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Real estate investment trusts, or REITs, are known for their dividends. However, some REITs pay significantly higher dividend yields than their peers. In this discussion, we'll look at why REITs pay such high dividends and how you can tell if a REIT's high dividend yield is too good to be true. Then, we'll take a closer look at three high-yield REITs that could be worth a look right now.
Before we dive in, it's important to mention that this discussion is about high-yield equity REITs, meaning companies that invest in properties. Mortgage REITs often pay high dividends but are a completely different type of investment.
Why do REITs pay such high dividends?
In simple terms, REITs tend to pay higher dividend yields than typical S&P 500 dividend stocks because they have to.
One of the requirements for being a REIT is that they pay out a minimum of 90% of their taxable income to shareholders. In exchange for doing so, they don't have to pay corporate tax on their income and can simply pass their profits through to shareholders.
One important concept is that taxable income doesn't typically tell the whole story when it comes to a REIT's income. Without getting too deep into the reasons, a REIT's actual income (and ability to pay dividends) is best represented by its funds from operations, or FFO, which is generally significantly higher than its net income. So, most REITs actually pay out more than 100% of their taxable income, and it's completely sustainable for them to do so.
Is a high-yield REIT's dividend safe?
One of the most important concepts for equity REIT investors to understand -- especially those who want high dividends -- is that of a yield trap. In a nutshell, a yield trap is a stock that has both a high dividend yield and problems with the underlying business, such as declining revenue or excessive leverage. The point is that it's important to make sure a dividend is not only high but also sustainable.
There are a few red flags that can help us detect potential trouble in a REIT's dividend:
- High FFO payout ratio: REITs tend to pay out most of their income to investors, but paying out too much is unsustainable. Most REITs pay out 50% to 90% of their funds from operations, or FFO. An FFO payout ratio that's higher than this range (especially over 100%) could be a red flag.
- Declining revenue or FFO: Even if a REIT has an acceptable FFO payout ratio, it won't for long if its revenue is steadily declining. We're seeing this quite a bit in lower-quality retail REITs in recent years. I typically don't suggest investing in REITs that don't have steady revenue growth for at least the past several years.
- High leverage ratio: It's a smart idea to avoid companies with high debt. And while there's no set level of "too high," one good idea is to compare a REIT's debt-to-EBITDA ratio with a couple of its peers. If it's significantly higher, it could be a sign to stay away.
Now, the presence of any of these red flags doesn't automatically mean that a dividend cut is inevitable or that the business is in trouble. For example, it's entirely possible that a company sold some of its assets at a profit, but since these assets are no longer generating income, revenue has declined. Or, maybe the REIT's payout ratio is high right now because of temporary rent deferrals related to the coronavirus outbreak. However, the presence of these red flags without a good explanation could be a sign of an unsafe dividend.
3 top high-yield REITs to buy now
Currently, the average REIT yields 3.56%, which is more than double the 1.4% yield for stocks in the S&P 500. Many REITs pay even higher dividend yields. Three high-yielders that look like attractive buys this May for investors are Medical Properties Trust (NYSE: MPW), STAG Industrial (NYSE: STAG), and W.P. Carey (NYSE: WPC).
A healthy payout
Healthcare REIT Medical Properties Trust currently yields 5%. It supports that payout with the steady cash flow generated by its hospital properties, which it leases to operators under triple net leases. Despite its properties being ground zero for a raging pandemic, the REIT didn't have any trouble collecting rent last year.
Instead, 2020 was a banner year for the company, as it closed nearly $3.6 billion of new investments, which helped grow its normalized FFO per share by 21%. Meanwhile, Medical Properties Trust has gotten 2021 off to an excellent start, as it's secured more than $1 billion of additional investments. That recently gave it the confidence to increase its dividend for the eighth straight year.
With a solid balance sheet, reasonable payout ratio, and access to capital, Medical Properties has the funding to keep acquiring hospital properties, implying that it should have no problem continuing to grow its attractive dividend in the coming years.
Lots of room to grow
STAG Industrial currently yields 4%. The industrial REIT supports that payout with a diversified portfolio of warehouses, light manufacturing facilities, and flex/office space. These properties are essential to their tenants, enabling STAG to collect nearly all the rent it billed last year.
The company steadily expands its portfolio via acquisitions. It expects to purchase $800 million to $1.2 billion of properties per year over the next five years. It will often buy value-add properties and leverage its extensive leasing and redevelopment expertise to create additional shareholder value.
This acquisition strategy has enabled the company to steadily grow its dividend. That trend should continue in the coming years, given the REIT's plan to pour billions of dollars into expanding its portfolio over the next five years.
A steady grower
W.P. Carey currently yields 5.5%. The diversified REIT supports that payout by owning a wide range of mission-critical properties. Nearly half its portfolios are warehouses and other industrial buildings. In addition to those properties, it also owns offices, retail properties, self-storage facilities, and other properties triple net leased to operating tenants. Because the REIT focuses on owning mission-critical real estate, it routinely collects a high percentage of its rent.
W.P. Carey steadily expands its portfolio via acquisition. It made $825.9 million of investments last year and should purchase another $1 billion to $1.5 billion of properties this year. Those additions should enable W.P. Carey to continue growing its dividend, which it's done every year since going public in 1998.
Great REITs for yield-seeking investors
Medical Properties Trust, STAG Industrial, and W.P. Carey all pay attractive dividends that yield more than 4%. Even better: All three have a long history of growing their payouts, which should continue for the foreseeable future. That income with upside makes them great high-yield REITs to consider adding to your portfolio this May to boost your income stream.
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