2023-03-20 11:00:00 ET
Summary
- One major worry for retirees is running out of money.
- It's a true but scary fact that most retirees see a massive income cut when they retire.
- You can build a portfolio that pays your way in retirement, and the best time to build it is now.
Co-produced with Treading Softly.
Financial worries and fears are ripe among retirees these days. 2020 struck a major nerve for many retirees but also pushed a large swath of working-class people into an unexpected early retirement. 2021 and 2022 piled on to those fears as inflation ran rampant and interest rates climbed, pushing floating-rate consumer debt into levels that fixed-income retirees saw as potentially budget-destroying.
In October 2022, Goldman Sachs released data from their Retirement Survey & Insights Report 2022 , which was highly concerning:
"51% of respondents who are currently retired reported that they are living on less than 50% of their pre-retirement annual income, including 29% who report living on 40% or less. Only 25% of retirees generate what many estimate as the amount needed to maintain their standard of living – 70% or more."
The moral of the story was that many retirees were forced into retirement early without the proper preparation – aka savings – and saw that their retirement income was marginal compared to what they were earning during their peak retirement years.
This can lead to retirees returning to the workforce part-time to pay bills or unexpected expenses – this is obviously less than ideal for those who want to spend their golden years enjoying their hobbies.
For years, I have been following successful investors and educating myself and others about income investing, and constantly refining my unique Income Method. Following it, I have built a portfolio that will allow me to provide for myself and my family in retirement, so I'll never have to work again if I don't want to.
Thankfully for High Dividend Opportunities members, I enjoy writing and researching!
Today we'll take a look at two outstanding picks from my personal portfolio that will help make this a reality.
Let's get started!
Pick #1: HR - Yield 6.4%
Healthcare Realty Trust Incorporated ( HR ) merged with another healthcare real estate investment trust ("REIT") giant, HTA, last year. The combined company is now the largest owner of MOBs (medical office buildings) in the U.S. HR 's focus is "on campus" or "adjacent" MOBs. These are medical offices that are affiliated with and on the same property as a major hospital system or are adjacent to a major hospital. This sector has been growing quickly as technology, modern techniques, and government/insurance funding are making outpatient services more practical and encouraging (if not outright forcing) patients to use outpatient services.
As with any large merger, it takes time for the two companies to become one. HR spent most of 2022 focusing on that combination, including selling properties to pay the $1.1 billion special dividend that was part of the merger compensation to shareholders.
HR was able to get their staffing levels to their target and announced that they have achieved their targeted synergies. The focus for 2023 will be on improving occupancy and investing in development/redevelopment opportunities within their existing portfolio. External acquisitions are expected to be modest but will pick up when the interest rate environment stabilizes.
There is significant upside potential embedded in HR's current portfolio. Management estimates that by getting occupancy up to 90%, HR would see cash flow increase by $0.15/share. Source .
Meanwhile, HR's development efforts target yields of 6.5-8%, and redevelopments yield 8-11%. With MOB properties selling at 6-6.5% cap rates, these strategies produce higher returns.
HR's FAD (funds available for distribution) came in at a run rate of $0.31 for Q4. HR had a FAD payout ratio of 94% after adjusting for the merger gyrations and is guiding for a payout ratio in the "mid to high 90s" for 2023. This prompted an analyst to ask directly about the dividend, and CEO Todd Meredith replied :
"So we feel very good about that momentum. And even if, as you just said, we found ourselves right at triple digits. I think we're very comfortable that the operational improvements are real in near term in '23, but also in '24. So we feel very comfortable that, that should drive down fairly quickly just through operational improvement. So we do not, at this point, anticipate any notion of any cut. Obviously, we're all watching the markets and looking at the extent of this. So that's something we re-evaluate as a Board and as a management team every quarter, every year. But for now, that's our outlook is that we feel very comfortable with where it's at."
CFO Kris Douglas added on, pointing out that part of the pressure on FAD is being caused by increased capital expenditures on leasing, which requires cash up-front but leads to higher rents.
"One thing I would add to that, Rich, is that one of the things that is putting some pressure there has to do with the capital for the absorption that we're seeing across the portfolio. So that's a good problem to have. And we look at that as growth capital that will enhance long-term cash flow and value. But that's something that if you're dealing with that in the short term, that doesn't point to a long-term dividend issue."
With the merger behind them, HR is turning its attention to fine-tuning its portfolio and improving occupancy. As earnings rise and the dividend payout ratio declines, we can expect HR to trend back toward historical valuations. We don't expect a dividend raise this year, but we are happy to collect our 6%+ yield while we wait for the valuation to recover.
Pick #2: XFLT - Yield 14%
XAI Octagon Floating Rate & Alternative Income Term Trust ( XFLT ) is a closed-end fund ("CEF") that invests in various types of floating-rate debt. The bulk of XFLT 's assets is invested in senior secured first lien loans, CLO equity, and CLO debt positions. Source .
XA Investments Q4 2022 Presentation
This diversity makes XFLT a little bit different than other publicly traded funds in the space, which tend to focus much more heavily on CLO equity investments.
XFLT has taken advantage of weak loan prices following COVID to scale up and dramatically grow its portfolio.
XA Investments Q4 2022 Presentation
Loan yields are at long-term highs, even as default rates are near historic lows. The last time loan yields were this high was at the height of the COVID pandemic when investors feared a massive wave of defaults.
XA Investments Q4 2022 Presentation
Note that the spike in yields in 2020 was very brief. The current trend has been more enduring and is driven more by Fed rate hikes than by credit risk.
XFLT saw its book value decline throughout the year, yet when we look at the financials, we can see that this is primarily from unrealized losses. Source .
XA Investments Q4 2022 Financials
XFLT earned $26 million in net investment income and realized net losses of just $1.6 million in 2022. XFLT's unrealized losses are at $61.1 million, or about 27% of net assets or $1.71/share. XFLT's strategy is to hold until maturity, so a very large number of those unrealized losses will never be realized. Loan prices decline, but when the borrower repays, they repay at par value.
XFLT has a structure that doesn't force them to sell. As a CEF, they can hold onto the investments and collect the interest payments all the way to maturity.
The debt markets have been in a tailspin, constantly reacting to the Fed, which has gotten progressively more hawkish at every meeting. Prices have fallen, primarily thanks to the Fed hiking rates. This creates an opportunity for investors who have the patience to buy up debt at yields we haven't seen for well over a decade and hold until maturity.
It is a fantastic time to invest in debt, and XFLT is a great option for retail investors to gain that exposure.
Conclusion
XFLT and HR are both excellent income generators with a reliable history of paying strong dividends into their shareholders' accounts. HR is absorbing a well-timed acquisition, and XFLT is picking up heavily discounted debt offering high yields. Both add up to continued strong income into my personal account, readily able to replace my paycheck as needed.
Are you worried about running out of capital or cash before your retirement comes to an end? That's a worry I do not wish upon any retiree. I want us all to have a prosperous and enjoyable retirement when the time comes!
These two excellent picks should be only part of a larger income portfolio with at least 42 individual holdings, as part of our "model portfolio" – we call this our Rule of 42 . That way, one investment alone cannot disrupt your overall income flowing into your account if it goes sideways for unforeseen reasons. Currently our portfolio carries an overall yield of +9%.
If you are looking for a great retirement, let the stock market pay for it! That's the beauty of income investing, and that's what our Income Method has to offer.
For further details see:
2 Dividends To Never Have To Work Again