The payout ratio of a Real Estate Investment Trust (REIT) refers to the percentage of its earnings that are distributed to shareholders in the form of dividends. It is a crucial metric for investors assessing a REIT’s financial health, sustainability, and ability to maintain or grow dividends over time. REITs must distribute at least 90% of their taxable income as dividends to maintain their tax-advantaged status.
Formula for Payout Ratio in a REIT
Unlike regular companies that use net income for the payout ratio, REITs typically use Funds from Operations (FFO) or Adjusted Funds from Operations (AFFO) as a more accurate measure of cash flow available for distributions.
- FFO Payout Ratio
Payout Ratio = (Dividends per Share / FFO per Share) × 100
- FFO adjusts net income by adding back depreciation and amortization (which are non-cash expenses) and removing gains from property sales.
- AFFO Payout Ratio (More Conservative Approach)
Payout Ratio = (Dividends per Share / AFFO per Share) × 100
- AFFO further adjusts FFO by subtracting recurring capital expenditures (CapEx) and other non-cash adjustments to better reflect actual cash available for dividends.
What Is a Good Payout Ratio for a REIT?
- 60% – 80% based on AFFO is considered a healthy and sustainable range.
- A payout ratio above 90% may indicate that the REIT is paying out too much and may struggle to maintain dividends.
- A very low payout ratio (below 50%) may mean the REIT is reinvesting a significant portion of earnings instead of distributing them.