Investors Alley

The real estate investment trust (REIT) sector has suffered for almost two years in a bear market that started at the end of 2021. REIT share prices should soon bottom, and it’s a great time to invest in the sector.

You want to find the best-run companies with the strongest potential for strong dividend growth.

Let me show you two…

REIT values dropped with the rest of the stock market during the 2022 broad-based bear market that bottomed in October 2022. REITs have not joined in the somewhat bumpy bull market that started a year ago.

The problem for REITs has been the Federal Reserve’s continued interest rate increase.

REITs must pay out 90% of their income as dividends, which means investors view these stocks as income investments. Income investment prices tend to move in the opposite direction of interest rates. As rates rise, investors want higher yields, which pushes down prices.

REITs own commercial properties, and—as real estate investors do—these companies use debt to pay for a large portion of the investment properties purchased and owned. Rising interest will increase the cost of debt as commercial mortgage loans or bonds mature and must be refinanced. Higher interest expenses can squeeze net income and the cash flow to pay dividends.

In addition to the interest rate challenges, REITs have been hit by the challenge of empty office buildings as employees resist the idea of returning to in-office work. Owners of city center office buildings face serious challenges.

In investors’ minds, office sector challenges have tarred the entire REIT sector. The reality is that there are a couple dozen different types of commercial properties, and most REITs focus on just one.

With the Fed close to finishing with increasing interest rates and expecting they will be able to start reducing rates next year, we should be close to the bottom of the decline in the REIT sector.

Here are a couple of investment ideas in the REIT sector. One is an ETF, and the other is a well-run but beaten-down individual stock.

The Hoya Capital High Dividend Yield ETF (RIET) employs a balanced approach to diversify the portfolio across small, medium, and large REITs. Here is the targeted portfolio breakdown:

RIET pays stable monthly dividends and currently yields over 10%.

Kilroy Realty Corp (KRC) is an office sector REIT. Kilroy develops, owns, and operates a portfolio of Class A office properties on the West Coast and in Austin, TX. Owners of lower-quality properties will feel the office sector problems. Class A buildings should stay fully leased.

Kilroy Realty has a long track record of above-average performance. With the share price down by more than 50% since April 2022 and a current yield of over 7%, the return potential from here for KRC is outstanding.

An old saying is that the stock market doesn’t ring a bell at the bottom of a downturn to announce the next bull market. REITs are poised for a bull market that could go on for several years.
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Last week, one of my favorite income stocks issued a press release with its preliminary third-quarter results. This business development company (BDC) extended its long tenure as the best company and stock in the category. If there ever were a “buy-and-hold forever” stock, this one would be at the top of my list.

Let me show you why…

Congress created the business development company structure to provide debt and equity capital to small-to-midsize corporations. A BDC must, by law, distribute 90% of its net investment income as dividends to investors.

Most BDCs focus on the lending side, making loans to generate relatively stable net investment income. Main Street Capital Corp (MAIN), the stock in question, is different. The company does make loans, but it also owns a significant amount of equity in its client companies. Main Street helps its clients with extensive management support.

Main Street typically announces preliminary quarterly results a few weeks before the release of the official results. The press release says it best, so I have excerpted it here (emphasis added):

In commenting on the Company’s operating results for the third quarter of 2023, Dwayne L. Hyzak, Main Street’s Chief Executive Officer, stated, “We are pleased with our performance in the third quarter, which resulted in continued strong recurring operating results, a new record for net asset value per share for the fifth consecutive quarter and a return on equity of over 17%. These third quarter results continued our positive performance over the last few quarters and resulted in a return on equity of over 17% on a trailing twelve-month basis, highlighting the consistency of our positive performance.”

Mr. Hyzak continued, “Our distributable net investment income in the third quarter exceeded the monthly dividends paid to our shareholders by over 45% and the total dividends paid to our shareholders by over 5%. Based upon the continued strength of our performance in the third quarter, we expect another meaningful supplemental dividend to be paid in the fourth quarter of 2023. This would represent our ninth consecutive quarterly supplemental dividend, to go with the six increases to our regular monthly dividends in the same time period, allowing us to deliver significant value to our shareholders, while continuing to maintain a conservative dividend policy and retain a meaningful portion of our income for the future benefit of our stakeholders.”

For the third quarter, MAIN paid a monthly dividend of $0.23 per share and a supplemental dividend of $0.275 per share. The monthly dividend was increased to $0.235 per share for the fourth quarter.

In the third quarter, MAIN paid $0.965 in total dividends, and the NAV increased by at least $0.61, to $28.30 at the bottom of the forecast NAV range. The dividends paid plus the book value growth gives a 5.7% return to investors for the third quarter.

This level of total return is not an outlier. The press release noted that supplemental dividends have been paid for nine consecutive quarters, with another likely for the fourth quarter. The monthly dividend has grown by 15% over the last three years. Over the same period, the NAV increased by 12.5%.MAIN has been a portfolio stock in my Dividend Hunter service since our second issue in July 2014. It is a stock that every investor should own.
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What do consumers do when they want the latest fashion, but inflation has priced it out of range? Answer, buy “used”, but authenticated, jewelry and watches from a company like Envela (ELA – Get Rating).  

Envela is in the “re-commerce” business operating in two segments. The first is consumer focused, and involves selling preowned luxury goods and metals. This includes high end jewelry, watches, and precious gems, as well as silver and gold. These items are sold through retail outlets and via its online presence. 

The second line of business is commercially focused and involves recycling and/or refurbishing consumer electronics and commercial IT. It’s a fairly unique model for a publicly traded company. 

If economic conditions continue to tighten and growth slows, Envela is in a great position, as sellers encountering tough economic conditions can liquidate their high end jewelry, but buyers seeking “value” have an option to still purchase high end goods. 

CEO Loftus highlighted this point in ELAs latest earnings release stating, “We are confident that our retail expansion strategies will not only generate increased revenue, but also enhance our market position, and ultimately provide strong returns for our investors. Supported by our solid foundation of financial health, we are still in the early stages of expanding our store footprint.” 

Envela presents a solid value here, with a PE of only just over 8, and trading at 8.4x earnings and 10x projected earnings. It possesses a strong balance sheet and good track record of sales and earnings growth. 

ELA’s strongest rating component in our POWR Ratings is in the Sentiment category, which aligns with my thoughts around the company doing well in a challenging inflation and growth environment. 

The stock is currently trading at the bottom of a long trading range dating back to late 2020, at just over $4. The stock has traded in the $8 range earlier this year, and could move back in that direction as demand for its products grows. 

What To Do Next?

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ELA shares were unchanged in after-hours trading Thursday. Year-to-date, ELA has declined -22.62%, versus a 12.74% rise in the benchmark S&P 500 index during the same period.

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Last week, in my 48-Hour Income service, we sat on our hands. First off, 48-Hour Income is a cash secured put selling service where the goal is to generate 1% to 3% returns per week. We generally make one trade a week with the occasional two-trade week. However, last week we made no trades. Why? …

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Last week, ONEOK Inc, finalized its acquisition of Magellan Midstream Partners. The deal produced a unique merger with some big effects on energy income investors like us.

So let’s review some pre-merger financial results and make a guess about ONEOK’s future.

In May, ONEOK Inc. (OKE) and Magellan Midstream Partners (MMP) announced an agreement for ONEOK to acquire Magellan in a deal valued at $18.8 billion. This was a unique deal: while both companies operate in the energy midstream space, ONEOK is organized as a corporation, and Magellan was structured as a master limited partnership (MLP).

The different business structures meant the deal would be a taxable event for Magellan investors. With an MLP, distributions paid are not taxable but instead reduce an investor’s cost basis. As a result, many MMP investors entered the deal with large taxable gains. Despite this issue, Magellan shareholders approved the acquisition, which is now a done deal.

Let’s look at what each company brings to the new combination.

Magellan Midstream operates a pipeline and terminal network transporting crude oil and refined products, and owns the most extensive common carrier refined products pipeline system in the U.S. The emphasis is on refined products, with 9,800 miles of pipelines and 54 terminals. Crude oil assets include 2,200 miles of pipeline and 39 million barrels of storage.

Here are MMP’s results for the first half of 2023:

Total revenue: $1.75 billion

Net income: $513 million/$2.52 per share

Free cash flow: $552 million

Distributions paid to shareholders: $425 million

ONEOK owns and operates a natural gas gathering, processing, and transport system.

Here are OKE’s results for the first half of the year:

Total revenue: $7.53 billion

Net income: $1.52 billion million/$3.38 per share

Adjusted EBITDA: $2.67 billion

Distributions paid to shareholders: $857 million

Shares outstanding 449 million

ONEOK issued 135 million new shares in the acquisition, increasing its share count by 30%. You can see that the MMP net income adds about the same percentage to the OKE results.

At the time of the merger announcement, ONEOK said it expects the deal to be earnings accretive starting next year. Earnings growth of 3% to 7% per year is expected through 2027, with free cash flow growth of more than 20% annually.

ONEOKE has been a Dividend Hunter-recommended portfolio stock since 2018. I like the stock for its attractive 6% yield combined with a long history of dividend growth. The dividend has grown by 28% since the addition. I expect the MMP acquisition will produce high single-digit annual dividend growth.
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I was pleasantly surprised to read a recent Wall Street Journal article highlighting the investment benefits of Business Development Companies (BDCs).

The article included a couple of BDCs that are on my Dividend Hunter recommended portfolio.

Let’s dig in, and take a look at why these BDCs are such great income investments…

The WSJ article was titled “The 11% Yield That Isn’t in Your Mutual Fund.” It took an evenhanded look at BDCs. Here are some excerpts and, when appropriate, my comments.

BDCs typically raise money from public stock investors that they then lend to small, often private, companies. After banks pulled back from lending in the wake of the 2008-09 financial crisis and again in March following the collapse of a handful of midsize lenders, BDCs helped fill the void.

BDCs have operated in good financial times and bad. It’s just when things turn bad that these stocks get more investor interest.

They give individual investors the opportunity to tap into high-yielding private markets that are usually only open to big, sophisticated institutions. The companies pay out at least 90% of the interest they receive in cash dividends, much like real-estate investment trusts, adding to their popularity among small investors.…

The fat yields on BDCs come with a catch: Unlike a standard fixed-pay bond, the payouts aren’t set in stone. What the shareholder actually receives depends on what the BDC earns from its investments. BDCs could end up paying dividends that are smaller—or larger—than projected.

The top-tier BDCs have consistently grown their dividend rates. These are businesses that can be managed for growth.

“As BDCs have become larger, we can now offer financing to much larger and more important companies than before,” said Craig Packer, CEO of Blue Owl Capital Corp. “Today, we lend to companies that any lender would like to finance.”

Blue Owl lends to nearly 200 companies for a total portfolio of nearly $13 billion.

Tim: Blue Owl Capital Corp (OBDC) has been a Dividend Hunter recommended investment since its 2019 IPO. The company has grown to become the second largest in the sector.

Rising interest rates have been a boon to the sector. About 80% of BDC assets are floating rate loans, according to Robert Dodd, senior analyst at Raymond James. That means the companies earn extra income from their loans when rates go up, as long as their borrowers can make their payments.

Many BDCs are earning much higher net interest income. Instead of increasing their regular dividends, the companies have been paying and declaring supplemental dividends. This dividend strategy allows investors to count on stable dividends if and when interest rates decline.

Shares of BDCs aren’t found in many common investment products. Securities and Exchange Commission rules require any mutual fund or index fund that owns BDCs to report management fees earned by the company as a fund expense. That drives up expense ratios reported by funds and, in turn, limits interest from institutions in the sector.

This last fact was new to me. It feeds into the investors’ focus on lower fees instead of investing for better returns.You don’t need an ETF for a mutual fund to get into BDC investing. These are publicly traded stocks, easily purchased through your brokerage account. I currently have four top BDCs on the Dividend Hunter recommended portfolio. To join and get the full list, take a look below.
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It’s coming. You cannot stop it.

The media cannot stop it by declaring it will not happen.

The economy is going to slow down. A recession is still more likely than not.

Even if the Fed stops raising rates (which is almost entirely dependent on energy and rent prices at this point), they will not lower them anytime soon.

As the economy slows, headlines about real estate will read like dispatches from Poland in the fall of 1939.

Predictions about the collapse of real estate leading to the end of banking and Armageddon will be everywhere.

After all, everyone knows that interest rates have risen, which will be bad for real estate.

Massive amounts of commercial real estate loans are coming due over the next couple of years.

A slowdown in the economy is going to be terrible for real estate.

That is just common sense, isn’t it?

Well, no. And therein lies our opportunity…

While it is true that Commercial Real Estate markets may not be as robust as they have been with interest rates at almost zero, most segments of the market will muddle through the refinancing cycle. While cash flows may flatline for a period, they will not dry up completely.

A lot of the cost of higher financing rates will be passed onto tenants, who will pass much of it on to customers.

Downtown skyscraper office properties will be the only area that will suffer semi-permanent damage. Working from home has changed their tenants’ real estate needs, and it will be a problem.

Residential real estate sales will continue to slow as buyers adjust to the new normal. Mortgage rates have more than doubled in less than two years.

Rates are almost three times what they were back in 2020 when the current housing boom kicked off.

However, if we look at a long-term chart of mortgage rates, current rates are on the low side of normal for the past fifty years.

My Mom had double-digit rates on all four homes she purchased in her lifetime. Two of the three had double-digit interest rates.

She had excellent credit, so she got a great rate for the market at that time.

Rates were higher, so she paid them for a nice house in a good neighborhood with decent schools.

Today’s buyers will eventually acclimate to the new normal and do the same.

The headlines about the multifamily market would have you believe that no one will ever rent an apartment again.

The truth is that multifamily occupancy rates across the United States are about 94%.

New supply is going to dry up as the economy slows.

Most banks and REIT lenders have already stopped funding new projects.

Rent growth will probably slow.

Existing properties, especially Class A properties with high-demand amenities, will be fine no matter what the headlines suggest. As of right now, Class A occupancy rates are comfortably above lower-grade buildings and improving.

As the economy slows, it will be the lower-end apartments that have occupancy problems. The Class A buildings should remain full.

In retail real estate, the same will hold true. Class A malls will be fine, while malls in less populated areas with lower incomes will struggle.

Open-air shopping centers with a strong tenant base in upscale areas will not just be okay.

They should be fantastic investments.

Lower prices because of headlines and uninformed selling of REITs will be an incredible opportunity.

We have added some high-quality real estate to The 20% Letter portfolio this year.

As prices fall, we will add more.

Real Estate has created more millionaires in the United States than any other asset class.

Buying real estate in weak markets has created enormous fortunes for patient-aggressive investors.

We will take advantage of the opportunity created in commercial and residential real estate.

You can either listen to the predictions of those who have predicted 22 of the last zero collapses of the United States, or you can get ready to take advantage of the massive opportunity currently being created.

It will be more than just Real Estate Investment Trusts.

It will be lenders.

It will be commercial real estate mortgage REITS.

It will be agency and multifamily mortgage REITs.

It will be commercial and residential brokers.

Property managers and real estate services companies will offer massive returns when purchased at bargain basement prices.

So will the global commercial real estate services and investment management companies. As the economy slows and the headlines darken, I expect panicked selling of real estate-related securities and assets to price at levels that allow massive long-term gains for patient, aggressive investors.

Check out the picture on the next page. It’s a beat up building that would’ve turned $25k into $4.1 million. It’s not a real estate play. Actually, with the Fed raising rates, it’s the best asset to buy right now. View this beat up, millionaire-making asset.

Last week, I went to fuel up my pickup truck and was shocked to see that gas prices had jumped overnight by $0.40 per gallon. Ouch!

I started digging into the cause, looking for an investment angle.

What I found reinforced my belief in what I think is one of the best investment opportunities in the energy sector…

Many news outlets reported the price jump, referencing a GasBuddy post. I found the original post and here is the opening paragraph:

Drivers in Oklahoma, Missouri, South Dakota, North Dakota, Nebraska, Minnesota and Kansas: be ready. GasBuddy, the leading fuel savings platform saving North American drivers the most money on gas, today predicts that gas prices in these states will spike anywhere from 50¢ to $1 per gallon over the next several days. While there are few details on the particulars on what is driving the increase, trade sources tell GasBuddy a refinery outage may be to blame.

I live in South Dakota and was traveling through Iowa (also hit by the increase) and Minnesota. I don’t remember seeing that magnitude of price increase in just a couple of days.

A few days earlier, I read an article titled: “‘No Plan B, No Excess Capacity Anywhere’: Oil Industry Warns of Looming Refining Crisis As ‘Dirty’ China Grabs Market Share.” Here is an excerpt from the article (emphasis mine):

The lack of spare crude-processing capacity due to under-investment, and shutdowns happening more frequently with refiners ramping up on better margins and deferring planned work were common themes at the APPEC by S&P Global Insights conference in Singapore this week. That’s left fuels like diesel and gasoline vulnerable to sudden swings when there are unplanned outages.

Here’s how to play this.

Refining companies operate with the significant challenge of having the prices of both raw material inputs (crude oil) and finished products (including gasoline, diesel fuel, jet fuel, and heating oil) determined in the commodity markets. As a result, refiners need to be highly efficient to stay profitable when the spread between oil and fuel prices is tight. The efficiency means that profits can explode higher when the spread widens.

In the U.S., refineries are operated by a range of companies, from large, diversified multinationals like ExxonMobil and Chevron down to small, single refinery companies. To start investing in refining stocks, I recommend looking at the three large companies whose businesses focus exclusively on refining:

Phillips 66 (PSX) is a $55 billion market cap company that owns and operates 13 refineries.

Marathon Petroleum Corp (MPC) has a $62 billion market cap and owns and operates 13 refineries.

Valero Energy Corp (VLO) has a $50 billion market cap and owns and operates 15 refineries.

One of these refining stocks is in my Monthly Dividend Multiplier newsletter recommended portfolio. The stock is on the portfolio due to a 2018 merger and has performed very well for my subscribers. I view all three as equally well-run, with comparable investment potential.

The bulk of stock market gains since last October are due to large price increases from a handful of large-cap, tech-focused stocks.

But growth stocks like that have had their time in the sun.

Let’s look at why value stocks could outperform in the future…

According to Investopedia, growth stocks are shares of companies that have the potential to outperform the overall market over time because of their future potential. In an upmarket, investors seem willing to pay any price to participate in the growth, which can produce rapid share price appreciation.

Value stocks are shares of companies that are currently trading below what they are really worth, and will thus provide a superior return. Value stock investors use fundamental analysis to determine a “fair value” for individual stocks. These stocks typically pay dividends with attractive yields. Value stock investing requires patience; it works best when it seems that no one else is buying this type of stock.

Market wags, coined by a Bank of America analyst to describe analysts, are calling the top-performing, large-cap tech stocks the Magnificent Seven. The stocks are Apple Inc. (AAPL), Microsoft Corp. (MSFT), Amazon.com Inc. (AMZN), NVIDIA Corp. (NVDA), Alphabet Inc. (GOOGL), Meta Platforms Inc. (META), and Tesla Inc. (TSLA). Year to date, through September 5, these seven stocks posted an average return of 102%. The S&P 500 is up 17.7%.

The S&P 500 is a market-cap-weighted index. The seven listed stocks are very large and account for 27% of the index’s market cap. This is fuzzy math, but if you multiply 102% by 27%, you get 27.5%. That result tells me the remainder of the S&P 500 has, on average, posted a negative return for the year.

Another clue is that the SPDR Portfolio S&P 500 Value ETF (SPYV) is up 10.7% for the year. The top three holdings of this ETF are MSFT, AMZN, and META, so this fund also benefited from the Magnificent Seven effect.

Throwing out the large-cap stocks, the Vanguard Mid-Cap Value Index Fund ETF Shares (VOE) is up just 1.1% for the year.

What would cause a rotation out of the large-cap growth stocks into value stocks? I think professional money managers will lead the shift. They must harvest profits from those 100%-plus gains to balance their portfolios. Some will go into value stocks as money rotates out of the Magnificent Seven. Buying will increase stock prices, leading to more buying, and soon, we will have a value stock bandwagon.I don’t know when value stocks will start a meaningful move, but it has been two years since there was a meaningful really for undervalued stocks. To my subscribers, I recommend the InfraCap Equity Income Fund ETF (ICAP) to get a great current yield from a value-focused fund manager.
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Fixed income investors who listened to Wall Street earlier this year and bought bonds have been left holding the bag. Rates have yet to peak, and yields have continued to move higher, lowering the value of any bonds the investors already held.

So, what should income investors do now?

With so much uncertainty still surrounding the path of the global economy and interest rates, conservative investors may just opt for parking funds in short-term Treasury bills that currently yield more than 5.25%.

For more aggressive investors, the best path to follow is a diversified approach for the income-producing part of your portfolio. Let me show you what I mean…

Pimco Income Strategy Fund

An easy way to diversify the fixed income portion of your portfolio is through a closed-end fund like the PIMCO Income Strategy Fund (PFL). Run by one of the best-known names in the fixed income space, the CEF offers exposure to varying credit types, credit qualities, and regions of the world.

Here is a brief description of the fund overview pulled from Pimco’s website.

Employing a multi-sector approach, the fund seeks high current income consistent with the preservation of capital by investing in a diversified portfolio of floating and/or fixed-rate debt instruments. The fund has the flexibility to allocate assets in varying proportions among floating- and fixed-rate debt instruments, as well as among investment grade and non-investment-grade securities.

In addition, the fund will not invest more than 20% of its total assets in securities that are, at the time of purchase, rated CCC/Caa or below by each ratings agency rating the security. The fund’s duration will normally be in the short to intermediate range (zero to eight years).

Finally, yield is just one component of the portfolio manager’s approach. Also considered are capital appreciation and principal preservation.

Be aware, though, that the fund does use leverage (total effective leverage = 23.76%) to try and improve its performance. This makes it more volatile than a non-leveraged bond fund.

So-called junk bonds comprise the largest chunk of the portfolio, with roughly 43% of the fund made up of non-investment grade and unrated bonds. While there is a modest allocation (roughly 12%) to government and agency securities, this is mostly a corporate bond fund.

Overall, PFL still qualifies as a well-diversified portfolio given its global exposure (about 23%) and mix of maturities. Industry-wise, PFL’s top investment sectors are: healthcare (9.14%), technology (7.9%), banks (6.04%), and consumer products (5.79%).

Maturity-wise, most of the bonds are currently in the intermediate range, with 27.58% having a maturity of three to five years, and 21.81% having a maturity of five to 10 years.

PFL Track Record

The PIMCO Income Strategy Fund is nearing the 20-year mark from its IPO, so it has been through the 2008-09 global financial crisis and the coronavirus pandemic.

Since its IPO, the fund’s 204% total return translates to roughly 6% annually. Like most bond funds, it performed reasonably well up until the post-pandemic period, when the Fed began hiking interest rates and effectively hammering fixed income valuations.

During the depths of the brief pandemic-related recession, PFL fell nearly 50% from peak to valley, but managed to gain it all back and then some before the end of 2020. Right now, the price of PFL is sitting about 35% or so below its post-pandemic peak.

Closed-end funds can trade at a premium or discount to their net asset value (NAV). PFL trades at a small premium of 3.43%. This is no doubt due to investors being attracted by its high yield—12.46%. PFL maintains a fixed monthly distribution policy that currently pays $0.0814 per share, or $0.9768 per share annually.

Part of the reason why PFL trades at a premium is its history of stability in its distribution. Income seeking investors just love predictability when it comes to their income streams. And, with the exception of one post-pandemic instance, this fund has delivered steadily. Judging its track record, it seems that the fund managers are willing to let the net asset value decline in favor of distribution stability.

It’s rather unusual to find a fund that encompasses so many different regions, credit qualities, maturities, and credit types, but PFL does it. Its rock-solid distribution history over the past 20 years makes the PIMCO Income Strategy Fund quite attractive. Predictable income is a good thing. PFL is a buy under $8 per share.
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