Investing in 2013: How to Profit from the Expanding REIT Universe

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Income investing in 2013 means continuing the sometimes difficult quest for yield in a low interest-rate environment.

The environment has, of course, been created by the U.S. Federal Reserve and its adherence to zero interest rate policy (ZIRP) in an attempt to reignite the U.S. economy.

That search for yield, in many cases, has brought investors rushing to REITs or real estate investment trusts. These are securities that sell on a stock exchange like a stock and invest in real estate either directly by owning properties or through owning mortgages. They offer high yields above 3.5% .

The good news for those in search of income is that the universe of REITs is expanding rapidly, offering a myriad of enticing opportunities.

Investing in 2013: More REIT Options

The past year or so has seen a rush of companies moving toward REIT status.

Firms in wide-ranging industries including healthcare, timber companies, outdoor advertisers, casinos, data warehouses and digital transmission towers have converted, or will soon convert, into REITs.

In order to become a REIT, a company must fulfill two requirements:

First, it must invest at least 75% of its assets in real estate and get a minimum of 75% of its revenue from rents or other direct real-estate activities.

Second, it must pay out a minimum of 90% of its profits to its shareholders in the form of dividends.

If a company meets these criteria, the government (Internal Revenue Service) will not tax those profits at the company level. But as stated previously, the dividends received by shareholders are taxed as ordinary income.

Besides the tax advantages, there are other reasons as to why are companies are making the conversion to REIT status.

It seems to be a very successful strategy to increase share price performance, making both management and shareholders happy.

Jeff Kolitch, portfolio manager at Baron Real Estate Fund, told Barron's that the average REIT trades at 22 times adjusted funds from operations (AFFO), a measure comparable to operating cash flow. There are many, many stocks that trade below 22 times operating cash flow, so conversion to REIT status gives many stocks an immediate boost.

In addition, the newly-converted companies enjoy the access to large amounts of capital enjoyed by real estate trusts. Equity REITs last year raised more capital through stock and debt offerings than the industry had in at least 12 years. The amount raised last year was also as much capital raised as the prior five years combined, according to research firm SNL Financial.

This trend toward an expanding REIT universe is likely to continue in the months and years ahead.

Adam Markman, a managing director at real estate research firm Green Street Advisors, told Bloomberg News, "The pace of conversions isn't slowing. The more success that we have, the more likely it is we'll see additional activity."

Michael Fitzgerald, a partner at Paul Hastings, has worked on REIT conversions and is also a supporter of the REIT trend.

"This is just the beginning. There's going to be a huge emphasis on tax structuring starting in 2013," he told the Financial Times.

This "tax structuring" should expand the REIT universe even further.

New "Stars" in the REIT Universe

For investors interested in income, some of the new "stars" in the REIT universe are rather intriguing.

The list includes: casino company Penn National Gaming Inc. (Nasdaq: PENN), communications infrastructure firms American Tower Corp. (NYSE: AMT) and SBA Communications Corp. (Nasdaq: SBAC), outdoor advertising company Lamar Advertising Co. (Nasdaq: LAMR), publisher Gannett Co. Inc. (NYSE: GCI), and data service companies Digital Realty Trust Inc. (NYSE: DLR) and DuPont Fabros Technology Inc. (NYSE: DFT).

Some of the above have already converted to a REIT, while others are still contemplating the move.

Other firms including CBS Corp. (NYSE: CBS) and Cincinnati Bell Inc. (NYSE: CBB) are spinning off part of their firm into a REIT. Cincinnati Bell has already done that with the spinoff its co-location business unit CyrusOne Inc. (Nasdaq: CONE). CBS is considering the spinoff of its billboard advertising unit as a REIT. That business accounted for about 10% of its operating profits.

If you're interested in investing in REITs in 2013, check out this latest offer from our Global Investing Strategist Martin Hutchinson, who has a winning strategy to find the best sources of yield.

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