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2 REIT Stocks to Buy Hand Over Fist and 1 to Avoid

Motley Fool - Mon Jan 29, 5:00AM CST

If you are considering investing in real estate investment trusts (REITs), you'll probably be attracted to the ultra-high yield that Annaly Capital(NYSE: NLY) provides. However, you'd probably be much better off if you went with the much lower yields on offer from Prologis(NYSE: PLD) and Rexford Industrial(NYSE: REXR) because both have significant opportunities for growth ahead of them. Here's what you need to know.

Prologis is everywhere

With a market cap of roughly $110 billion, Prologis is one of the largest REITs you can buy. It has a portfolio of more than 5,500 warehouses spread across North America, South America, Europe, and Asia. In total, it owns 1.2 billion square feet of warehouse space in 20 countries, almost every foot of which is located in a key global distribution hub. That makes it something of a one-stop shop for customers.

Dozens of $1 bills planted into soil like seedlings, with a hand reaching down to plant one.

Image source: Getty Images.

Right now, the company is benefiting from the rollover of existing leases to current market lease rates. The numbers are huge, with the fourth quarter of 2023 seeing new leases signed at rates that were roughly 74% above the expiring lease. While the industrial REIT can't keep that kind of growth going forever, leases don't all expire at one time, so there's more benefit to come from lease expirations. Longer term, Prologis also owns undeveloped land around its properties on which it can build new warehouses. Management estimates this to be a $40 billion opportunity. So there are multiple avenues for future growth, both short term and long term.

That said, investors have soured somewhat on the warehouse sector as online shopping and related logistics needs that exploded during the pandemic return to prior levels. This has pushed the stock well below its recent peak and the yield toward decade highs. At 2.8%, the dividend yield won't excite you, but the company's growth prospects suggest that dividend growth will continue to be attractive. On that score, the dividend increased by a huge 11% per year over the past decade.

REXR Chart

REXR data by YCharts

Rexford is in one very attractive place

The diversification in Prologis's property portfolio is a definite plus, but sometimes a highly focused portfolio can be just as attractive. That's the case with Rexford Industrial, which operates exclusively out of Southern California. It is a much smaller REIT, with a market cap of almost $12 billion and a portfolio that spans 45 million square feet of warehouse space.

The big story here is that Southern California is the largest warehouse market in the U.S. and has some of the lowest vacancy rates in the country. The Southern California region is actively working to increase housing and limit warehouse development (with many warehouse locations actually being converted to housing), which should keep demand high for years to come. This has supported the same large rent boosts that have benefited Prologis. With the severe supply constraint, however, Rexford's unique regional focus is likely to lead to many years of strong rent growth for the REIT.

The dividend yield is a modest 2.8%, but like Prologis, dividend growth has been very attractive at around 18% per year during the past five years. Investors' negative view of warehouses, meanwhile, has also pushed Rexford's yield toward decade highs despite the strong fundamentals of the business.

Annaly keeps letting dividend investors down

One chart tells you the whole story about Annaly and why dividend investors will probably want to avoid it. As seen below, despite offering a 10%-plus dividend yield for most of the past decade, Annaly wasn't a great stock to own given multiple dividend cuts and the steep share-price decline.

NLY Chart

NLY data by YCharts

So, in the end, buying Annaly's big yield would have left investors with less income and big paper losses (if not realized losses). That's a bad outcome if you are trying to live off of the income your portfolio generates.

To be fair, Annaly isn't exactly a bad REIT. It is just a mortgage REIT, which is a unique and complex business that is heavily affected by interest rate changes and property market dynamics, among other things. Annaly is really a way for institutional investors, using an asset allocation framework, to get exposure to mortgage securities. But the huge yield often lures in individual dividend investors thinking that they have found a diamond in the rough. History suggests that won't end up being the case.

Be careful what you wish for

It is very easy for an investor to be beguiled by Annaly's 13.2% yield. But a dividend yield alone isn't enough of a reason to buy a stock, as the REIT's terrible dividend history shows. That said, the backstories behind Prologis and Rexford are much more attractive, even though their yields are lower. Most investors would be much better off with the lower yielders here.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Prologis and Rexford Industrial Realty. The Motley Fool has a disclosure policy.

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