A Dynamic Duo for Yield in 2022

COVID-19, inflation and the Federal Reserve have so dominated the financial news that it was easy to miss the run-up in utility and real estate shares.

In the fourth quarter of 2021, real estate investment trusts (REITs) averaged a 17.5% return and utilities averaged 12.9%. The first few days of 2022 were poor, but I remain all-in on the duo, given that the chatter about higher interest rates is unlikely to translate soon into livable terms on savings accounts, CDs, money market funds and new government bonds.

I have doggedly dissed the dated doctrine that demeans REITs and utilities as "bond proxies" whose business models and investor returns depend on low and falling interest rates. I predict that both groups (other than in rare, random cases of mismanagement) will flourish as America absorbs this moderately higher inflation along with strong economic growth.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of Kiplinger’s expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of Kiplinger’s expert advice - straight to your e-mail.

Sign up

These are not merely defensive stock sectors. Utilities earn more and pay bigger dividends when they sell extra water and power. They are major landowners and both builders of and investors in renewable-energy projects.

The bulk of property-owning REITs are also developers and acquirers whose appreciating land and building values and rising rents support ever-higher dividends.

In 2021, according to Hoya Capital, 130 publicly traded realty trusts boosted dividends. That is more than 75% of them. It's not unusual to see five-year compound growth rates of 10% for cash flow and dividends.

I urge that all income-focused portfolios maintain core positions in both REITs and utilities, with regular contributions as you see fit. Through Jan. 7, Standard & Poor's real estate index shows an annualized 10-year total return of 12.6%; utilities clocked in at 11.2%. Dividends are 4% of that haul with utilities; 3.5% with real estate.

What Stocks to Buy Now

Within the property REIT sector, 15 of 16 subsectors returned at least 18% in 2021 (lodging was the exception). I advise you to stay with what is working, but with REITs, one year's laggards often become next year's leaders (not always the reverse, though).

Housing and industrial REITs are expensive now. Hold them for their high yields, but do not chase them with fresh cash. Lodging and healthcare REITs should score well in 2022; comeback ideas include Community Health (CHCT (opens in new tab), $48) and Omega Healthcare (OHI (opens in new tab), $31), and in hotels, Host Hotels and Resorts (HST (opens in new tab), $18) and Xenia Hotels and Resorts (XHR (opens in new tab), $18). Hotel REITs still pay zero or a pittance in dividends, but the shares are deeply discounted to net asset value, and when profits return, so will their payouts. Remember, retail and office REITs were pronounced dead two years ago but revived.

Utilities are essential businesses. Everyone needs heat and light, and usually there is a local monopoly. Utilities should clean up over the years from electric cars and cheaper electricity generation from wind and solar. They have ready access to inexpensive capital and a friendly administration that wants to help with reconstruction and service quality.

My favorites include American Water Works (AWK (opens in new tab), $174), National Grid (NGG (opens in new tab), $72) and Xcel Energy (XEL (opens in new tab), $69). Or use the Utilities Select Sector SPDR Fund (XLU (opens in new tab), $70). I am not a fan of indexing, but consolidation within the industry leaves less scope for active managers to find mispriced investments. The ETF's yield is just shy of 3%.