What I love about real estate is the way it combines steady income and capital appreciation. Well-chosen property investments can appreciate rapidly over the long term and compensate you with hefty rental yield cash flows along the way. The trick is to find underappreciated segments of the broader property market.
In my opinion, no other segment is as underrated as the commercial real estate investment trusts (REITs) sector. REITs act like mutual funds for property portfolios, which means that you can add real estate exposure with a simple click. Some even offer double-digit dividend yields.
However, most real estate investors tend to focus on residential properties. Commercial sites are more volatile and complicated, but they offer higher yields and better valuations.
Here’s a top commercial REIT that pays out 12.08% in dividends (which could mean $1,208 in dividends on a $10,000 investment).
American Hotels
As the name suggests, American Hotel Properties REIT (TSX:HOT.UN) owns and manages a portfolio of hotel properties across the U.S. The portfolio now includes 79 hotels in 51 cities and 22 states.
Most of these are operated by upscale brands like the Marriott and Hampton Inn by the Hilton Group. According to the company’s analysis, these premium brands tend to have wider profit margins which allows them to pay higher rents for premium locations. The firm’s capitalization rate was estimated at 8%, which is above average for the real estate sector.
That above-average cap rate is only part of the reason for American Hotel’s lucrative dividend yield. The other reason is the fact that the stock has been plunging for the past few years as the company has struggled to convert its gross margins into net margins.
Net profit was a mere 0.5% of revenue over the past 12 months. Meanwhile, free cash flow has failed to keep up with the annual dividend payout.
The problem seems to be the company’s debt burden. At $654 million, the outstanding long-term debt is far higher than the value of the firm’s underlying equity. Another problem is that the portfolio isn’t operating at full capacity right now.
The team says a substantial portion of its portfolio is currently being renovated, which is dragging down performance. Once the renovations are completed, the team expects to pull the debt burden lower and boost funds from operations (FFO). In fact, the team believes the dividend payout from FFO could be as low as 72% in the next few years.
Nonetheless, the firm’s lucrative dividend could be at risk of a cut if the American economy dips into recession next year. A sudden shift in interest rates could be detrimental to the firm’s bottom line and compel the team to cut dividend payouts.
On the other hand, if the economy performs better-than-expected and the firm can manage its debt burden effectively, the stock could quickly surge much higher.
Bottom line
A $10,000 investment in American Hotels REIT could deliver $1,208 in annual dividends for your tax-free savings account (TFSA), however investors need to be aware of the underlying risks and approach this company as a speculative buy. If the bet pays off, the potential rewards in 2020 could be huge.
