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Now is the Time to Buy these Unloved Income Investments

Fed Chairman Ben Bernanke first raised the specter of “tapering” on May 22 of this year. Although investors knew the Fed had to end its program of quantitative easing eventually, hearing the truth from the chairman still had a significant effect on the market. Interest-rate sensitive investments reacted most dramatically. In...

Fed Chairman Ben Bernanke first raised the specter of “tapering” on May 22 of this year. Although investors knew the Fed had to end its program of quantitative easing eventually, hearing the truth from the chairman still had a significant effect on the market.

Interest-rate sensitive investments reacted most dramatically. In the stock market, investors unloaded shares of companies that depend on borrowing as part of their business. Real Estate Investment Trusts—which own real estate (usually purchased with borrowed money) and sometimes mortgages—felt the full force of the blow. Many REITs lost 15% or more of their value over the next few weeks. For the most part, they stayed unpopular, and near their lows, for the rest of the summer.

But then, in September, the Fed essentially called off the taper, announcing that it would continue buying $85 billion in bonds per month for the foreseeable future.

Many REITs reacted positively to this news, predictably. However, most still haven’t retaken their pre-May-22 levels. That spells opportunity for income investors who like high yields and good deals.

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And, as David Dittman wrote in a recent issue of Canadian Edge, the factors that eventually trigger tapering—mainly economic growth—will also be positive for REITs. He still recommends buying REITs, especially those with properties in thriving areas of the U.S. and Canada.

Dittman recommended just such a REIT in the latest Dividend Digest. Here’s his recommendation, followed by another idea from the Dividend Digest that also fits his criteria.

“Northern Property REIT (NPR-U or NPR.UN) generated 37.1% of its 2012 revenue from Canada’s growth-engine provincial economies, Alberta and British Columbia, where oil and gas development and production promise to support more growth in coming years. Northern Property, along with second-quarter results, announced a 3.3% increase to its monthly distribution rate. That’s a sure sign of management confidence in the sustainability as well as the growth trajectory for its operations. ...

“Northern Property reported second-quarter funds from operations (FFO) per unit of CAD0.57, up 7.5% on a continuing operations basis from CAD0.53 a year ago. Acquisitions completed during 2012 and developments completed during 2013 are starting to drive growth for the REIT and its unitholders. ...

“Northern Property, along with its fellow Canadian REITs, has sold off hard since the U.S. Federal Reserve started dropping hints that its $85 billion per month bond-buying program—popularly known as ‘QE3,’ denoting the third round of the Fed’s effort at quantitative easing of the money supply—would at some point, once triggered by economic data, come to an end.

“Investors have dropped traditional high-yielding equities such as REITs and utilities en masse, as interest rates have risen since May on indications of imminent QE3 ‘tapering.’ … They’re now eschewing solid, sustainable growth and income for yields that remain at historically low levels and will likely remain so for some time given the Fed’s commitment to the ‘zero bound’ on its benchmark fed funds rate into 2015.

“And the factor that will drive market rates higher [in] an improving economy is, for REITs as it is for high-yielding oil and gas exploration and production companies, a net positive. Faster growth and lower unemployment translate into higher rents in areas such as Alberta and British Columbia that will drive North American expansion.

“Plus, history suggests operational performance for REITs doesn’t suffer in a rising interest rate environment, despite their near-constant need for financing. With higher rates, in short, come higher rents.

“It’s impossible to forecast where exactly interest rates will eventually land. The simple reality of the matter is that long-term lending rates remain exceptionally low, notwithstanding the upward trend of the last few months. And, as management recently noted, every mortgage that Northern Property has renewed recently has been done on better terms than those that have expired.

“Northern Property, which is yielding 5.8% as of this writing, is a buy under $30.”—David Dittman, Canadian Edge, October 4, 2013

And here’s the second idea, from The Wealth Advisory:

“Investors Real Estate Trust (IRET) owns a diversified portfolio of income-producing properties. The company’s multifamily residential, office, medical, industrial and retail properties are located in 12 states, primarily in the Upper Midwest. It has just under $2 billion worth of properties under management. This REIT also has a very healthy dividend yield of 6.4%.

“Investors Real Estate Trust is selling at just over 12 times next fiscal year’s projected FFO, or funds from operations—the REIT equivalent of what earnings represent for equities. Investors Real Estate Trust’s multiple is a slight discount to larger competitors like Apartment Investment & Management, at 13.2 times 2014’s projected FFO, and Equity Residential, at 17.6 times 2014’s projected FFO. Investors Real Estate Trust also provides a much higher dividend yield than either of those rivals. ...

“The regions of the country in which the company’s property portfolio is situated are growing faster than the country as a whole. ... Finally, the company has a clean balance sheet, with a weighted average interest rate on its overall debt under 6%. We rate Investor’s Realty Trust a buy under $8.50 a share.”—Brian Hicks, The Wealth Advisory, September 18, 2013

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Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.