Another giant REIT player often found gracing the top spot in portfolios and indexes is Simon Properties, the nation's largest mall landlord, which in late July reported funds from operations per share of $1.65 for the second quarter, an increase of almost 20% from the year before. Its portfolio of regional malls and Premium outlets saw a 9.4% increase in same-store sales per square foot. The company raised its quarterly dividend from 60 cents to 80 cents in the fourth quarter of 2010 and has signaled it will raise it again in the fourth quarter of this year. Its dividend yield rose to 2.90%.
Boston Properties, an owner of skyline candy buildings in New York, Washington, D.C., Boston and San Francisco, said its funds from operations per share in the second quarter increased 16% to $1.23 per share from $1.12 per share a year earlier. The company owns 152 commercial real estate properties.
So the question is now, with all the equity coming into the space and the yields improving, are the prices of REITs getting ahead of themselves? "Valuations look good but they're not cheap anymore," says Halle. "REITs' valuations already anticipate some of that growth. If the anticipated growth of NOIs comes through, REITs are cheap. But no one throws their entire bet down on the table at once; you kind of wait and see how it's going to work out. And as the earnings start to come through, which should be in the next 12 months as earnings start to increase-we think they will-REITs we think are a good bet."
Morningstar's Martin says that the FFO dividend payout ratios today stand at 70% across the industry. The average across the industry historically has been 72%.
"When you have a payout ratio averaging about 70%, that gives REITs pretty good cushion and some real dividend protection," he says. "It gives you dividend protection if you should need it, but it also gives you the ability to grow dividends as well. I would be much more concerned if I see an FFO payout ratio hit more than 85%. That concerns me a bit. Certainly 90% or above. I'm questioning the potential dividend protection and the potential dividend growth rate."
An example of a company he likes is Alexandria Real Estate Equities, which he put on Morningstar's "Best Ideas" list. Alexandria is a science and lab REIT that leases to biotech firms, universities and pharmaceutical labs, which makes it a competitive niche player. He says this company's adjusted funds-from-operations payout ratio is 43.9%. "That is a very conservative payout ratio," he says. "With that kind of a payout ratio, they have pretty attractive free cash flow, they have some real dividend protection. If they wanted to bump their dividend 20%-I don't think that's going to be the case, but let's just say they wanted to-[their payout ratio] would be at 52.7%. That would still be conservative."
Martin also likes other companies in the health care REIT space, like Ventas and Health Care REIT, which are growing dividends and able to hang on to long-term leases that help them better weather downturns. "They've done some M&A and they've made significant acquisitions-large portfolios that give them some scale, some efficiencies that they can bring into their portfolio."
Also, he says, health care companies can sustain higher payouts, such as Health Care REIT, which he says was strong enough to maintain its 90% adjusted free cash flow dividend payout ratio through the downturn because its management was so strong.
"Health care REITs generally have a higher payout ratio and they typically grow their dividends at 2% to 5% a year. Whereas, you know hotel REITs are much more cyclical. They are very closely tied to the economy. If I see an FFO to payout ratio of 80% there, I get concerned."
Since 1990, Martin says, equity REITs have increased annual dividends by an average of 5% while average inflation was 2% over that period. "Over the next two to three years, we estimate that REITs will be increasing their dividends at 5% or better."