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Monthly REIT Income: The High-Yield Risk

By Reuben Gregg Brewer – Nov 19, 2013 at 10:04AM

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If you want to replace your monthly income in retirement, monthly dividend paying REITs are a great option. Just make sure you understand the risks you're taking.

One of the biggest changes in retirement is the loss of your salary. Buying securities that pay monthly dividends can replace that lost income. There are a number of real estate investment trusts (REIT) that pay monthly, but you should be careful to avoid the potential siren song of a high yield.

A great company
Realty Income (O 1.60%) calls itself "the monthly dividend company." It owns over 3,800 properties in 49 states. It generally uses a triple net lease model, in which it owns the property, but the lessee essentially pays for all of the costs such as maintenance, taxes, and insurance.

Realty Income has paid monthly dividends for 44 years, increasing the distribution 73 times. Between 1994 and 2012, the average annual increase was around 7%. That's about twice the historical inflation rate and is analogous to getting an annual raise.

Moreover, the REIT is conservatively managed. Debt makes up just 35% of the company's capital structure. Realty Income is also conservative regarding the leases it signs and the properties it purchases. This helped it weather the 2007 to 2009 recession without a dividend cut. More recently, Realty Income has been focusing on higher-quality tenants.

Realty Income is among the highest-quality REITs and has proven it can provide you with dependable monthly income.

The yield trap
With a yield of nearly 5%, a million-dollar portfolio invested entirely in Realty Income stock would bring in almost $50,000 a year (I'm rounding to make the math easier.) That's not a small sum, but what if you could own a monthly dividend payer that brought in $80k or more a year?

That's where companies like Whitstone REIT (WSR 2.38%), Wheeler REIT (WHLR 2.54%), and Gladstone Land (LAND 0.44%) come into play. This trio yields from around 8% to 10% -- but not without risks.

For example, Whitestone REIT owns shopping centers in secondary and tertiary markets. It generally buys properties that need to be repaired and updated. That's an interesting business model that can lead to plenty of upside, but it also comes with notable redevelopment risks. As a result, the company's monthly dividend hasn't increased in several years.

Investors in Whitstone REIT, which at mid-year owned just 55 properties in three states, are taking on more business risk and aren't getting annual raises. Realty Income's 5% yield pales in comparison to Whitestone's 8% or so, but the added risk and lack of dividend growth should be a big concern.

Wheeler has only been public since late 2012 and owns just 15 properties across seven states. Like Whitestone, it focuses on secondary and tertiary markets. The company's prospectus specifically states that the portfolio doesn't produce enough income to cover the REIT's 10% yield. It will either have to grow fast or eventually cut its dividend. Doubling your income would be nice, but the risk of a pay cut is a big issue.

Another concern is that Jon Wheeler, the company's founder, owns or is involved with numerous properties that are likely to be sold to Wheeler REIT over time. That provides an avenue for portfolio growth, but it also complicates such transactions. Taken as a whole, the $50k a year "pay" increase from owning Wheeler over Realty Income comes with real risks and will require careful monitoring if you take the plunge.

Gladstone Land, meanwhile, owns farmland. It uses the same triple net lease format as Realty Income, which keeps costs low, but farmland is a unique niche that is pretty much untested in the REIT structure. At the end of the day, it might not be able to find enough sellers of high-quality farms to support long-term growth.

Even though a yield near 9% may be enticing, this REIT is navigating uncharted waters. It will also be difficult for investors to keep tabs on what Gladstone Land actually owns unless you are a farmer by trade.

This isn't to suggest that Whitestone, Gladstone Land, and Wheeler are bad companies, of course. They do, however, come with greater risks than Realty Income. If you are looking to replace your monthly paycheck with a monthly dividend check, you need to think carefully about the interplay between risk and return; this quartet highlights some of those trade-offs. In the end, you may decide that a higher yield is worth some added risk, but it's not true in every case. 

Reuben Brewer has a position in Realty Income. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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