REITs worth a look

BOSTON – When a seasoned real estate investor like Ross Meredith admits to being scared, you know it’s time to do your homework before leaping back into a battered market.

Meredith, a 63-year-old retired bank examiner from Salt Lake City, has traded shares of real estate investment trusts for more than three decades. REITs are companies that own, and often operate, income-producing real estate.

Meredith is a self-described “dividend-aholic” who relies on REITs’ quarterly payouts to supplement retirement savings and earn spending money for travel. After all, REITs are mostly about dividends. To escape corporate taxes, REITs must distribute at least 90 percent of their taxable income to shareholders each year.

Meredith was savvy enough to scale back his REIT holdings in 2006 when he saw property values and REIT share prices continue rising even as the industry took on too much debt.

But these days, Meredith mostly likes what he sees in REITs – even if he finds it “terrifying” to try sorting those mostly likely to rebound from the ones that will continue foundering.

REITs boast particularly attractive dividend yields – the amount of the dividend paid divided by the share price. (For example, if a company’s annual dividend is $1.50 and the stock trades at $25, the dividend yield is 6 percent.) Historically, REIT dividend yields average around 5 percent to 6 percent. The yield now? About 8 percent.

Any investor looking to get into REITs now should also be aware that the currently attractive yields are something of an illusion. Both components that go into the yield equation appear certain to shift in ways that will bring yields back down.

As for stock prices, experts believe REIT shares have been beaten down so much that they’re likely to rise – at least eventually – from prices that are near 10-year lows. That expectation assumes the government’s efforts to ease the credit crunch will continue gaining traction.

With respect to dividends, yields are inflated because they’re based on the level of payouts over the past four quarters. So if a REIT cut its dividend just last quarter, its current yield reflects a combination of the current payout level, and the higher level in the three quarters before the cut was made. Most REITs that cut recently aren’t expected to return payouts to the old levels anytime soon.

The reality is that current dividend levels are in many cases unsustainable – debt troubles will eventually compel more REITs to cut payouts so they can shore up balance sheets.

Meanwhile, Meredith still likes REITs overall as good sources of income – even if many of the first-quarter numbers that REITs begin reporting this month will be accompanied by dividend cut announcements.

“I think if the company is not so deeply in debt that its cash flow is seriously impaired, there is a lot of staying power in the average REIT,” Meredith says. “There are quite a few of them today that are real bargains.”