Using REITs to Generate Monthly Income With Little Downside Risk/10 REITs Trading Near Their 52-Week Low

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Using REITs to Generate Monthly Income With Little Downside Risk
4 comments | by: Matt D'Alto March 14, 2011 | about: ICF / IYR / KBWY / REK

In our current world of sub-1% interest-bearing money market accounts, I find myself increasingly looking for "creative" ways to boost the yield of my investable cash these days. The problem is, shorter-term bonds are generally of little help to this objective. You need to go out to at least 10-year paper today for the incremental yield to matter, and that kind of duration risk right now just doesn't seem palatable to me given I have trouble seeing the future one-year out, much less 10 years. Treasuries and corporate bonds, especially those with longer-term maturities, broadly seem somewhat overpriced to me in the shorter-term and make me nervous about investing new capital at current levels.

Certainly this thirst for yield has created some of the recent demand for higher-yielding equities. Many of higher-yield alternatives, such as REITs, have attracted investors and thus have seen yields come down over the past 18 months or so. Still, the yield spread on a typical REIT relative to a money fund remains meaningfully wide.

For the most part, I have been unwilling to be long REITs because of some of the risks I still foresee in the real estate market, which I believe the market has largely ignored because of the Federal Reserve's current easy-money policy. But until Helicopter Ben decides it is time to tighten policy, the downside risks will continue to be masked.

Even with the risk of rising rates sometime in the future, I believe I have devised a relatively low-risk strategy for investing in REITs that will allow investors to take advantage of their current higher-yielding cash flow characteristics, while protecting your downside investment risk in the event of a correction in REIT prices. And you do not need a lot of capital or knowledge about individual REITs to execute this strategy.

Review of PowerShares KBW Premium Yield Equity REIT Portfolio (KBWY)

In recent months, Keefe, Bruyette & Woods and Invesco PowerShares have partnered and come to market with a new ETF called the PowerShares KBW Premium Yield Equity REIT Portfolio (KBWY). What makes this particular REIT ETF unique is that it is the only REIT ETF (at least that I am aware of) that pays its dividends on a monthly rather than a quarterly or semi-annual basis. To some, this may not be that big a deal, but personally I like the idea of earning a more frequent income stream wherever possible (something about present value that I learned in business school).

According to the KBWY prospectus,

The Fund will normally invest at least 80% of its total assets in equity securities of real estate investment trusts.

Thus, while the fund currently holds a mix of 30 smaller-cap REIT names and is not forced to be a market-cap weighted REIT index, the fund should nevertheless be relatively highly correlated with the performance of most major cap-weighted REIT indexes over time.

Based on its last monthly dividend, the annualized dividend yield of KBWY is 4.96%. This yield compares favorably with those of other popular cap-weighted REIT ETFs like the Cohen & Steers Realty Majors Index Fund (ICF), whose distribution yield is currently 3.37%, or the Dow Jones U.S. Real Estate Index Fund (IYR) whose comparable yield is 4.39%. To reiterate, both of the latter ETFs pay distributions only on a quarterly basis, making KBWY a potentially more attractive alternative investment from a cash-flow standpoint.

To be fair, the potential risk to investing in KBWY (other than the risk of investing in REITs generally) is that it is still a very new and fairly illiquid ETF. Since the beginning of 2011, this ETF has traded about 4,700 shares per day. So this ETF obviously will not be a viable alternative for traders with significant capital to put to work. But smaller investors, for example, only need to buy 200 shares of KBWY to make a $5,000 investment, given its current market price over $25/share.

I would also expect the liquidity of this product to grow with time, since it has only been a public offering since late 2010. The KBW name brand and distribution muscle behind it also gives me confidence in the product's longer-term liquidity growth and viability.

Hedge KBWY with REK

As I mentioned before, my objective is to capture the monthly cash flow stream from this REIT investment, not to bet on the upside of REITs as an asset class.

To accomplish this objective, I would pair up a long of KBWY with a long of the ProShares Short Real Estate ETF (REK). This fund's objective is to seek returns inversely correlated with the Dow Jones U.S. Real Estate Index, which is a market-cap weighted REIT index. Note that REK is not a leveraged ultra-short fund – it is "only" 100% inversely correlated, which is perfect for this essentially market-neutral income strategy.

Why go long REK, and not just pair up with a short of another REIT ETF instead? Well, you could do that. The problem with shorting any REIT ETF, however, is that you have to "pay" the fund's quarterly dividend if you are short on the ex-dividend date of that ETF. You could try to time this by getting in and out of your short before the ex-dividend date, but the commission costs of doing so may defeat the objective here, which is to earn a higher and more frequent yield on your cash. By simply going long REK, you gain an inversely-correlated hedge to your KBWY position.

In addition, REK has not had any recent distribution events associated with it, so again it protects the downside of your REIT investment, but doesn't offset any of the monthly income stream associated with being long KBWY. Finally, using a "long-long" strategy allows you to execute this pair trade in an IRA, where your monthly income can be earned on a tax-deferred basis (remember, you cannot short any securities in an IRA due to regulations against borrowing in such accounts).

Another alternative to REK is to go long a traditional open-end mutual fund called The Short Real Estate ProFund (SRPIX). This fund should largely mirror the performance of REK. The benefit to choosing SRPIX over REK is that you can buy SRPIX commission-free through many broker mutual fund distribution platforms (like Schwab OneSource). REK, however, would provide you with greater control over taking advantage of intra-day price volatility, as SRPIX is priced only once a day, at the close of the market. Either way, it's really just a question of personal preference.

Ideally, this hedged income strategy would be even better if either KBWY or REK traded options. In this way, you could enhance your income stream by writing call options against your long positions (to learn more about covered call writing, see my blog entry on the basics of this option strategy). Unfortunately, neither ETF offers option trading at this point in time.

This strategy isn't for everyone, and it doesn't provide a perfect hedge against a downturn in REITs since the holdings in KBWY and REK are not identical. But the two securities should be oppositely correlated enough to be roughly REIT-market neutral; and in the meantime, you can collect a monthly cash flow stream that currently is at least 400 basis points higher than what you can earn in your money market fund.

If any of my followers or readers have feedback or alternatives to the strategies listed above (particularly related to optionable ETFs for such a strategy), please write in your comments below – I'd love to hear them!

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KBWY, REK over the next 72 hours.


10 REITs Trading Near Their 52-Week Low by: Alex B. Gray March 16, 2011 | about: AAT, CDR, CSA, FUR, HPP, MSW, NLP, SBRA, TCI, TRNO Font Size: PrintEmail Recommend 0 Share this page
Share0 When the U.S. stock market collapsed in the spring of 2009, REITs where hit very hard as real estate prices and occupancy rates suffered. Most REITs have recovered a good portion of their losses and the REIT indexes have performed well since those dark days. However, there are some REITs that have struggled to get back on their feet. In most cases, there is a very good reason for a stock to trade at the low end of its range so a detailed analysis would be necessary before any commitment of capital. However, occasionally these stocks can be a good hunting ground for value or a place to find a stock that is in transition and poised for a turnaround. Below are ten REITs that are trading near their 52-week lows.

Winthrop Realty Trust (FUR) operates as a real estate investment trust through the ownership of real property, loans secured by real property, the debt and equity of other real estate related companies and joint venture investments. Due to the nature of the their business, the company's holdings are very diverse and do not represent a specific real estate sector or geographic location. The company recently reported that earnings for 2010 were $16.2 million versus a net loss of $84.5 million in 2009. Funds from operations for 2010 were $32.4 million versus a negative $70.4 million in 2009. The trust also declared a quarterly dividend of $0.1625 per share payable April 15, 2011.

The 52-week range is $10.10 - $14.59 and the stock is currently trading at $11.48.

American Assets Trust, Inc. (AAT) primarily owns, operates and develops retail and office properties in California and Hawaii. The trust also has interest in apartments and one 369-room hotel. The trust just went public earlier this year at $20.50 per share and declared its initial dividend on March 4 of $0.17 per share. The company has not reported operating results since becoming a publicly traded trust, but the Form S-11showed the trust returned to profitability in 2009 after losses in 2008 and 2007.

The 52-week range is $20.45 - $22.00 and the stock is currently trading at $20.95.

Terreno Realty Corporation (TRNO) is focused on acquiring, owning and operating industrial real estate in the U.S. coastal markets of Los Angeles, Northern New Jersey/New York, San Francisco, Seattle, Miami and Washington D.C./Baltimore. Terreno went public as a blind-pool and has been acquiring properties since its offering in early 2010. Since the trust started as a blind-pool just a year ago, it was difficult to measure financial performance for 2010. Numbers reported over the next couple of quarters should prove to be more relevant. The trust did initiate its quarterly dividend at $0.10 per share and it will be payable April 19, 2011 to stockholders of record on April 5.

The 52-week range is $16.56 - $20.56 and the stock is currently trading at $16.90.

Sabra Healthcare REIT, Inc. (SBRA) owns and invests in real estate serving the healthcare industry. Most of the trust's current portfolio is skilled nursing facilities and assisted living facilities. The trust was the result of a spin-off from Sun Healthcare Group, Inc. (SUNH) in late 2010. The trust did announce that funds from operations from November 15 - December 31, 2010 were $0.12 per diluted share and earnings broke even for the period. The trust anticipates paying its initial dividend in 2011.

The 52-week range is $16.18 - $31.02 and the stock is currently trading at $17.58.

Hudson Pacific Properties, Inc. (HPP) acquires, owns and operates primarily high-end office properties in Northern and Southern California. The trust also owns two entertainment studios in Hollywood, California. The company just reported that funds from operations increased to $5.1 million in the fourth quarter of 2010 compared to $4.4 million in 2009. The company also increased its 2011 guidance for funds from operations from $0.82 - $0.86 to $1.01 - $1.06. In addition the company increased its dividend 31.6% in the first quarter of 2011 to $0.125 per share.

The 52-week range is $14.06 - $17.85 and the stock is currently trading at $14.13.

Cedar Shopping Centers, Inc (CDR) owns, develops, acquires and manages supermarket-anchored shopping centers and drug store-anchored convenience centers in the states of Connecticut, Maryland, Massachusetts, Michigan, New Jersey, New York, Ohio, Pennsylvania and Virginia. The trust announced funds from operations was $38.6 million for 2010 which was $16.3 million lower than 2009. The trust paid a dividend of $0.09 per share on February 22, 2011.

The 52-week range is $4.91 - $8.39 and the stock is currently trading at $5.38.

Cogdell Spencer, Inc. (CSA) owns, develops and manages medical office facilities in twelve states throughout the United States. The trust reported earlier this month that 2010 funds from operations excluding non-recurring events and impairment charges was essentially flat year over year at $28.5 million. The trust recently declared a quarterly dividend of $0.10 per share.

The 52-week range is $5.67 - $8.52 and the stock is currently trading at $5.73.

Transcontinental Realty Investors, Inc. (TCI) acquires, finances and operates real estate properties across the United States with a focus on acquiring undervalued properties. The company owns primarily apartment communities, office building and various other commercial properties. Most of these properties are currently located in Texas with a concentration in the Dallas-Fort Worth and Houston areas. The day-to-day management of the trust has been assigned to Prime Income Asset Management, LLC. The trust has not reported full year results for 2010, but third quarter results showed a net loss from continuing operations of $11 million compared to a loss of $13 million for the same period in 2009. The trust currently does not pay a dividend.

The 52-week range is $3.26 - $13.13 and the stock is currently trading at $3.85.

NTS Realty Holdings Limited (NLP) owns and operates apartment communities, residential communities and commercial properties. The trust's residential properties are primarily located in Indiana, Kentucky, Tennessee, Florida and Virginia. The commercial properties primarily consist of office buildings and are primarily located in the Louisville, Kentucky area. The company has yet to report earnings all of 2010, but did show a net loss of nearly $3 million for the third quarter which was essentially flat compared to the same period in 2009. The company recently declared a quarterly distribution of $0.05 per unit.

The 52-week range is $3.20 - $5.52 and the stock is currently trading at $3.40.

Mission West Properties, Inc. (MSW) is engaged in the acquisition, development and management of primarily research and development related properties in the Silicon Valley of California. The trust recently announced that funds from operations for the full year of 2010 decreased to $56 million from $60.5 million in 2009. The company paid a quarterly dividend of $0.15 per share to stockholders on January 6, 2011. This equates to a yield of over 9.2%.

The 52-week range is $6.45 - $7.74 and the stock is currently trading at $6.49.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.