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What makes MLPs and REITs different than Dividend Stocks? | Investing for Beginners - YouTube
Channel: Let's Talk Money! with Joseph Hogue, CFA
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I鈥檝e found the five best dividend stocks
for 2019 and they鈥檙e not technically dividend
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stocks.
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I鈥檓 going to reveal these five stock picks
along with two types of investments everyone
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needs in their portfolio.
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In fact, I have a retirement fund that鈥檚
exclusively invested in one of these and earn
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double-digit returns every year.
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We鈥檙e talking dividend investing today on
Let鈥檚 Talk Money.
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Beat debt.
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Make Money.
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Make your money work for you.
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Creating the financial future you deserve.
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Let's talk money.
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Joseph Hogue with the Let鈥檚 Talk Money channel
here on YouTube.
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I want to send a special shout out to everyone
in the community, thank you for taking a little
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of your time to be here today.
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If you鈥檙e not part of the community yet,
just click that little red subscribe button.
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It鈥檚 free and you鈥檒l never miss an episode.
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I love dividend stocks and we鈥檝e had a few
really popular dividend investing videos here
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on the channel but there are two huge cash
flow investments that people sometimes overlook.
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These two investments trade like dividend
stocks but are a special type of company.
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We鈥檙e talking about master limited partnerships
(MLPs) and real estate investment trusts or
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REITs.
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Not only are these two of the best cash flow
investments you can make but it鈥檚 a great
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way to protect your money from ordinary stocks.
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In this video, I鈥檒l explain why these two
types of stocks aren鈥檛 dividend stocks.
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I鈥檒l reveal the danger in treating them
like other stocks and why they should be part
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of everyone鈥檚 portfolio.
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I鈥檒l then share the five best investments
in MLPs and REITs you can make this year .
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First, there are two very important differences
between these two types of stocks and other
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dividend stocks that you must know about.
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First is that they are pass-through companies
which means they pass profits through to investors
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and taxes are treated differently.
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These companies and their investors get special
tax breaks because of the way they handle
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cash flow and profits.
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Second, and this is the one that most investors
miss, is that these companies can鈥檛 be valued
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like other dividend stocks.
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These companies own assets like real estate
and pipelines that mean a huge amount of depreciation
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on the income statement.
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They take that depreciation off their earnings
to lower taxes but it also means that earnings
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are a terrible view of profitability for the
business.
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So if you ever hear anyone talking about the
price-to-earnings ratio of an MLP or a REIT,
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they don鈥檛 know what they鈥檙e talking about.
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You can鈥檛 use the P/E ratio with these stocks.
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There is a special way to value each of these
types of stocks and I鈥檒l show you how to
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do that for each.
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On to these special types of dividend investments
though.
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First, let鈥檚 look at the master limited
partnership.
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MLPs are a company set up to own energy assets,
usually oil or natural gas pipelines and storage
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facilities.
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MLPs get a fee from energy companies for letting
them use those pipelines and storage.
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This is one of the benefits to MLP investing
is that profits don鈥檛 necessarily depend
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on the price of oil.
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The stock price is going to bounce around
a little if the price of oil jumps or crashes
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but the company is still collecting those
fees on the volume of oil pumped through the
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pipelines . Compared to an oil company where
sales are directly affected by the price of
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oil, MLPs are a little safer here because
of those fees.
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Since MLPs pass their income and expenses
on to investors through special reporting,
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the company doesn鈥檛 pay taxes.
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That鈥檚 a very efficient way to hold the
assets and it鈥檚 why many oil companies have
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sold off their pipelines into an MLP company.
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With MLPs you don鈥檛 get that double taxes
problem you get with regular companies where
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the company pays taxes on profits first then
investors pay taxes again on any returns.
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Another benefit to MLPs is that the cash return
you receive isn鈥檛 all taxed in the same
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year either.
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Some of those dividends count to lower your
cost in the shares so you don鈥檛 pay taxes
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on them until you sell the stock . And if
you pass these through to your heirs in an
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estate, taxes are never paid on that portion
of the return.
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Because they pass almost all the income on
to investors, MLPs have some of the highest
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cash return of any types of stocks.
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The dividend on the Alerian MLP ETF, a fund
that holds shares of MLPs, pays an 8.4% annual
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dividend yield.
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There is one downside to MLPs I want to point
out before getting to how to value these stocks
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and my two favorite MLP picks.
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MLP investors get a K-1 form, a special tax
form each year, from the company that details
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the return.
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This means a little more work at tax time
to report the investment but any online tax
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software makes it easy to file taxes on these.
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Now on to how to value an MLP.
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Remember, you can鈥檛 use the price-to-earnings
ratio here.
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These companies have a huge amount of depreciation
that makes earnings misleading but it doesn鈥檛
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affect actual cash flow.
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So what we鈥檙e going to do is use what鈥檚
called price-to-distributable cash flow or
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price-to-DCF.
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Finding this value for distributable cash
flow, the amount of money the company has
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available to return to investors, is important
also because it gives us an idea of sustainability.
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A company can鈥檛 pay out more than is available
forever so it鈥檚 a good metric to make sure
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that dividend isn鈥檛 going to be cut any
time soon.
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I鈥檒l show you how to calculate DCF yourself
but all MLPs will calculate it on their reporting.
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I do it myself only because I like to double-check
the numbers coming out of the company and
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make sure I鈥檓 comparing stocks with the
same calculation.
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Here鈥檚 the table, and again don鈥檛 get
freaked out because this is always provided
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to you in reporting.
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To find how much money the company has available
to distribute, you take the cash flow from
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operations, this is all going to be found
on the Statement of Cash Flows, and you remove
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any spending on capital and income from non-controlling
interests.
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That gives you sustainable DCF which is what
the company can return to investors and still
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keep operations running smoothly.
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While sustainable DCF is a better measure,
most people use the DCF as reported because
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it鈥檚 sometimes the only number reported.
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To get to DCF, you also add back that income
from non-controlling interests as well as
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working capital reported.
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The big one here is adding back this proceeds
from asset sales.
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This is technically proceeds the company can
return to investors, a company can鈥檛 forever
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be selling its assets and still keep business
running so that鈥檚 why we use that sustainable
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DCF if it鈥檚 available.
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With this number, you can find that valuation
with the price-to-DCF or you can find how
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much the company is returning to investors
for what鈥檚 called the distribution coverage
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ratio.
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This is how much DCF the company earns versus
how much it pays out.
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This last measure is important because an
MLP that pays out more than it鈥檚 Distributable
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Cash Flow can鈥檛 do so forever.
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You see here the coverage ratio for a group
of MLPs and that the average is around a DCF
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that鈥檚 1.2 times the distribution.
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This means the company has cash flow about
20% higher than what it鈥檚 returning but
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you also see some companies here that save
back more or much less.
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Now on to my two favorite MLP picks for 2019.
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DCP Midstream, ticker DCP, is an integrated
MLP which means it owns energy assets throughout
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the supply chain from pipelines to processing
plants and storage.
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This gives it better pricing power and more
control negotiating with energy companies.
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DCP hedges most of it鈥檚 exposure to natural
gas prices and 80% of its revenue is that
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fee-based so it鈥檚 not going to be as volatile
as even other MLPs.
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The company pays an 8.6% dividend and a 1.35-times
distribution coverage which means that dividend
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is relatively safe.
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Pipeline volume increased 35% in the third
quarter versus last year so cash flow is on
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a good trend and shares trade for about 8-times
DCF.
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Our next MLP pick here is Energy Transfer
or ticker ET. ET is a little more diverse
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than DCP both geographically and by assets.
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The company owns natural gas pipelines through
several regions as well as some oil pipeline
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and export facilities.
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Energy Transfer has one of the best project
backlog profiles I鈥檝e seen in MLPs meaning
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it has a lot of projects lined up for growth.
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Cash flow jumped 40% year-over-year in the
second quarter so this is a company growing
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fast.
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The 8.2% dividend yield is covered by about
1.2-times DCF and shares trade for about 8.8-times
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DCF.
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One last note about MLPs here is that you
shouldn鈥檛 own them in a retirement or tax-advantaged
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account.
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The profits here are already taxed-advantaged
so you lose that benefit if you hold them
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in an IRA or Roth IRA.
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Our next dividend stock investment here is
real estate investment trusts or REITs and
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these are my favorite of the two.
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Those of you in the community know I鈥檓 a
big believer in real estate and I love REITs
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because they give everyone the opportunity
to get into property investing but without
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that big down payment needed.
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We鈥檝e got another video on the channel detailing
the seven property strategies I used after
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getting out of the Marine Corps to get started
with no money.
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I鈥檒l leave a link to that in the video description
below but the fact is that direct property
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investing can still be a lot of time and work.
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So REITs are special companies set up to manage
commercial real estate and pay out the cash
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flow to investors.
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REITs can specialize in a property type so
apartments, office, retail, warehouse and
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self-storage or they can hold a mix of properties.
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Most REITs hold properties across the country
so it鈥檚 a great way to diversify your portfolio
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of individual properties, getting exposure
to other regions and property types.
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REITs pay no corporate taxes as long as they
pay out at least 90% of income to investors
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so like MLPs this makes for a great way to
manage property, avoid that double taxation
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and means huge cash dividends for investors.
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In contrast to MLPs, REITs can be held in
a retirement account and that鈥檚 how I invest.
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The dividends from a REIT are either taxed
as income or at the capital gains tax rate
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so you would owe taxes on these if you hold
them in a regular account.
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Holding them in a retirement account means
I don鈥檛 pay any taxes for decades on all
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that cash flow.
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This is a great strategy for any high-yield
investment like dividend stocks, REITs or
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bonds.
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Hold these in a retirement account so you
pay no taxes.
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Your other stocks where most of the return
is through those capital gains when you sell
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it, those you can hold in a regular investing
account.
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There are primarily two types of REITs, an
equity REIT which actually owns the properties
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and a mortgage REIT which invests in real
estate loans.
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Now these mortgage REITs pay higher dividends
but they tend to be more volatile, especially
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when interest rates are rising . I鈥檝e invested
in mortgage REITs but prefer equity REITs
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as a better long-term investment.
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Just like with MLPs, you can鈥檛 rely on reported
earnings for a REIT because of that high amount
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of depreciation they get from real estate.
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Instead, we use a measure called Funds from
Operations or FFO.
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FFO is very similar to that DCF we saw with
MLPs.
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You take the reported net income of the REIT
and add back depreciation but minus out any
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gains they made on property sales.
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Those property sales are a source of income
but not something the REIT can do forever
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and expect to stay in business.
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Investors also look at the adjusted funds
from operations this AFFO, which takes out
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capital expenditures.
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Capex here is money the company spends to
keep its properties in good shape so maintenance
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spending.
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Remember, the idea is to find how much cash
the company has available to distribute without
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cutting into money it needs to run the business.
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Again, like the DCF calculation for MLPs,
you don鈥檛 necessarily have to do this yourself
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because it鈥檚 always reported by the company.
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It鈥檚 just a good idea to understand the
concept and be able to double-check the company鈥檚
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reporting.
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You use FFO just like our other metric so
you can take the price of the REIT over FFO
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to compare the valuation to other REITs.
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You can also get a coverage ratio of FFO over
the dividend to see how safe the yield is
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for the stock.
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Now I鈥檓 going to share three REITs that
I own and love for strong dividend yields
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and price appreciation.
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Dividend yields are a little lower for REITs
compared to MLPs but you tend to have higher
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price appreciation in the shares.
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This is because those real estate properties
appreciate and REITs tend to hold a little
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more back for growth than MLPs.
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First here is Extra Space Storage, ticker
EXR, which owns over 1,600 storage facilities
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across the country . This is a great property
type because it鈥檚 very easy to manage so
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costs are extremely low and that means lots
of cash flow.
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Let鈥檚 face it, we Americans love to buy
lots of stuff we don鈥檛 have room for and
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that means rented storage space.
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Occupancy at EXR is at 93%, almost completely
full, and the percent of the population using
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self-storage has risen to 8%, doubling over
the last 20 years.
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Shares have produced a 715% total return over
the last decade, the highest among storage
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REITs and second-highest against all REITs.
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The dividend has grown 115% over the last
five years and pays a 3.6% yield.
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Our next REIT is Ventas or ticker VTR, a leader
in medical and senior living properties.
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The company is well-diversified with about
55% of net operating income from senior living
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facilities, nearly a fifth from medical office
space, another 7% from university-based research
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centers and the rest from a mix of health
centers and loans.
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I love the healthcare REIT space because of
that broad demographic trend and the stability
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in healthcare spending.
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The senior living space has been weak lately
on over-supply but is turning around and the
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boomer generation is just now aging into the
segment.
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Shares pay a 5.2% dividend yield and have
produced an annualized 13.5% return over the
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last two decades.
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The shares trade for about 15-times FFO on
a really strong outlook for growth.
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Our last REIT pick isn鈥檛 a REIT itself but
a fund that holds REITs, the Vanguard Real
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Estate ETF, ticker VNQ.
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The fund holds shares of 184 REITs across
all property types.
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The VNQ is the best way to get that instant
diversification for your real estate portfolio
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because it holds pretty much everything and
the expense fee on the fund is one of the
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lowest you鈥檒l find.
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Shares pay a 4.4% dividend yield and have
produced a total return of 11.3% annually
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over the last decade.
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Do not neglect these two types of dividend
stocks for your portfolio.
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Not only do they pay dividend yields of three-
and four-times the rest of the market but
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they鈥檙e going to give you exposure to assets
that will smooth out risk of a crash in other
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stocks.
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Remember to value these stocks differently
with that DCF or FFO calculation and check
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out some of those five great dividend picks
I highlighted.
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We鈥檙e here Mondays, Wednesdays and Fridays
with the best videos on beating debt, making
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more money and making your money work for
you.
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If you鈥檝e got a question about money, just
subscribe to the channel and ask it in the
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comments and we鈥檒l answer it in a video.
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