Is a 6 percent REIT yield a warning sign or normal?

Question

Just started looking at this stuff. Two things tripped me up in the same afternoon.

First, I pulled up a REIT and its price-to-earnings number looked insane compared to normal stocks, but an article said to use FFO instead and I don't know what that stands for or why earnings apparently don't work here.

Second, I sorted a list by dividend yield and the top ones were around 9 to 12 percent while most were 4 to 5. My gut says the high ones are broken somehow but I don't know what to check. Is a 6 percent yield fine and a 10 percent yield a trap, and where's the line?

Rena Guide · Accepted Answer

FFO stands for funds from operations. Net earnings for a property owner get pushed down by depreciation, which is a bookkeeping charge for the building wearing out. It's a real expense in the long run, but it's not cash leaving the company this year, and well-maintained real estate often holds or gains value while the books say it's declining. So earnings understate the cash a REIT actually generates, and a price-to-earnings ratio for a REIT looks strange for that reason. FFO adds depreciation and amortization back and strips out gains from selling buildings, which are one-time events. You'll also see AFFO, adjusted funds from operations, which subtracts recurring capital spending like re-roofing and tenant improvements. AFFO is closer to what could actually be paid out.

On yield: dividend yield is the annual dividend divided by the share price, so it goes up when the dividend rises or when the price falls. A 10 percent yield is usually the price telling you something. The check is the payout ratio against AFFO. If a REIT pays out more than it generates, the dividend is being funded from borrowing or asset sales and can be cut. Look at the last several years of dividend history too.

Broad equity REITs typically yield in the 4 to 6 percent range, so 6 percent isn't alarming by itself. There's no clean line, and the sector matters as much as the number. Mortgage REITs run structurally higher yields because they own loans rather than buildings, and their share prices behave very differently when interest rates move. If your high-yield list is mostly mortgage REITs and office, you've found the two explanations.

gregpowell66 · Answer

Coming from construction I'll say the depreciation piece clicked for me fast. We build a building, it lasts 50 years, the accountant writes it down over 27 or 39. The paper loss has nothing to do with the roof.

bmoreno23 · Answer

AFFO is the one I'd never heard of. So the dividend I care about should be compared against AFFO and not FFO, because FFO ignores the money that goes back into the building?

chriswalton8 · Answer

@ember yes, and be aware companies define AFFO themselves. It isn't a standardized number the way GAAP earnings are. Two REITs can compute it differently and you can't always compare them line for line.

jordan_ellis2 · Answer

Pulling the dividend history rather than the yield is what finally helped me, after six months of reading. A REIT that raised its dividend eleven years running tells you more than a snapshot ratio.

dpatel_re · Answer

Payout against AFFO is the right check but I'd add debt maturity schedule. A REIT with a wall of maturities coming due has to refinance at whatever rates exist then, and that can squeeze the dividend even when occupancy is fine. It's in the notes to the financials, usually a table by year.

samantha_ruiz · Answer

@sextant that's the part I underestimated. REITs live on external capital because they distribute most of their income, so they can't retain much to fund growth. Rates matter to them more than to most equities.

stephen_ok9 · Answer

Which is also why the current valuation discount is interesting rather than just sad. Cheap shares plus tightening new supply is a decent setup for the owners of existing buildings, assuming the rate picture actually eases.

joe_delgado5 · Answer

Or the discount stays for another three years and everyone who bought the thesis gets bored first. That's happened before.

hannah_west29 · Answer

@flint fair, but boredom pays 4 to 6 percent here while you wait. Different from waiting on a flip that isn't moving.

derekj19 · Answer

@girder on your original sort, did you check whether those 12 percent names had cut the dividend at any point? Half the time the yield is calculated off a trailing dividend that no longer exists.

Is a 6 percent REIT yield a warning sign or normal?

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