For investors in pursuit of dividend returns, choosing between real estate investment trusts (REITs) and stocks is a tough decision. Understanding the differences between REITs and stocks can help investors determine which asset class better suits their investment needs.
REITs vs dividend stocks
What are they?
REITs are trust structures that hold various real estate investments and property assets. When the real estate investments appreciate in value or bring in rental revenue, the REIT will pay out dividends to investors. Hence, investment gains can be both short term (from rental payouts) and long term (from real estate appreciation).
Generally, the listed equity of a company that is able to payout high, consistent dividends is called a dividend stock. These companies are usually well-established blue-chip companies, with long histories of stable earnings. Good dividend stocks should also be increasing their dividend payout amounts over time.
Compared to growth companies, companies that have a high dividend yield generate strong operating cash flow, which they do not reinvest heavily into technology or capital. The term “Dividend Aristocrats'' is used to describe public companies that can consistently raise dividends yearly. Some popular examples of these companies include Coca-Cola, McDonald’s, and IBM. In Singapore, some popular dividend stocks include SingTel, DBS Holdings, and ST Engineering.
Similarities and differences between REITs and dividend stocks
REITs and dividend stocks are largely similar. They can both be bought and traded on stock exchanges. They are both potential sources of passive income, given the regular dividend payouts.
Having said that, there are several notable differences between REITs and dividend stocks that investors should take into account before choosing between them.
Sector focus and diversification
The largest difference between REITs and dividend stocks is naturally their sector of focus. As the name suggests, REITs focus largely on the real estate sector. Dividend stocks on the other hand, are not limited to a single sector. Financial institutions, telecommunication companies, and consumer goods companies typically pay out higher dividends compared to sectors such as technology.
REITs are thus more attractive to investors who want to invest in real estate without the high capital outlay and the effort required to purchase and maintain a property. High payout stocks would appeal more to investors looking to diversify their portfolio beyond real estate.
Real estate has historically been one of the best hedges of inflation, but the same cannot be said for stocks. Inflation benefits real estate investors — as inflation rises, so do property values. Landlords can also charge higher rent and pass the higher profits onto investors.
On the other hand, dividend stocks may or may not react well to inflation. Some companies might be able to pass higher costs down to consumers, but others would experience declining profits. If these businesses are unable to increase revenue to offset higher costs, investors might face a dividend cut.
Lastly, and possibly the difference most investors are most concerned about, dividend returns. On average, REITs pay higher dividends than dividend stocks. The average dividend yield payout by dividend stocks in the S&P 500 is only around 1.7% in October 2021, while the FTSE EPRA Nareit index pays a dividend yield of around 3.5%.
Singapore REITs are mandated to pay 90% of their income to investors annually, in order to be exempted from paying corporate tax. Not having to pay taxes means that more of the REIT’s profits can be paid out to investors. The 90% payout mandate also means that by investing in REITs, investors can be sure that they will be able to receive regular dividend payouts regardless of market conditions.
In comparison, dividend stocks are not strictly required to pay dividends, therefore companies may cut dividend payouts under certain circumstances. Usually, dividend cuts are due to weakened earnings or insufficient funds to pay investors the required dividend amount. Such a cut is a negative sign for the company, as it shows that the company’s financial health is struggling. When choosing to invest in dividend stocks, investors should ensure that the company can be profitable in the long run, so that they do not suffer from a dividend cut.
However, REITs are also subjected to investment risk and distribution cuts. At the peak of the COVID-19 crisis, REITs were expected to be hit with a severe drop in distributions per unit due to the lockdown of shopping malls and work from home arrangements. While the distributions eventually recovered as businesses normalised, there was a huge plunge in REITs’ unit prices during the period of uncertainty.
Highest yielding REITs and sectors in Singapore
Singapore currently has 42 REITs & property trusts. As of April 2021, Singapore REITs (S-REITs) averaged a 5.6% dividend yield, with five S-REITs (shown below) generating dividend yields above 7%.
However, investors should keep in mind that there is more to a dividend stock than just the dividend yield. Good dividend stocks should also have a low dividend payout ratio (amount of dividends paid out as a percentage of overall profits) and a sustainable core business.
Ultimately, choosing between REITs and dividend stocks would depend on the investor’s risk tolerance, time horizon, and return objectives. Better returns does not automatically mean a better fit in investors’ portfolios.
What is the best way to build a high yield portfolio?
While REITs and dividend stocks are able to provide more consistent dividend payouts when financial markets are stable, they are still susceptible to sizable market volatility and dividend cuts during crises. It is critical to diversify across sectors and countries within a REIT portfolio so that your portfolio becomes more resilient. For example, while China shopping mall REITs were initially badly hit by COVID-19, they recovered the quickest when China managed to keep COVID-19 under control. Similarly, data centres and logistics REITs performed strongly during the pandemic relative to office and retail REITs.