The REIT Mix

On a few occasions during the last year, in our newsletter and quarterly client letter, we have discussed one of our strategies for capturing more income for balanced account portfolios: in lieu of bonds, we’re adding preferred stocks, master limited partnerships, and real estate investment trusts (REITs).
With interest rates so low, these types of securities pay out substantially more income to investors than bonds of comparable risk.
To participate in the roiled real estate markets, relatively steady REITs merit particular attention. Publicly traded REITs have been around since the early 1960s. Currently there are nearly 200 sold on stock exchanges.
The companies behind REITs invest directly in real estate. At least 90% of the taxable income that the REIT receives from the rents and leases of the properties must be distributed to investors (in the form of dividends) for the REIT to qualify for the special tax status that it receives from the IRS.
Also, because 75% of the assets of a REIT must be invested in real estate, REITs only make investment sense for a few types of industries: residential housing, commercial retail and office establishments, healthcare facilities, public storage structures, and a few other industries where rent- and lease-paying buildings or land makes business sense.
One of the newest categories is technology real estate. With so many Internet users–especially businesses–moving their data and applications from desktops to powerful remote servers, the companies hosting the movement are in need of bricks and mortar facilities in which to locate the high-speed servers, switches, and other relevant equipment that form the backbone of the Internet. Technology REITS are stepping into the breach.
There are a handful of publicly traded data-center REITs. With Internet traffic continuing to grow at record rates and with it the prospects of these companies, this number will certainly grow.
The tech-REIT we profile in the accompanying article, Data Realty Trust, is one of the largest and oldest companies in the industry. The company has four securities: the common stock, DLR, and three different preferred stocks (DLRCP, DGRDP, DLR-E). Two of these preferreds are convertibles– holders can convert the REIT into a stated amount of common stock. The third preferred, DLR-E, has a higher dividend than the common stock and the other preferreds, but is not convertible into common stock. When we are buying Digital Realty Trust as a bond proxy, we buy DLR-E. If we are buying it for capital appreciation, we buy the common. It should be noted that although the dividends on REITs are relatively high, the dividends are not eligible for the 15% tax rate accorded most dividends.