leading occupancy rates and broad diversification of quality tenants across multiple industries and regions, with rents secured through long-term, inflation-adjusted leases.
Sources: Company investor presentations, 10Qs.
As this table shows, all three REITs own a large amount of property. This property is highly diversified across America's different regions and almost all available square footage available for leasing is currently generating rental income. The reason that diversification across region, or country is important is so that an economic down turn in one area, such as a housing bust in the southwest, or recession in Germany, won't threaten the REITs ability to cover or grow its dividend.
For example, W.P Carey gets 68% of its rental income from U.S. properties but also has a diverse international portfolio spanning nations like Germany, Canada, Mexico, Malaysia, and Japan. Meanwhile, Realty Income gets its rental income from 211 tenants in 49 states and Puerto Rico, and no single customer represents more than 5% of its rental income.National Properties' customers number over 400, including such well known names as Sunoco, SunTrust, and 7-11.
With each REIT's rental income secured by long-term leases with annual rent increases built in, investors can be secure in the knowledge that their dividends are backed not only by secure cash flow, but also a quality and diverse customer base that spans the entire breadth of the U.S. economy ( Realty Income has customers representing 57 industries)or in the case of W.P Carey, the globe.
Risks to know aboutAs wonderful as I believe these REITs to be, there is one major risk that I think potential and current investors need to consider -- that of rising interest rates.
With the U.S. economy growing at 4.6% and 5% over the last two quarters, respectively, the Federal Reserve is widely expected to start raising interest rates by mid-2015.REITs are dependent on low interest rates to be able to borrow and acquire new properties that allow them to grow funds from operations per share and safely and sustainably grow their dividends over time.
Luckily for investors in these REITs, management only targets properties with high capitalization rates -- i.e., the rate of return on real estate investments -- and all three have investment grade credit ratings, which help them borrow cheaply. For example, the capitalization rates for National Retail Properties' most recent acquisitions has been 7.4% and in recent years it's been able to borrow over $1 billion at an average interest rate of 3.67%.
That 3.73% difference between capitalization rate and borrowing costs represents potential profit and is high enough to allow interest rates to increase substantially before the REIT is unable to continue growing both the size of its business and its dividend through acquisitions.
Safe, high, and growing income is what you need for a prosperous retirementRealty Income, National Retail Properties, and W.P. Carey offer the trifecta of high-yield retirement investments. This high yield is secured by some of the highest occupancy rates in the industry, long-term contracts with annual rent increases built in, and a business model that keeps costs to a minimum. The low-cost nature of the triple net lease business model, combined with a strong past of dividend increases, means that these REITs not only have high, safe payouts, but also appear likely to continue growing them. This could potentially boost your retirement income in the years to come, offsetting inflation and raising your standard of living during retirement.
The article 3 of My Favorite High-Yield Retirement Stocks originally appeared on Fool.com.
Adam Galas has no position in any stocks mentioned. 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.
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