Stag Industrial Inc (STAG), Whitestone REIT (WSR): REITs as an Inflation hedge: Three to Watch

Although interest rate increases may take real estate investment trusts (REITs) down a notch, REITs are also a long-term inflation hedge. That means it could be time to start considering names like Stag Industrial Inc (NYSE:STAG), Whitestone REIT (NYSE:WSR), and Omega Healthcare Investors Inc (NYSE:OHI).

Interest Rate Sensitivity

There’s no question that REITs are interest rate sensitive. When rates head higher REIT shares will head lower. However, interest rates tend to go up because of inflation. And that’s where REITs shine.

Property REITs own hard assets. Since they aren’t making any more property, it tends to increase in value over time. That’s one reason to consider them when inflation is heading higher. However, a better reason is the way that leases are written.

Most property leases have automatic escalators written into the contract. The escalators are usually tied to inflation. So, REIT rent rolls will eventually catch up to inflation. The inflation hedge gets even better because most REIT debt is fixed rate. So, a REIT’s cost of funding growth is static but its rents are increasing. That creates leverage in rent growth as automatic rent increases kick in.

Interest rates have been moving up, so investors should be preparing for that initial shock by making a list of REITs they might like to own. Some names to consider are:

Industrial Player

Stag Industrial Inc (NYSE:STAG), which yields around 6%, is a solid, higher yielding option in the industrial space. Relatively small, it focuses on second tier markets and owns just over 180 properties. While buying in second tier anything may sound risky, STAG is a well financed and disciplined competitor in a highly fragmented market. Its main competitors are mostly small private owners with just one to ten properties. This gives the company a notable edge.

In addition, Stag Industrial Inc (NYSE:STAG)’s investment team examines properties to ensure that they are essential to a lessee’s operations. This helps reduce the risk of broken leases.

The company’s shares yield well above the average industrial REIT because of its relatively short trading history and second tier market focus. While the yield is compelling now, it would be an even better deal with a 7% to 8% yield.

Renovations

Whitestone REIT (NYSE:WSR) also focuses on secondary markets, buying strip malls and office buildings that it calls “community centered properties” that are in need of tender loving care. It then redevelops the buildings and re-leases them. Although it has a small presence in Illinois, its portfolio is mainly in Arizona and fast growing Texas.

Redevelopment can be risky, particularly for a company with only about 50 properties. However, over the last three years, Whitestone REIT (NYSE:WSR) has been able to increase rent rolls, and acquisition activity has been reasonably brisk. And, with such a small portfolio, even modest acquisitions are meaningful to the top and bottom lines.

The yield was recently around 7%, well above larger players like Kimco Realty Corp (NYSE:KIM), which yields around 3.8%. Adding to the allure for income seekers, Whitestone REIT (NYSE:WSR) pays monthly dividends.