These Stocks Yield Up to 13.5%... But I Doubt You Know About Them

My husband Melvin and I bought our first home when we were expecting our first child. After an exhaustive search, we settled on an up-and-down duplex. It was built in the 1940s and had a rental suite in the basement.

The purchase was a good decision from a financial standpoint. Rental payments covered a substantial part of our mortgage, and about two years later we were able to sell it for 20% more than we paid.

But from a lifestyle perspective, it was not ideal. First, the rental suite's bathroom faucet started leaking. Then ceiling tiles came tumbling down. Soon the rent was a week overdue and counting. There was always something.

 

I learned some important lessons from that experience. First, carefully selected real estate could be highly profitable. Second, I didn't want to deal with the upkeep required by rental properties.

Thankfully, there are real estate investment trusts (REITs).

As an income investor, you likely know plenty about these securities. REITs own leased property, letting investors own a diversified portfolio of properties and letting someone else look after the hassles of managing them.

As one of my first picks for my premium High-Yield Investing advisory, I added shopping center REIT Simon Property Group (NYSE: SPG) at $53.00 per share in August 2004. I sold it nearly three years later at $94.95, after collecting $9.06 per share in distributions, for a total return of 96%.

Equity Inns (NYSE: ENN), a lodging REIT added shortly after in January 2005, did even better. Total returns were 118% in just under three years. Sun Communities (NYSE: SUI), which runs manufactured home communities, was added in October 2010 and so far has provided total returns of about 40% in just over a year and a half.

You can see why I like REITs.

There's just one problem. U.S. REITs have been sharply bid up since the spring 2009 bottom. As a result, their yields, which move inversely to prices, have come down. U.S. equity (non-mortgage) REITs are yielding an average 3.4%, according to the benchmark MSCI U.S. REIT index.

The solution? Canadian REITs.

You may not have heard of them, but Canadian REITs (CanREITs) are similar in many ways to their U.S. counterparts. As in the United States, to qualify as a REIT in Canada at least 75% of revenues must come from rental income. CanREITs also pay out most of their taxable income to avoid paying corporate taxes and maintain their REIT status. Better yet, while most U.S. REITs pay dividends quarterly, most CanREITs pay monthly.

One difference between the two is that most U.S. REITs are corporations, but CanREITs are generally unincorporated investment trusts. That means, in case of bankruptcy, unitholders would be responsible for the REIT's liabilities. However, CanREITs typically guard against this possibility by purchasing insurance and excluding unitholders from liability in their loan contracts wherever possible.

The biggest difference, though, is their size. In the United States, you can choose among dozens of large capitalization REITs. Simon Property Group, for example, has a market cap of around $45 billion.

In Canada, the selection is more limited. The largest REIT by market cap is RioCan (TSX: REI.UN; OTC: RIOCF), a shopping center developer with a market cap of $7 billion. Only 16 CanREITS have market caps over $1 billion.

But at this point, many Canadian REITs are yielding higher than their U.S. counterparts. The average Canadian REIT pays a 5.0% yield, compared to 3.4% for U.S. REITs. This includes Canada's Scott's REIT (TSX: SRQ.UN; OTC: SOREF), which owns buildings leased to KFC, Taco Bell, Subway, and Shell gas stations, among others. Right now the shares yield more than 13.5%.

Meanwhile, Canada has a healthy housing market, strong banks, and effective government policy that underlie a healthy business environment.

As measured by the S&P Case-Shiller U.S. Home Price Index, housing prices in the U.S. have declined 26% as of the end of 2011. In contrast, housing prices across Canada actually increased 17% during that period, as measured by Canada's National Bank Home Price Index Composite.

Of course, the key to successful REIT investing is selecting the specific property sector most likely to benefit from the current economic environment.

There's no guarantee, but in my view the two strongest Canadian REIT sub-sectors right now are office space and apartments.

In many Canadian cities, the going market rate for office rents is now higher than lease rates. When these leases expire, therefore, rents should rise, driving REIT cash flow higher and potentially boosting distributions for office REITs.

Meanwhile, there's a lack of new multi-family supply in Canada. Consistent and stable demand is based on population growth and the housing needs of new immigrants. Proposed legislation to make underwriting standards harder for first-time home buyers may also lead to more people remaining as renters.