Most Investors Get This Wrong About REITs
If you're looking at a company's dividend stats and you see that they have a payout ratio greater than 100%, it should definitely raise some eyebrows. A payout ratio that high would mean that the company is paying out more in dividends than they're actually earning, and should be viewed as a sure sign of a looming dividend cut.
Now while the payout ratio is a reliable metric when it comes to analyzing the dividend safety of regular companies like Procter & Gamble (PG) or Coca-Cola (KO), and a payout ratio greater than 100% for these companies would certainly raise some eyebrows, REITs like to dance to a different beat. They have their own metric called the Funds from Operations (FFO) Payout Ratio, and that's what we need to focus on.
Why the difference, you ask? Well, REITs have a unique structure that requires them to distribute a significant portion of their income to shareholders. They do this by paying out most of their taxable income in the form of dividends, and in return, they receive favorable tax benefits.
Because of this, the regular payout ratio doesn't quite capture the full picture of a REIT's dividend coverage and financial health, and is often a gut-wrenchingly higher number than the FFO payout ratio.
Here are a few examples to show you the difference:
O - Payout Ratio: 209% / FFO Payout Ratio: 73%
WPC - Payout Ratio: 117% / FFO Payout Ratio: 79%
AMT - Payout Ratio: 196% / FFO Payout Ratio: 55%
As you can see from the numbers above, the distinction between these two ratios is an important one to understand. Without knowing the difference, you'd be looking at all these REITs thinking their dividends don't stand a chance!
And now that we've got that all cleared up, I want to hear from you. Which REITs do you have in your portfolio? Write to me here and let me know. I'd be curious to hear if we have any of the same ones.
And a big thank you to the 5 readers who responded last week. You rock! 🙌
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