Which REITs are reliable?
The COVID-19 pandemic has taken a toll on many sectors across the globe. The real estate sector is one of the hard-hit areas of the economy. As restaurants, bars, retail stores, and offices shut down around the world, landlords, property owners, and property management companies are going through an extended period of declining revenues. It is no surprise that the S&P 500 Global REIT index has fallen more than 30% since the middle of February 2020. In regular times, REITs (Real Estate Income Trusts) are some of the most popular types of securities investors hold for their abundant and reliable dividend income. However, the COVID-19 pandemic has caused many REITs' investors to question the reliability of investing in REITs. In this blog post, we share a list of reliable REITs worthy of attention despite the COVID-19 impact.
Aren't all REITs reliable?
When we published the COVID-19 investment resources, we discussed not every company can survive the COVID-19 pandemic. Those with ample cash and access to capital and manageable debt have the highest likelihood of going through the COVID-19 economic crisis and coming out of it ready to take off. The same logic applies to REITs. Not all REITs are worth your investment dollars. Some REITs have the operational strengths that can survive through the economy's cycles and keep rewarding the investors with a reliable source of income.
How to find Reliable REITs?
There are 335 REITs listed on the main U.S. stock exchanges. In the first step, we wanted to get rid of those with massive liabilities and debt. REITs with high-interest expenses compared to their earnings (EBIT) are the worrisome bunch. Companies with debt have to be able to cover the interest expense of their debt using their earnings. Just by using that as criteria, nearly two-thirds of REITs are out of the list. To make the search for reliable REITs even more precise, we applied a few additional filters:
Those criteria are pretty standard for evaluating companies with strong balance sheets. However, there is one data point that is particularly important for assessing REITs. For a non-REIT dividend-paying stock, typically, investors look at the stock's payout ratio. This ratio refers to the percentage of the company's earnings that is used to fund dividends. When such a rate goes above 70% to 80%, it is seen as a red flag. All companies need to reinvest a portion of their earnings to grow, and it's not an operationally savvy idea to borrow money to pay dividends. Therefore, the dividend payout ratio is an indicator of the sustainability of the dividend payment in the future. If a company uses almost all of its earnings to pay dividends, or worst, if it uses funds beyond its profits to fund its dividend payments, the sustainability of the dividend payment is questionable. The same logic applies to REITs. However, the usual payout ratio is not the right way of measuring the sustainability of a REIT's dividend.
Best Brokerage for Dividend Investors
REITs are one of the best dividend-paying investments. Especially if you choose to reinvest your dividend income back into your portfolio, gradually and steadily, you own more of the companies you have initially added to your portfolio. All you need to do is to sign up for a brokerage account that allows you to easily opt-in a dividend reinvestment option (a.k.a. DRIP). We like M1 Finance, particularly, for its easy ways of managing your account, including opting in a DRIP offer.
What is a FFO payout ratio?
Being in the business real estate, a REIT has a high depreciation cost. This cost is purely an accounting-driven number, and it is not an actual cash expense. Companies use depreciation to "expense" the initial capital they invest in acquiring the real estate over a few years. This accounting practice allows investment in real estate to be worthwhile by reducing the nominal earnings of the property or landowner and giving the owner significant savings in the amount of income tax that is calculated using the company's earnings. Because of this accounting practice, the earnings of a REIT are artificially (of course, legally) underestimated. Consequently, you cannot blame a REIT for having a high payout ratio and use it as a reason to skip investing in it. Instead, REIT investors look at FFO per share (Funds from Operations per share) and use that as a replacement for the earnings per share to calculate the company's payout ratio. Accordingly, we used the FFO payout ratio in our search for reliable REITs.
That adjustment in our screening process resulted in an additional 20 or so REITs that are reliable but would have been rejected if we used the standard calculations of the payout ratio.
Once we applied all the above-mentioned filters, the final results were a list of 32 REITs most likely reliable enough to go through the COVID-19 pandemic or any other economic crisis and come out of it without the need to cut their dividends.
The list is available to all Stock Card users on the Discover page using the "Reliable REITs" tag. You can access it by creating a free account on Stock Card.
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