Warren Buffett would rather invest extra cash for future growth than dividend payments, but that doesn’t mean the Oracle of Omaha Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) won’t buy stocks that do both, especially if the price is right. For example, Berkshire stepped in and bought a nearly 10% stake in a real estate investment trust (REIT) Store capital (NYSE: STOR) last year after its share price fell. Does this REIT also deserve a place in your portfolio? Here’s why Store Capital’s business model makes it one of the best income-generating stocks Berkshire Hathaway owns.
A strong defense is a good offense
One of the biggest risks facing REITs with exposure to commercial real estate is tenant bankruptcy. The rise of e-commerce has taken a heavy toll on traditional brick-and-mortar sales, and as a result, many national and regional retail companies have closed stores or gone bankrupt, leaving homeowners in deep trouble.
Although Store Capital makes its money by renting to retail store operators, its business model is specifically designed to protect against vacancy risk. Instead of renting commercial space to retailers who make most of their money from the sale of goods that can be easily obtained elsewhere, it rents freestanding real estate properties to service-oriented businesses, including gyms, cinemas , furniture stores, restaurants, early childhood education providers and others whose services are not easily replaced.
The REIT further protects itself against the risk of tenant bankruptcy by acquiring properties at prices below their replacement cost, carefully vetting tenants at the unit level, and then signing mid-size tenants in many areas for long-term leases. Its investment to market value per property averages 82% and overall it leases nearly 2,100 properties to over 412 tenants operating in over 100 sectors. And because no tenant represents more than 3% of revenue, the impact on its business would be small if a customer falters.
Store Capital’s approach has resulted in an occupancy rate of over 99%, and through contracts that include automatic escalators at around 1.8% per year on average, renewals and management of portfolio of its properties, the company is well positioned to achieve its projection for 5% annual internal growth for shareholders.
How it earns income investors
High occupancy, continued investment in new properties, and a model that relies heavily on direct leases provides plenty of funds from operations (FFO) to bring in more and more money for investors in the form of dividends.
After including capital expenditures, routine maintenance amounts and rent increases, the company’s Adjusted FFO (AFFO) has grown an average of 7.2% per year since 2014. Thanks to these increases, Store Capital was able to increase its annual dividend on average. 6.6% per year over this period, and currently the REIT’s dividend yield is 4.3%.
There is reason to believe that its dividend payouts will also continue to grow. Most of its loans are at fixed rates, so they won’t increase due to rising interest rates, and the company’s pipeline of new properties exceeds $12 billion, even after adjusting for a net $495 million in acquisitions and divestitures so far in 2018. Considering the potential AFFO advantage and the fact that the company’s dividend payout ratio is only 70%, there is plenty of financial flexibility to support larger payments in the future.
Is this REIT a buy?
There are other REITs that offer a higher dividend yield than Store Capital, but they arguably invest in riskier ventures which make them less attractive than Store Capital. I don’t know how long this REIT will stay in Berkshire Hathaway’s portfolio, but I think this company offers investors a very attractive balance of risk and dividend-friendly reward, which makes owning it smart in portfolios of income.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.