Healthcare’s Healthy Prognosis
- May 01, 2012
U.S. equity REITs are currently required to pay out 90 percent of taxable income to shareholders in the form of dividends to maintain their REIT status. These steady dividend streams are important to REIT investors, so many analysts will look at AFFO payout ratios to determine whether REITs will be able to maintain their current dividend levels going forward.
AFFO (also known as funds or cash available for distribution) adjusts funds from operations for non-cash items such as straightlining of rents and non-revenue-generating capital expenditures to get to an earnings metric that is a good proxy for cash flow per share. Comparing forward AFFO estimates to a company’s current annual dividend rate provides a good look at how well a company would be able to maintain that dividend level going forward.
U.S. equity REITs currently show an average 2013 estimated AFFO payout ratio of 66 percent. Healthcare REITs are currently paying out the highest percentage of their forward AFFO in the form of dividends, with a payout ratio of 82.9 percent. Not surprisingly, healthcare REITs also show the highest current dividend yield, at 6.6 percent. These REITs, for the most part, are a defensive sector, with long-term triple-net leases in place. While this has made the sector attractive in recent years, ongoing difficulties in the broad market may make it less appealing going forward if the economy continues to improve.
Hotel REITs are at the bottom of the list, with an average estimated AFFO payout ratio of 35.5 percent. Four of 17 U.S. hotel REITs are not currently paying dividends at all. The short-term nature of rental rates casts them as the antithesis of the healthcare sector. When the market declines, hotel REITs are going to feel the negative effects almost immediately. On the flip side, when the market begins to improve, they will be able to mark their leases to market, providing value for the sector very quickly.
—Jason Lail is manager of real estate research for SNL Financial.