We buy real estate investment trusts (REITs) for their yields first and foremost. Show us the money!
Dividend growth is good, too. A 4% yield looks twice as nice if we believe our income will double in just a few years.
After all, a 4% payer that boosts its dividend by 10% wonaEURtmt yield 4.4% for very long. Investors will buy its price up and in doing so bid its payout per share back down. And thataEURtms OK. This dividend-powered appreciation is actually the easiest way for us to double our money with safe REITs!
But dividend safety really is the key here.
High yields and payout growth are great, but they mean nothing if the company is living beyond its means and setting itself up for a dividend cut (or worse, a suspension!) in just a few years, leaving you in the lurch. So to avoid this form of retirement-killer, many experts suggest looking at the payout ratio.
However, thereaEURtms a catch: You have to make sure youaEURtmre looking at the right payout ratio. And this is where most folks make a costly mistake.
When it comes to aEURoenormalaEUR stocksaEUR"Pfizer (PFE), Exxon Mobil (XOM) and the likeaEUR"you get the payout ratio by dividing the annual dividend payout by the companyaEURtms earnings per share (EPS). However, youaEURtmll get an even more accurate result if you use free cash flow (FCF) per share, which is much less prone to manipulation than EPS. (In fact, FCF is so important that itaEURtms one of the metrics used by the DIVCON system to determine dividend safety.)
In these aEURoeregularaEUR stocks, I demand a payout ratio of less than 50%. Any higher, and you risk a dividend cutaEUR"not to mention a near-automatic price crash when thatA bad news hits.
Just like price charts donaEURtmt tell a REITaEURtms whole story, however, EPS and FCF payout ratios donaEURtmt do the job with real estate, either.
HereaEURtms an exampleLetaEURtms dial upA Physicians Realty Trust (DOC), which rents space to doctors and pays a nice 5%-plus dividend. Stock screener Ycharts gives us this:
If you go by this Ycharts screen, DOC has paid outA more than twiceA its cash flow as dividends in the last 12 months, and fourA timesA EPS.
Luckily for us, those arenaEURtmt the right numbers.
The number to know with REITs is funds from operations (FFO). ItaEURtms a critical REIT measure of profitability that accounts for the fact that real estate tends to increase in value over time, and backs out any asset sales because (naturally) you canaEURtmt rely on asset sales to be part of your core operations every quarter.
Now if we look at DOC again, we see that it generated $1.09 per share in FFO over the past four quarters. Since it paid out 92 cents per share in dividends, its real payout ratio is 84%.
aEURoeWait, isnaEURtmt 84% still unsafe?aEUR
ThataEURtms the last difference you need to know when evaluating REITs: Well-run real estate owners such as Physicians Realty Trust can easily manage ratios up to 90%. To be honest, figures that high are pretty common because of the nature of the business: REITs collect steady rent checks, take what they need to keep the lights on and send the rest of the money to you.
Lesson learned: DonaEURtmt be fooled.
These three high-yielding REITs, for instance, would send up a warning flare on any basic screener. But IaEURtmll show you that theyaEURtmre actually quite safe when you do this vital aEURoesecond-levelaEUR math.
Realty Income (O)
Dividend Yield: 3.9%
Realty Income (O) leases out single-tenant properties to a number of hardy tenants, including the likes of Walgreens (WBA), 7-Eleven, LA Fitness and AMC Theaters (AMC). It does so on a net-lease basis, which means net of property taxes, insurance and maintenance, resulting in a much more predictable revenue stream than your typical REIT.
Realty Income also is the standard bearer for monthly dividend stocks. So much so, in fact, that it proudly splashes its self-given nicknameaEUR"aEURoeThe Monthly Dividend CompanyaEURaEUR"all over its website. It has earned that nickname, however, amassing a pile of 588 consecutive monthly dividend distributions, including 87 straight quarterly payout hikes.
You canaEURtmt ask for a better reputation among REIT investors, but newer investors to the retail space could understandably be scared away.
After all, Realty Income pays out almost twice as much in dividends as it earns in net income. In fact, if you ask FinVizaEUR"one of the best free stock screenersaEUR"Realty Income has one of the five highest payout ratios among retail REITs.
Reality, fortunately, is much kinder.
A closer look, via Ycharts, shows that Realty Income passes the cash dividend payout ratio test, which is a small relief in itself. More importantly, FFO easily covers the dividend and then some. Realty Income has raked in $3.22 per share in funds from operations over the trailing 12-month period, but paid out only $2.653 in dividends. ThataEURtms a comfortable 82% FFO payout ratio.
Just note that Realty Income doesnaEURtmt deliver a screamingly high yield, and youaEURtmre paying dearly for the REIT at the moment. O shares trade at almost 22 times FFO at the moment, when so many others trade in the teens.
Monmouth Real Estate Investment Corporation (MNR)
Dividend Yield: 4.9%
Monmouth Real Estate Investment Corporation (MNR) is another net-lease REIT, but in this case, the focus is industrial properties.
Warehouses have always been a familiar sight across the company, but theyaEURtmve bloomed in the age of Amazon.com (AMZN) and e-commerce. As internet retailersaEUR"and traditional retailers doing more of their sales onlineaEUR"have grown, so too has the need to stockpile products in these facilities for eventual delivery to consumersaEURtm homes.
MonmouthaEURtms portfolio is an easily recognizable blend of traditional warehouse needs and beneficiaries of the new retail environment. It has tenants such as Coca-Cola (KO) and Milwaukee Tool, but also retailers such as Ulta Beauty (ULTA), Best Buy (BBY) and Home Depot (HD) aEUR
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.