The headline appeal of REITs is income. Understanding where it comes from — and how to judge it — keeps you from chasing a yield off a cliff.
Rent in, dividends out
A REIT collects rent from its tenants, covers its costs, and — because of its tax structure — passes most of what’s left to shareholders as dividends. REITs must distribute roughly 90%+ of taxable income to keep their favourable tax status, so they tend to pay higher dividend yields than typical stocks. For income-focused investors (retirees, for instance), that steady, property-backed cash flow is the draw.
Read it with FFO, not just earnings
There’s a quirk: standard accounting makes REITs subtract big depreciation charges on their buildings, which understates the actual cash they generate. So REIT investors use funds from operations (FFO) — roughly net income with depreciation added back — as the truer measure of a REIT’s earning power and the safety of its dividend. A dividend that looks unaffordable on reported earnings may be comfortably covered by FFO.
Don’t just chase the highest yield
A very high yield can be a warning, not a gift. If a REIT’s share price has crashed because the market fears its tenants are failing or its debt is dangerous, the yield spikes — but the dividend may be about to be cut. As always: a high payout is sometimes high for a reason. Judge the sustainability (is it covered by FFO?), not just the headline percentage.
Worked example
A REIT reports net income of $0.40 per share but pays a $0.90 dividend. On reported earnings that looks reckless — it’s paying out 225% of profit. But the building portfolio carried $0.70 per share of depreciation, a non-cash accounting charge.
FFO ≈ net income + depreciation = $0.40 + $0.70 = $1.10 per share Payout on FFO = $0.90 ÷ $1.10 ≈ 82%
Read through FFO, the $0.90 dividend is comfortably covered — the “225%” was an accounting illusion created by depreciation. This is exactly why REIT investors reach for FFO instead of headline earnings before trusting a payout.
The takeaway
REITs turn rent into dividends, paying out 90%+ of taxable income — which is why they’re an income favourite. Judge the payout with FFO (not just reported earnings), and treat a suspiciously high yield as a question, not a bargain. (This is education, not investment advice.)