What makes the yield of a REIT increase?
Thanks to Hothead_randy for this question, which really gets to the heart of REITs and what makes them interesting.
The short answer is that a REIT’s estimated yield can increase if the stock price goes down or if the dividend increases.
For a longer answer, let’s dig into both and get a better feel for the relationship between the REIT’s income stream, dividends, and the stock price.
The concept of “yield” measures how much income in dividends an investor could expect relative to the REIT’s stock price.
For example, if Fake REIT Inc. (FREIT) planned to declare dividends of P0.25/share per quarter, that would be P1.00/share for the whole year, and if FREIT’s stock price was P10.00/share, that would be an estimated yield of 10% (forward annual dividend / current stock price).
If FREIT’s stock price increases to P11.00/share tomorrow, but the amount of dividends that we expect FREIT to declare doesn’t, then when we put those numbers into the equation (P1.00 annual dividend / P11.00 stock price) we get a new estimated yield of 9.1%.
If instead of going up, FREIT’s stock price dropped to P9.00/share, and expected dividends remained the same, then we’d get a new estimated yield of 11.1%.
It makes intuitive sense that the return on investment would be better if we paid only P9.00 per share for the right to receive P1.00 in dividends, than if we paid P11.00 per share for that same right.
Sticking with the FREIT example, let’s assume that the REIT’s stock price doesn’t change at all, it’s stuck at P10.00/share, but that the REIT operates a portfolio of renewable energy power plants that sell electricity to the open market.
Then something happens internationally that drives up the costs of everything, so FREIT is getting way better prices for the electricity that it’s selling on the open market, and that increase is projected to remain in place for the next 12 months.
That increases FREIT’s income, which increases its net income, which increases the size of the dividend that FREIT is legally required to declare. FREIT is now expected to declare P0.50 in dividends per quarter (P2.00 per year), and if we plug that into the equation (P2.00 annual dividends / P10.00 stock price) we get an estimated yield of 20%.
These are over-simplified examples that ignore the many other factors that can push and pull on a REIT’s stock price and on a REIT’s income/dividend stream, but they’re only meant to demonstrate the fundamental relationship between dividends and price when we’re talking about yields.
MB BOTTOM-LINE
There aren’t really any FREITs in the real world. Nothing is certain. Take all of the commercial REITs as an example.
They’ve had to deal with COVID interrupting work in office towers, with the government’s weird top-down work-from-home rules, and they’ve also had to contend with blowback from the foreign and economic policy in terms of POGOs and whether those toxic tenants will be permitted to remain, encouraged to flourish, or required to leave.
Some REITs might be vulnerable to storms blocking solar panels.
Some might be vulnerable to supply-chain issues that shut stores and keep people away from malls.
Some REITs choose to suddenly chop their dividend by 25% without explanation, and that’s just the way life is.
This is why yields tend to be lower for REITs that are well-run, stable, and consistent.
Buyers are willing to pay more for that safety and certainty.
That demand drives the price of the stock up a bit, and as we’ve discussed, that pulls down the yield!
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Merkado Barkada's opinions are provided for informational purposes only, and should not be considered a recommendation to buy or sell any particular stock. These daily articles are not updated with new information, so each investor must do his or her own due diligence before trading, as the facts and figures in each particular article may have changed.
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