My REIT income dropped 31 percent after I'd budgeted around the old number

I wanted income without a second job, so 55k went into three REITs picked for yield and sector spread. Residential, net lease retail, and a healthcare name. Blended yield at purchase was about 5.6 percent, so roughly 3,080 a year, which I put into my monthly budget at about 256.

That was the mistake. I budgeted the number as if it were rent on a lease.

Over the next year one of the three cut its distribution, another held it flat while I'd assumed small annual increases, and the third raised it slightly. Blended income came in around 2,120, down about 31 percent from what I'd planned. The gap was roughly 80 a month against a budget that didn't have 80 a month of slack in it. I ended up putting a couple of months of groceries on a card, which is a small thing that felt much bigger than it was.

The share prices were roughly flat overall across the three, so this isn't a story about the market falling. It's a story about me treating a variable payment as a fixed one.

What I understand now that I didn't: a REIT dividend is a board decision made every quarter. The rule that pushes REITs to distribute most of their taxable income sets a floor on the payout ratio, and it doesn't promise you a dollar amount, and it doesn't stop a cut when the underlying income falls.

What I'd do differently: budget on maybe 70 percent of the stated yield, treat anything above that as extra, and hold more than three names so one board's decision doesn't move a third of my income.

Answer

1samantha_ruizAU4APRO6

The fix isn't really the 70 percent haircut, though that helps. The structural problem is that you connected a variable income stream directly to a monthly expense line with no buffer between them.

What I'd build instead: let the dividends land in a separate cash account, let them accumulate for four quarters without touching them, and then pay yourself a fixed monthly amount out of that account based on what actually arrived the prior year. Now a cut hits the buffer account first, and you get a full year of warning before your grocery budget notices. You'd also stop needing to guess at forward yields, because you'd be spending money you already received.

On diversification, more names helps, and it helps less than people think, because sector shocks hit several names at once. A broad REIT index fund distributes across dozens of holdings and the distribution still varies quarter to quarter. The buffer is what makes variability tolerable, at any number of holdings.

And separately, you should confirm with an accountant how these distributions get taxed in your situation, because the after-tax number is the one your budget actually spends, and the treatment isn't the same as ordinary stock dividends.

6 replies

1karen_whitfieldPG4APRO7

Three names is the part I'd fix first. Any single position is one board vote away from repricing your budget, and at three names each one is a third of your income line.

I hold land and get no income at all from most of it, so I'm the wrong person on cash flow. But the discipline transfers. You don't budget on the best case of an asset you don't control.

-1nicole_adeyemiPassivePRO5

"Budgeted the number as if it were rent on a lease" is the sentence. And even rent isn't that reliable, ask anyone who's had a tenant leave in month three of a twelve month term.

Did you look at the payout ratios before buying? The one that cut, was there a sign in the filing?

2bmoreno23AB1B

I'm new to this, and what surprises me is that a 5.6 percent blended yield sounds modest, not aggressive. I'd have assumed the risky version was chasing 9 or 10. So a cut can come out of a position that looked reasonable?

1devon_pierce Get yoursPRO5

@ember yes. A moderate yield tells you the market isn't screaming about the payout, it doesn't tell you the payout is safe. Property-level income can fall for ordinary reasons, a big tenant leaves, occupancy slips, debt reprices at maturity, and then the board adjusts.

@marlow the 70 percent rule of thumb you landed on is directionally sensible and I'd want to know where 70 came from. If it's a guess, say it's a guess.

1brandonlee36Passive

@keystone's buffer account is what I do with rent from my small portfolio and it works for the same reason. A year of collections in front of a year of spending.

@marlow one more thing. You said prices were roughly flat, and that's actually the notable part. You took the income hit without the price hit, which means the market had mostly priced the cut in already. Whoever was watching the payout ratio saw this before you did.