Four REIT stocks pass a strict quality test, with dividend yields as high as 6.19%

Investors can never predict the exact timing of rate cuts, but many expect the Federal Open Market Committee to begin cutting the target range for the federal funds rate on September 18, after its next policy meeting.

The federal funds rate has been between 5.25% and 5.50% since last July. That has allowed some income-oriented investors to avoid tough decisions, with 5% bank CDs available. An investor wondering why an adviser would recommend a bond investment when attractive CD rates (in accounts protected by the Federal Deposit Insurance Corp.) are easy to come by may not understand that “short-term bank yields are disappearing,” said Lewis Altfest, CEO of Altfest Personal Wealth Management, which he founded in 1983 and which manages $1.7 billion in client assets.

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Evidence that some investors agree with Altfest comes from the inverted yield curve for U.S. Treasuries. The Federal Reserve has kept short-term interest rates high in an effort to curb inflation. The yield on three-month Treasuries BX:TMUBMUSD03M was 5.22% early Monday, while the yield on the 10-year Treasuries BX:TMUBMUSD10Y was just 3.89%. In a lower-inflation environment, it would be normal for long-term rates to be higher than short-term rates.

Long-term interest rates are already low because demand for long-term bonds is high — investors are flocking to long-term bonds, which could indicate that they expect the U.S. to enter a recession, or at least that they expect short-term interest rates to fall. When bond prices rise, their market yields fall.

Share prices of real estate investment trusts can move in a similar way to bonds (in the opposite direction of interest rates) because these companies are required to pass on at least 90% of their profits to shareholders in the form of dividends, in exchange for tax benefits. REITs fall into two broad categories. Equity REITs own and lease properties or sell them for a profit after acquiring, developing or improving them. Mortgage REITs are primarily lenders or investors in mortgage-backed securities.

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So far this year, the S&P 500 SPX real estate sector is up just 4.3% excluding dividends, the second-worst performer among the 11 sectors that make up the U.S. large-cap benchmark stock index. That could signal concerns about high vacancy rates and declining real estate values ​​for office buildings. That’s one reason you should do your own research to form your own opinion when considering an investment.

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Screening of REIT stocks

For a broad look at the REIT sector, we started with the Russell 3000 Index RUA, which is designed to represent about 98% of the companies publicly traded in the U.S. The index includes 172 REITs of various types.

Investors will naturally be interested in REITs with high dividend yields. So the screen focuses on the ability of companies to increase their payouts or at least avoid cutting them.

Within the REIT industry, the metric “funds from operations,” or FFO, is commonly used to measure a company’s cash flow available for dividends. FFO adds depreciation and amortization (non-cash figures) to earnings, while netting out gains on the sale of properties. Further down the line, the costs of maintaining properties that REITs rent out are netted out to “adjusted funds from operations,” or AFFO.

An obvious way to screen REITs for dividend coverage would be to look at consensus AFFO estimates. But we went further and took a conservative approach.

In an interview with MarketWatch, Altfest said that REITs with high dividend yields “can be attractive,” but warned investors not to expect growth for their stock prices. “It’s going to be hard for these companies to grow because they’re paying out the largest percentage of cash flow,” he said.

In making our initial selection for the REIT screening, we narrowed the list of 172 companies down to 108 that were covered by at least five analysts surveyed by FactSet and for which consensus 2025 AFFO estimates were available. We divided the AFFO per-share estimates by current stock prices to arrive at estimated AFFO yields. Comparing the AFFO yields to current dividend yields revealed whether there was room to pay higher dividends, based on the estimates.

There were 87 REITs left with a stated headroom for 2025 of at least 1%. And when we sorted this list by current dividend yield, there were four REITs with yields above 10%, with two above 13%.

“There are people who get caught up in the yields of REITs,” Altfest told MarketWatch. “The 13% you’re talking about is clearly not a high-quality yield. There’s something going on.” In other words, the high dividend yield means investors are avoiding these stocks.

For additional screens for quality, Altfest suggested looking at revenues. “If you see their revenues going down, that could be a sign of trouble — for example, in an office REIT, where leases are expiring and they’re having trouble re-signing or bringing someone else in,” or where the REIT needs to reduce its cost per square foot at renewal.

So we further trimmed our REIT list by removing any companies whose quarterly revenue per share declined from the previous quarter or from the year-ago quarter. We used per-share numbers instead of raw revenue numbers because per-share numbers reflect any dilution to shareholders from the issuance of new equity. This left us with 38 REITs.

Since depreciation and amortization are added back to earnings as part of the AFFO calculation, we went one step further. Altfest asked: “Isn’t the highest portion of the dividend coming from depreciation?”

It turns out that of our 38 remaining REITs, only four passed this final portion of the enhanced screening. They are all equity REITs. Here they are, sorted by dividend yield:

Click on the tickers to learn more about each company.

Click here for Tomi Kilgore’s guide to the wealth of information available for free on MarketWatch’s quote page.

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