Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Why REIT Dividends Hold Up in a 4.5 Percent Treasury World
Transcript
- Lucas: So the ten-year Treasury is yielding four point five three percent as of this week. That's down a few basis points from last week, but still well above where it sat for most of the past decade. Luna: Right, and that's the big question for income investors. If I can get four and a half percent from a government bond, why would I take the risk of a REIT? Lucas: Exactly. And that's been the knock on REITs for the last couple of years. But I want to look at one specific example — Realty Income, ticker O — because I think it shows why the answer isn't as simple as just comparing yields. Luna: O is the monthly dividend company, the triple-net lease giant. It's up about one point eight percent over the past five days. So the market seems to like it right now. Lucas: And its dividend yield right now is roughly five point two percent. So you're getting about seventy basis points of spread over the ten-year. That's not nothing. But the real story is in how O generates that income and whether it can sustain it. Luna: So walk me through the mechanics. How does a triple-net lease REIT keep paying when rates are high? Lucas: The key is that most of O's leases have built-in rent escalators — usually one to two percent annual increases, sometimes tied to inflation. So their rental income grows over time regardless of what the bond market does. And because they're triple-net, the tenant pays for property taxes, insurance, and maintenance. O's expenses are relatively predictable. Luna: So the dividend isn't static. It's growing, even if slowly. That's the difference between a bond coupon and a growing dividend stream. Lucas: Right. A bond paying four point five percent gives you the same coupon until maturity. O's dividend has increased for over twenty-five consecutive years. That compounding matters a lot over a five or ten year horizon. Luna: And what about the payout ratio? I know that's been a concern for some REITs. Lucas: O's adjusted funds from operations payout ratio is around seventy-five percent. That's comfortable for a net-lease REIT. They're not stretching. And their balance sheet is investment-grade rated, so they can access debt markets at reasonable rates. Luna: So they're not forced to cut the dividend just because rates are higher. But what about the stock price? O is trading around sixty-two dollars. That's down from its highs. Lucas: It is. And that's actually why the yield is attractive now. When the stock price falls, the yield rises, assuming the dividend stays the same. So investors who buy today lock in that higher yield. If rates eventually come down, the stock price could appreciate, and you get both income and capital gains. Luna: That's the classic 'buy when there's blood in the streets' for REITs. But let me push back a bit — what if rates stay here or go higher? Then the stock might stay flat or fall more. Lucas: That's the risk. And that's why you have to look at the underlying business. O's tenants are mostly investment-grade retailers and service providers — Dollar Tree, Walgreens, FedEx. They're not mom and pop shops. So the rent collection rate is historically above ninety-nine percent. Luna: So even if the stock price is volatile, the dividend is stable. That's the income investor's trade-off. Lucas: Exactly. And if you look at the broader REIT market, many are yielding four to six percent now. The spread over Treasuries has compressed, but it's still positive. And the dividend growth potential is the differentiator. Luna: We should also mention that the ten-year yield has actually ticked down a bit recently — from four point five six to four point five three. That helps REIT valuations a little. Lucas: It does. And the two-year yield dropped too, so the yield curve is still positively sloped at about forty-two basis points. That's a healthier environment for REITs than an inverted curve. Luna: So if someone is building an income portfolio today, how should they think about REITs versus bonds? Lucas: I'd say use both. Bonds give you certainty and safety. REITs give you income growth and some upside if rates fall. But don't just buy any REIT. Look for ones with low payout ratios, investment-grade tenants, and a history of dividend growth. O is a good example, but there are others. Luna: And what about the tax treatment? REIT dividends are mostly taxed as ordinary income, not qualified dividends. So that's a consideration. Lucas: True. But in an IRA or 401k, that doesn't matter. And for taxable accounts, you can use a REIT ETF like VNQ or SCHH to diversify and simplify. Luna: Speaking of which, before we wrap up, I want to mention something. If you find these income investing conversations useful, there's a way to support the show directly. It's a small thing, but a couple of dollars a month genuinely helps keep this podcast ad-free and independent. Lucas: Yeah, we've never run ads, and we want to keep it that way. If you've gotten value from our episodes — maybe a better understanding of dividends or a different perspective on REITs — consider throwing a few bucks our way at buy me a coffee dot com slash fexingo. Luna: It really does make a difference, and we appreciate everyone who chips in. Now back to REITs — one more thing I want to ask, Lucas. How do rising Treasury yields affect the borrowing costs for REITs like O? Lucas: Great question. O has a weighted average interest rate of around three point five percent on its debt, and most of it is fixed-rate. So even if new debt costs more, the existing portfolio is cheap. They also have staggered maturities, so they're not forced to refinance everything at once. Luna: So they have time to wait for rates to come down before they need to borrow more. Lucas: Exactly. And because they generate strong cash flow, they can also fund acquisitions with retained earnings or equity issuance when their stock price is favorable. They're not forced sellers or borrowers. Luna: That's a good reminder that not all REITs are created equal. The quality of the management and the balance sheet matters a lot. Lucas: Absolutely. If you're looking at a REIT with a high yield but high leverage and weak tenants, that's a red flag. Stick with the ones that have been through cycles — O has survived the 2008 crisis, the 2020 pandemic, and the 2022 rate hikes. Luna: So to sum up: REIT dividends can still compete with four point five percent Treasuries, but you have to pick carefully. Focus on dividend growth, payout ratios, and tenant quality. Lucas: And remember, the yield you buy today is locked in if you reinvest dividends. Over time, the compounding can beat bonds. That's the long game. Luna: Alright, thanks Lucas. That's a solid framework for anyone building income in this environment. Lucas: Thanks Luna. See you next time.