Investing in stocks can be like riding a rollercoaster – fun at times, but exceptionally nerve-wracking at others. The allure of high returns often comes hand in hand with high volatility, leading investors to make rash decisions at the worst moments. If this rollercoaster ride is all too familiar, fear not. An alternative exists: real estate investment trusts (REITs). These dividend-driven investments dance to a different beat than traditional stocks, often outperforming the broader market. Among the myriad of REIT options, three entities shine particularly bright, especially for newcomers to the REIT world.

Before diving into specific picks, let’s explore REITs in more detail.

Understanding the World of REITs

REITs, in their essence, are pretty straightforward. As the name implies, real estate investment trusts own various revenue-generating real estate properties. While some REITs specialize in economically sensitive assets like hotels, most have a more stable portfolio consisting of rental real estate such as apartments, malls, offices, retail spaces, and warehouses. These rental properties, though susceptible to economic downturns, usually host tenants capable and willing to meet their rent obligations, making REITs attractive options for dividend-seeking investors.

Not a fan of dividends? Think again. Research findings suggest that over the long haul, factoring in dividend payments, REITs actually outperform the S&P 500 by an average of around one percentage point per year.

Image source: Getty Images.

Short-term performance paints a slightly different picture. Last year witnessed the broad market skyrocketing ahead, leaving the average REIT in its dust. Over the past decade, the S&P 500 has generally outperformed REITs, albeit marginally.

However, this superior long-term performance comes with some crucial caveats.

Firstly, a prolonged period of historically low-interest rates buoyed stock performance over the past decade, only to see a sharp rise in 2022 as the rare pandemic era came to a close. This interest rate turnaround favored stocks while putting rate-sensitive REITs at a disadvantage.

Secondly, despite lagging returns, REIT shares have shown and continue to exhibit less volatility than traditional stocks, moving about 25% less erratically. Moreover, they often march to their own drumbeat, quite distinct from the broader stock market. Simply put, dabbling a bit more in REITs and slightly less in regular stocks could have helped you get a good night’s sleep over the past several years.

Against this backdrop, if you’re ready to explore new avenues, here are three REITs worth considering.

1. W.P. Carey

W.P. Carey (NYSE: WPC) boasts an extensive array of commercial and industrial properties. While retail property forms the largest segment, it constitutes less than a quarter of its overall rent-yielding assets, with tenants like car dealerships. No industry holds more than 10% of its tenant list, and its top tenant, U-Haul, contributes less than 3% of its total rent income. This diversified tenant base supports the REIT’s current annualized dividend yield of 6.2%.

But what truly sets W.P. Carey apart is the structure of its rental agreements. As a net lease REIT, it pushes costs like taxes, insurance, and maintenance onto tenants, significantly reducing the risk associated with being a landlord. The company also bakes in rental rate increases into leases upfront, ensuring fair market rent collection well into the future.

Observers of REITs may recall a 20% dividend cut by W.P. Carey last year, breaking a streak of annual dividend increases lasting decades. While a warning sign, this move doesn’t necessarily signal imminent struggles leading to more dividend slashes. The dividend cut was largely due to shedding office properties, aligning its asset base with reduced demand for such real estate. With that transition complete, such defensive maneuvers are unlikely moving forward.

2. Realty Income

Realty Income (NYSE: O) takes a different approach, focusing solely on retail and retail-related properties. Top tenants include Dollar General, Walgreens, Dollar Tree, and 7-Eleven. Despite this retail-heavy portfolio, its tenant list remains diversified, with no single customer comprising more than 4% of its business.

While retail might seem risky given the industry’s vulnerability to economic shifts and online competition, a closer inspection of Realty Income’s tenants reveals resilience. Not only has the REIT paid monthly dividends since its inception in 1969 but has also raised payouts 124 times over the years, pointing to stable performance.

Realty Income’s current yield hovers just under 6%.

3. Digital Realty Trust

Finally, consider investing in Digital Realty Trust (NYSE: DLR). While its 3.4% dividend yield trails behind Realty Income and W.P. Carey, its growth potential more than compensates for the lower yield.

Specializing in data centers, including AI data centers, Digital Realty Trust targets a pressing need. With the explosion in digital data collection, there is a growing demand for more computing capacity. The rise of artificial intelligence further amplifies this necessity, requiring additional computing power and data storage. In essence, more computer servers must be installed to meet this surging demand.

The need for digital infrastructure is unmistakable. Numerous companies utilize extensive server banks already. As AI applications gain momentum, this requirement intensifies. While its dividend yield might be moderate, Digital Realty Trust’s potential for growth is substantial.