Real estate investment trusts (REITs) have to pay out 90% of their taxable income as dividends, which allows them to avoid corporate-level taxes. That generally makes these property landlords great dividend payers, which is why income-focused investors tend to like them. But what if there was another tool at your disposal that could make investing in dividend paying REITs even better? Luckily there is, and it's super easy to use.
Big yield
A lot of dividend investors get caught up in one simple number -- dividend yield. The bigger the better! And, to be fair, dividend yield is important on many fronts. For example, it is a tangible return on your investment that can be used to pay living expenses in retirement. Also, dividend yield can be used as a valuation tool, with historically high yields suggesting a stock could be attractively priced.
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The problem is that a fat dividend yield alone isn't enough information to make an educated investment decision. Big yields are often a sign that a company is facing material headwinds. You need to understand the problems and the potential impact they could have on the company before you jump aboard. There's always a risk/reward trade-off. If the company, REITs included, can't overcome the obstacles it faces the dividend could get cut. The yield probably won't be so attractive after that.
The better plan of attack for real estate investors is to focus on REITs that have a history of increasing dividends over time. Long histories of annual dividend increases don't happen by accident, so they tend to highlight well-run companies. Dividend King Federal Realty, for example, has a record of raising its annual payout for more than 50 years. It is the longest streak in the sector, but not the only impressive one, with REITs like Realty Income, Universal Health Realty Trust, National Retail Properties, and Essex Property Trust all in the Dividend Aristocrat space, with 25 or more annual hikes.
Rising value
But there's an intertwining here that's important. As noted, a high yield can come about if a company is facing headwinds. So yield is a valuation tool, with low historical yields indicating when a stock is dear and vice versa. But companies that increasing their dividend-paying ability over time are usually also improving their businesses over time. And as the dividend grows, the stock generally inches up along with it to maintain the yield at what Wall Street considers an appropriate valuation. It's the same logic that underpins the price-to-earnings ratio, only dividends tend to be more consistent over time.
Given the nature of REITs as property owners, slow and steady dividend increases are generally the norm. However, that doesn't mean you can't find REITs with rapid dividend growth. For example, Equity Lifestyle Properties (ELS -0.36%) has increased its dividend at a huge 15% a year, on average, over the past decade. During the past year, the dividend was increased about 8%.
Over the past decade, the REIT's portfolio of manufactured-home communities, recreational-vehicle parks, and campgrounds has rewarded investors with an income increase of more than 230% increase. And the stock itself has risen about 340% on top of that, increasing investors' net worth as well.
Balance is the key
Before you run out looking for big dividend-growth REITs, step back and take a deep breath. Rapid dividend increases can only go on for so long before scale starts to limit growth opportunities. And you want to make sure that the business backing the dividend you are buying is strong. However, if you start your REIT search by looking for landlords that have a history of raising their dividends, you'll be giving yourself a leg up on investors who only look at yield.
