Right now, though, rising interest rates have been hitting property prices and shares in real estate businesses have been falling. So is now a good time to buy REITs, or is there danger on the horizon?

Property investing

I like the idea of renting out property to generate passive income and the most obvious way of doing this is by buying a property to let out. Unfortunately, there are three main obstacles to me doing this.

The first is financing. To buy a property, I’d either need huge amounts of cash that I don’t have or a mortgage that I don’t want. 

The second issue is work. If I bought a property to rent out, I’d have to find a tenant, sort out the legal work, and maintain the property, so I wouldn’t really be generating passive income. 

The third is that returns on buy-to-lets where I live look pretty uninspiring. The average rental property in my area seems to have a yield of around 3.8% before taxes and fees.

None of these problems is decisive, but all of them can be avoided if I invested in a REIT instead of buying a property to rent out.

REITs own property and rent it out to tenants. They distribute their rental income to shareholders in the form of dividends. 

Investing in a REIT allows me to avoid the major issues I have with buying a property to let out. I don’t have to buy a property outright, I don’t have to work on it, and the dividend yields can be attractive.

Interest rates

I own two REITs in my investment portfolio. They are Federal Realty Investment Trust and Realty Income Corporation.

Recently, shares in both have been coming down. This is the result of rising interest rates, which is putting pressure on the real estate sector more broadly.

Rising interest rates are bad for REITs for a few reasons. But the most pressing one is that it makes debt more expensive.

A consequence of paying out their earnings as dividends is that REITs often have to use debt to fund their growth. And higher interest rates mean that debt is more expensive.

This could be a particular problem for REITs that have debt that is due to mature soon. Higher interest rates could mean that they have to pay more in interest than they do at the moment.

Neither of the REITs that I own is particularly exposed to this, though. Their debt maturities are fairly well structured so that there isn’t an excessive amount of it expiring at any one time.

REIT investing

I still think that owning shares in a REIT is the best way for me to generate passive income from property. And I’m looking to add to my investments right now.

The prospect of higher interest rates is a genuine concern for property investors. But I think that the REITs that I own can continue to generate solid returns for me.

Part of that plan involves reinvesting the dividends that I receive. But I also have new money to use in buying stocks in September.

This month, I have around £1,000 to invest. There are two dividend stocks that have caught my eye in my quest to generate lifelong passive income.

Federal Realty Investment Trust

At the top of my list at the moment is Federal Realty Investment Trust (NYSE:FRT). This is a real estate investment trust (REIT) that makes money by leasing retail space to its tenants.

In order to facilitate its growth, Federal Realty has increased its share count by around 25% over the last decade. This is the main drawback with the stock.

As I see it, though, this is a small downside for a very good company at an attractive price. Federal Realty is a dividend king, meaning that it has raised its distribution to shareholders each year for the last 50 years. 

I think it’s worth taking a moment to think about what that entails. It means that the organisation increased its payouts following the 9/11 attacks, the 2007/08 financial crisis, and the global pandemic.

This demonstrates to me that the company finds ways to move forward even in difficult times. In an uncertain economic and political environment, I think that this consistency is valuable.

Over the last month, the stock has fallen by just under 5%.

As a result, the dividend yield is now over 4%, which I find very attractive.

GSK

I’m also looking at GSK (LSE:GSK) as a passive income opportunity. I don’t usually invest in pharmaceutical stocks, but I think that this one is just too cheap for me to ignore at the moment. 

Shares in GSK have fallen by almost 19% over the last month. This is because of a lawsuit concerning potentially cancerous side-effects of Zantac, a heartburn medication.

So far, the Zantac litigation issues have caused GSK’s market cap to fall by about £30bn. To my mind, that looks far too extreme.

I was reading the other day that settlements for drug side-effects tend to be in the region of $2bn-$7bn. I take this to mean that a £30bn decline in market cap is pricing in the very worst.

More generally, though, I also don’t think that the legal issues are likely to have an enduring effect on GSK’s business. The company’s competitive position is supported by patents and intangible assets that have nothing to do with Zantac (which is available without prescription). 

Of course, there’s a risk that the lawsuit could come out worse than I’m anticipating. But I think that the market’s pricing of the stock at the moment is factoring in the worst.

At current prices, GSK looks like a buying opportunity to me. So I’d look to add shares while the dividend yield is above 4%.

It’s important to pay attention to how safe the stream of dividends is, though. Buying a stock with a 9% dividend yield today is no good if the company isn’t going to be able to pay dividends after this year.

Moreover, when things go wrong with dividend stocks, they can go really wrong. A good example of this is Compass Minerals (NYSE:CMP).

Last November, Compass Minerals announced that it was cutting its dividend by 79%. Overnight the stock fell from $72.10 per share to $57.02.

There’s a general lesson here. Companies lowering their dividends can cause their stock prices to fall sharply, meaning that investors get hit both in the loss of passive income and a lower share price.

It’s therefore really important for me to make sure that the companies I own shares in aren’t likely to lower their dividends. With that in mind, here are two of the safest dividend stocks on Earth.

REITs

The stocks in question are Federal Realty Investment Trust (NYSE:FRT) and Realty Income (NYSE:O). Both are real estate investment trusts (REITs).

As REITs, both businesses make their money by renting out real estate. A consequence of being a REIT is that both companies are required to distribute 90% of their rental income in the form of dividends.

This means that neither company has the opportunity to decide not to pay dividends. Unlike Compass Minerals, management can’t decide to retain earnings to focus on growth instead of returning cash to shareholders.

In general, I think that being required to pay dividends is disadvantageous. In my view, it can leave management unable to take advantage of growth opportunities.

However, I do believe that the fact that both stocks are REITS makes for additional dividend safety. As I see it, the dividends are likely to keep flowing as long as the companies keep generating rental income.

Dividend aristocrats

Another reason for thinking that these are two of the safest dividend stocks on earth comes from their history. Realty Income is a dividend aristocrat and Federal Realty is a dividend king.

Dividend aristocrats have raised their dividend annually for at least 25 years. Realty Income has 28 years of consecutive annual dividend increases.

Federal Realty has been increasing its annual distributions for 55 years. That puts it through the 50 years required for dividend king status.

In both cases, a long history of dividend increases gives me confidence that these will continue. It means that each company has raised its payout consistently through various difficult economic environments.

Furthermore, each company’s dividend is central to its identity. Management makes information about its distribution record a central feature of its website in both cases.

Again, this indicates to me that dividend payments from both companies are likely to continue to increase.

Safe dividend stocks

Lowering its dividend can sometimes be the right thing for a company to do. But I don’t think that either Federal Realty Investment Trust or Realty Income are likely to be in this position – I see them as two of the safest dividend stocks I can buy.

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The stock is Federal Realty Investment Trust (NYSE:FRT). It’s a real estate investment trust (REIT) that owns and leases 104 properties (predominantly retail properties) in eight major US areas.

Competitive advantages

When I’m investing in a business, I look for something that sets it apart from its competitors. In the case of Federal Realty, this is the quality of its assets.

Specifically, the company’s big advantage comes from where its properties are located. Federal Realty’s portfolio is concentrated in densely populated areas where the median income is high.

These are desirable characteristics for retailers, but space in these areas is limited. This makes it nearly impossible for competitors to develop comparable portfolios, giving Federal Realty an advantage over other retail REITs.

Outlook

Federal Realty has proved itself to be a resilient business. Like other REITs, it distributes its income to shareholders in the form of dividends, making it an obvious passive income stock.

The company has increased its dividend each year for the past 54 years. That puts it beyond Dividend Aristocrat status, making it a dividend king.

Unsurprisingly, Federal Realty faced a challenging period during the pandemic. Since then, though, the company has recovered well.

Management anticipates occupancy rates between 92.5% and 93% by the end of the year. And it also expects funds from operations – a key measure of REIT profitability – to increase by 5% and 9%.

Overall, I think that the outlook for Federal Realty looks strong. The business has a great track record of weathering difficult conditions and is recovering well after its latest challenge.

E-commerce

Investing in retail properties might seem risky with e-commerce on the rise. As retailers move their businesses online, demand for physical shops seems likely to decline.

I agree that the shift to e-commerce is likely to result in decreased demand for retail properties. But I think that Federal Realty is well protected from this threat.

As companies reduce their store count, I expect them to close their least efficient outlets first. Federal Realty’s focus on high-quality assets means that it typically houses more productive stores.

This means that I expect demand for Federal Realty’s properties to remain strong even as the overall demand for retail stores declines. The quality of its assets should protect it from the threat of e-commerce.

Investment thesis

Federal Realty has a strong track record and a positive outlook. I think that the quality of its assets should allow it to continue to prosper even as retailers expand their e-commerce operations.

At current prices, the dividend yield is 4%. I’m happy to buy this in my Stocks and Shares ISA and let the dividends compound.