2 High-Yield Equity REITs That Warrant Caution

"The point is that you can't be too greedy." - Donald Trump

As noted in a recent article, cult stocks are smaller companies that employ relatively large media and/or investor interest versus other companies of a similar size and nature. With such interest, these stocks often swing wildly versus their peers.

Two high-yielding equity REITs are yielding 6.74% and 8.75% and have attracted quite a following this year. Both of these REITs have underperformed the Vanguard REIT Index ETF (VNQ), a proxy for U.S. traditional equity REITs.

1. Digital Realty Trust (DLR), $46.29 (6.74% Yield)

Digital Realty Trust has attracted quite the amount of attention this year with its above-market yield and leadership position in the data-center REIT space. On the downside, DLR has garnered negative press in the form of heavy short-selling interest, specifically from hedge fund manager Jon Jacobson of Highfields Capital that was made public in early May 2013.

As noted in the 52-week performance DLR chart versus the VNQ, Digital Realty held a negative divergence from the real estate index in both February and May. Once the market turned in late May, DLR headed straight down save for a few dead-cat bounces along the way.

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The company is now trading at dirt-cheap valuations due to several company-specific problems. Long investors who have become attached to this stock have lost over 30% in the past year, while the index has been flat. While I have argued that the dividend appears safe, I have also repeatedly warned investors that the investment is risky.

According to a November 14, 2013 focus article on DLR, author Brad Thomas argued that the dividend was well-covered and is expected to increase in 2014. Also, he believes that the NAV (value of assets) of DLR to be somewhere between $54 and $63 per share. He also expects $4.61 in 2013 FFO, which would lead to a current valuation of 10.04x FFO.

With such a low valuation, the company is trading at levels suggesting heightened risk. With an extremely low valuation, a high amount of short interest and an end to the tax-loss selling season near, DLR may be a short-term trade opportunity but also appears to be a dangerous investment at this time.

2. Whitestone REIT (WSR), $13.03 (8.75% Yield)

Whitestone is a shopping-center REIT that is concentrated mostly in Arizona and Texas. Due to an abnormally high yield with monthly distributions, this REIT has gained heavy investor attention.

What investors do not realize is that with such a high yield comes additional risk. The shares are bid down due to inadequate dividend coverage, above-average portfolio concentration risk and financial risk. In the last six months, WSR has lost over 23% of its value.

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Some of the negatives that have held WSR back include a dividend payout ratio above 100%, limited geographic diversification, high debt, a short history as a public company and a low property count.

In short, the current risk at WSR is too high for a safe buy recommendation. With an elevated risk specific to WSR, income investors may be better served with a lower-yielding, stable and well-run REIT such as Realty Income Corp. (O).

Conclusion

Over the past year, the domestic equity REIT market has performed poorly however these REITs have performed worse with heightened volatility.

As REITs are already burdened by such negative storyline and bearish outlook in the name of "rising rates," investors should exercise added caution with the names mentioned above. Rather than use yield, popularity or perceived relative value as a proxy, investors should remember to base investments on company valuations, fundamentals and long-term objectives.

Source: 2 High-Yield Equity REITs That Warrant Caution

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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