Stock Quotes in this Article: DLR, EQR, HCP, O, PCL

BALTIMORE (Stockpickr) -- If you're an income investor, real estate investment trusts (better known as REITs) probably hold a special place in your heart. After all, this special class of stock is basically purpose-built to generate investment income. That's saying a lot in an environment where rates are effectively zero.

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But with around 220 REITs floating around on public exchanges, knowing which ones to buy and which to ignore can be quite a chore. That's why today we're taking a closer look at five favorite REITs for income investors.

As the name implies, REITs own real estate (or real estate-related assets like mortgages). But don't think of these stocks as a way to get exposure to the real estate sector. Instead, most are better thought of as a pure-play income generation tool. That's largely because of a tax law passed in 1960 gives REITs the ability to skip paying taxes by passing on earnings to investors. The caveat is that they have to distribute 90% of their earnings to their owners. As a result, they typically sport very big dividend yields.

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2013 has been a stagger-start year for REIT investments. By and large, these trusts have failed to match the breakneck pace of the S&P 500. But with relative strength coming back into the sector this summer, that could be about to change.

There are many different flavors of REITs on the market right now; here's a look at five that offer a best-in-class combination of high yields, gain potential, and niche business appeal.

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These REIT names are worth owning in 2013.

Equity Residential

Apartment landlord Equity Residential (EQR) owns more than 550 communities spread across some of the most attractive markets in the United States. That positioning gives EQR some important advantages – with properties centered around large metro areas, occupancy rates are high, multifamily inventories are low, and barriers to entry keep that arrangement from getting thrown off-balance.

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Zeroed out interest rates have helped spur home buying again, but they haven't eroded the benefits of being a renter in urban areas where EQR's target demographic of younger, often mobile, professionals live. While February's $9 billion acquisition of Archstone is still getting shaken out in shares of EQR, the firm looks well positioned to post impressive increases in sales and profitability once the dust settles.

Typically, residential REITs offer fewer benefits than their commercial peers. That's because shorter standard leases coupled with regulations that favor residential tenants. Despite that fact, EQR's solid demographics and attractive portfolio gives it returns that few other residential REITs can claim. At last count, the firm pays out a 3.4% dividend yield.


HCP (HCP) is a healthcare REIT that owns hospitals, medical office buildings, and senior housing/nursing facilities. That niche exposure makes HCP more attractive than your typical trust – especially as aging baby boomers ramp up their healthcare and senior living needs. Right now, HCP pays out a hefty 4.6% dividend yield.

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Because HCP is the landlord, not the service provider, it's able to take advantage of the increased demand for healthcare services without being subjected to regulatory headwinds. Even if legislation squeezed margins for hospitals, for instance, it doesn't change the fact that those facilities still need physical locations.

Like most commercial operators, HCP leases properties on a triple-net basis. That means that the tenant, not HCP, is on the hook for real estate taxes, insurance, and maintenance costs. That means that HCP just collects a regular, predictable rent check from its tenants, along with a pre-set price bump each year for inflation. For income investors, that's a winning combination.

Realty Income

They call Realty Income (O) the "monthly dividend company." The $10 billion retail REIT has been paying out a monthly dividend for the last 44 years, making it an especially attractive name for investors who need faster-paced income streams. It's a hefty payout too: Those monthly dividend checks add up to a 4.5% yield at current price levels.

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Realty Income has interests in more than 3,600 properties, the vast majority of which are freestanding single-tenant retail units. Like HCP, Realty Income signs long-term triple-net leases with its tenants, a necessary component of being able to pay out consistent income each month. The long-term nature of Realty Income's tenants is another key to its financial health – on average less than 3% of tenants are up for renewal each year, which means that occupancy rates have a pretty strong floor built-in.

Financially, Realty Income is in excellent shape – just don't compare the firm's balance sheet outside of the sector. Obviously, the REIT business is capital intense, and since REITs have to pay out the vast majority of income to investors, it's very difficult to build up a war chest. That said, Realty Income sports relatively low leverage and plenty of untapped credit. This trust is a good go-to for any income investor's portfolio right now.

Plum Creek Timber

Plum Creek Timber (PCL) isn't your typical commercial REIT. Instead, the firm is a niche trust that operates in the timber business, one of the less conventional businesses allowed by the REIT Act signed in 1960. PCL owns 6.6 million acres of timberlands in 19 states.

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Only the timberland business falls under REIT rules, with logging operations treated as a traditional taxable corporation. For all intents and purposes, though, PCL's bread and butter remains its timberland; the firm earns more money through recreation, development, and conservation efforts than through logging. That could change as the housing market heats up, especially as supply constraints push timber prices higher. Either way, Plum Creek's combination of tax-advantaged REIT income and conventional business makes the firm a unique name to own right now...

Financially, PCL is in strong shape, with more than $350 million in cash offsetting a reasonable $3 billion debt load. While PCL resorted to liquidating land to fund its dividend in the wake of the Great Recession, recent acquisitions should help calm investors' concerns. For the moment, this stock pays a 3.5% dividend yield. While Plum Creek isn't a conventional REIT by most measures, it does make a great non-core holding for income-seekers in 2013.

Digital Realty Trust

Last up is $8 billion specialty REIT Digital Realty Trust (DLR). With a 5.7% yield, DLR sports the biggest dividend payout of today's names right now.

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Digital Realty trust is unique because of its technology focus. The firm owns 16.8 million square feet of datacenters, internet gateways, and tech firm office buildings spread across the country. Exposure to such an in-demand, specialized type of properties presents a major tailwind for DLR right now -- particularly in the datacenter business, which has been growing at a fast pace as consumers' appetites for hosted data continues to grow.

That also means that DLR's tenants are generally sticker than most. There aren't big barriers preventing an office from moving, but the huge investments tech firms make to customize their datacenters help to keep them in one place. Tenants who move have to bear the additional switching costs of replicating their previous setups. Data trends are unlikely to abate anytime in the foreseeable future – as consumers carry around more data-hungry smartphones and tablets than ever before, capacity at phone carriers, ISPs, and cloud storage services will continue to go for a premium. And DLR's shareholders should continue to benefit.

To see these short squeezes in action, check out this week's REIT portfolio on Stockpickr.

-- Written by Jonas Elmerraji in Baltimore.


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At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.

Follow Jonas on Twitter @JonasElmerraji