Hungry For Income? Try These REITs

One day, interest rates on bonds and money-market funds will climb out of the basement. Until then, investors looking for dependable income sources have little choice but to sift through the long list of real estate investment trusts, which pay an average dividend yield of 5.8%, more than triple the typical stock.

But can any REIT still be worth buying? The group has trounced the broad market each year since 2000. Over the last three years, REITs have returned an annual average of nearly 19%, while the Standard & Poor's 500-stock index lost 5.5% a year. If interest rates do rise, as I expect, won't REITs be hurt, since borrowed money is the mother's milk of real estate? No question, finding the right REITs today takes care.

PRUDENCE. Curious, in any case, to see if one might build an income portfolio composed of REITs with a fairly dependable stream of cash, I turned to Morningstar's Principia Stocks, a database on CD-ROM with figures on 186 REITs. I first asked the program to screen out those with market values under $1 billion and those that had not raised dividends at least 5% annually over the past five years. I also nixed companies with high (over 8%) or low (under 5%) yields. If the yields are too high, the market may have bid down the stock because it expects a dividend cut. And since this portfolio's aim is income rather than capital gains, I didn't want to settle for below-average yields. For prudence, I cut the more highly leveraged REITs, those whose assets more than tripled the equity.

That left 13. Next, I looked over the semifinalists' Sept. 30 financial statements. I wanted to see that their operating cash flow covered their dividends and other distributions. Also, I wanted to ensure that they are not overly threatened by rising interest rates. Finally, I wanted diversity in the type of properties held by these REITs. So I picked four, one each in the office, residential, retail, and industrial sectors (table).

Equity Office Properties Trust (EOP ) and Equity Residential (EQR ) are both offsprings of Chicago real estate maven Sam Zell and, respectively, the largest office building and apartment REITs. As are its rivals, Equity Office is suffering a weak office-space market, with rising vacancies and declining lease rates. Yet its financial heft makes it a standout. Similarly, Equity Residential's 2003 results through Sept. 30 showed the effects of a poor labor market, with net operating income on a same-unit basis falling 7.5%. It should be able to withstand the downturn until stronger job growth creates firmer rental conditions.

Kimco Realty (KIM ), based in New Hyde Park, N.Y., operates 675 shopping centers across North America. Its funds from operations so far this year have grown more than 8%, and Kimco recently raised its dividend for the 12th straight year. Liberty Property Trust (LRY ), with headquarters in Malvern, Pa., has two-thirds of its property portfolio in industrial buildings and the balance in offices. Funds from operations this year were up nearly 6% through September, on a rise in revenues of less than 5%. That was good enough for the market, which on Dec. 10 welcomed Liberty's sale of almost $100 million in stock via an offering led by Goldman Sachs (GS ).

Which raises the main risk today in REITs -- that the whole group will suffer when investors' enthusiasm for real estate investing eventually wanes. Just the same, if it's income you want from your portfolio, carefully adding some real estate shares is inescapable.

By Robert Barker

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