BDCs vs REITs: Which dividend stocks should you buy?

Income-focused investors are swimming in opportunities as interest rates remains at their highest point in over two decades. Short-term government bonds are yielding over 5%, which is a remarkable thing for assets that generated no return in over a decade.

Real Estate Investment Trusts (REITs) are also generating strong yields as their stocks have plunged in the past few months. Companies like Easterly Government (DEA), Global Neat Lease (GNL), Granite Point Mortgage (GMPT), and AFC Gamma (AFCG) are yielding over 10%.

REITs are struggling for a number of reasons, including higher debt repayments, the upcoming wall of maturities, tight liquidity in the banking sector, and overall low demand for commercial properties. 

Meanwhile, Business Development Companies (BDC) have done modestly well while maintaining their higher yields. Companies like Main Street Capital (MAIN), Ares Capital, and Gladstone Investment are all yielding over 6%. The chart below compares the VanEck BDC Income ETF (BIZD) and Vanguard Real Estate ETF (VNQ).

VNQ vs BIZD ETFs

BDCs are benefiting from the current environment for a number of reasons. For example, while REITs are hurt by higher rates, these companies thrive in this environment since they are lenders. They make more money when interest rates are in an uptrend.

Further, the collapse of several regional banks has led to more demand for shadow banks and private credit. This has seen these companies have more financing demand, which helps them be selective on who they lend to. 

Most importantly, BDCs are required by law to invest in diverse mid-market companies, which is beneficial in this challenging macro environment. 

I suspect that interest rates will remain at an elevated level for a few months, which will benefit BDCs. These companies will also be in a good shape even when rates start falling as analysts at UBS expect. Besides, US inflation is in a strong downtrend.

BDCs and REITs have their unique characteristics. Most BDC stocks have jumped by over 10% this year while REITs have plunged. This decline has left REITs, including some good ones, being highly undervalued. 

Therefore, I believe that income investors should avoid broad REIT and BDC ETFs like the Vanguard Real Estate ETF (VNQ),  Real Estate Select Sector Fund (XLRE), and the VanEck BDC ETF (BIZD).

Instead, analysts recommend being selective in the companies you select. In the REIT sector, it makes sense to allocate to companies with a solid balance sheet, high occupancy rates, and those without maturities in the near term. Some of the REIT stocks to consider are Alexandria Real Estate (ARE), Rexford Industrial (REXR), Americold (COLD), and Realty Income (O).

The same is true for BDC companies. Some of the most notable ones to consider are Main Street Capital (MAIN), Gladstone Investment (GAIN), Ares Capital (ARCC), and Prospect Capital.

MLPs are other high-yielding companies you can consider. These are companies involved in energy sourcing and transportation. It is possible to find quality MLP companies like Enterprise Product Partners and Energy Transfer.