High-yield dividend REITs are quite attractive since they offer high and continuing income. But make sure you have the full picture.
Read This before You Plunge into High-yield Dividend REITs
Into the New Year, you may have stock trading and investment resolutions to make and one of them could be investing in stocks offering high dividends.
High-yield Dividend Stocks Are Irresistible
High-yield dividend stocks are attractive and irresistible, and understandably so. The possibility of earning not only a high income but also a continuing one is hard to resist, but it can push you to take greater risks than you usually do. That could result in your capital really getting depleted. Analysts advise caution with regard to high-yield stocks since such massive yields are an indication that the dividends these companies are paying are unsustainable for them and they are in big trouble. You wouldn’t want to jump head on into quicksand even if it’s filled with cocoa!
But if done in a measured manner, buying stocks offering reasonable distribution payouts can be rewarding. Here are some tips by Chuck Saletta, an experienced Motley Fool analyst, that are worth remembering before taking the plunge into high-yield dividend REITs (real estate investment trusts).
REITs Are Legally Required to Pay High Dividends
While dividends are usually paid by companies whose profit margins are high enough to set apart some of them for paying dividends, some companies are legally required to pay out really high dividends – 90% of their income. These stocks are REITs, and they need to pay these high dividends to retain the corporate tax advantages offered to companies like them. When they maintain the aforementioned level of dividend, REITs can classify these dividends as expenses and avoid paying corporate taxes on that income generated by passing it to their shareholders. For shareholders though, REIT dividends can only be classified as ordinary income and are therefore taxed.
Payments that Qualify for Tax Reductions
Saletta notes that some REITs pay out over 100% of the income they generate in their distributions. These excess payments get qualified frequently as return of capital or capital gains, based on the manner in which the REIT generated the money. These extra shareholder distributions could get you tax reductions unlike the ordinary income. But these extra distributions drain the company’s capital.
Equity REIT and Mortgage REIT
Since we are on the topic of REITs, Saletta reminds that there are two kinds of REITs – equity REITs and mortgage REITs. When it comes to equity REITs, they own physical properties. They tend to pay distributions that are more than their reported income levels due to the fact that these REITs can keep some of their cash flows from being classified as income because of depreciation on the value of their buildings. If these equity REITS increase the rents on their facilities, they can increase their income over a period of time.
Mortgage REITs, on the other hand, buy investment in mortgages or securities backed by mortgages. They usually have greater dividend yields. This, Saletta notes, is an indication of their heavy leverage and exposure to significant interest rate risk. If these interest rates continue rising, the mortgage REITs could have their margins squeezed while their borrowing costs rise as their existing holdings drop in value.
A Word of Caution
Saletta brings to light a very important point with regard to high dividends. For companies that are legally required to pay high dividends, the law only holds true if their business is actually making money. If a company’s ability to generate cash is not sufficient, it will have to cut its dividend payment so it can protect its operations. A dividend cut usually results in a reduced share price for the company, but it certainly wouldn’t be as bad as missing a bond payment which would result in default.
In the current environment of low interest, you find these high-yield dividend REITs to be attractive investment options. They are more attractive than bonds. But make sure that you fish out companies having a dividend structure that is well-supported, and can convince investors like you that the dividends they are maintaining can continue and not reduce. Trade all real-estate stocks, both long and short commission free at TradeZero.
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