Given the relatively stable nature of rental flows, property companies often tend to distribute a relatively high and stable share of their profits in dividends, making their stocks an attractive option for those investors looking for a consistent source of income. In fact, Robeco research shows that dividends would have accounted for roughly half of the total return achieved, over the past 20 years, by real estate stocks included in the S&P Developed Broad Market Index (BMI).
This explains why so many investors consider dividend yield as the single most important investment criterion, when considering this type of company. But is that really the case? Or, put differently, do real estate stocks exhibiting high dividend yields really achieve higher total returns in the long run? Our research suggests that selecting property stocks based on their dividend yield turns out to be shortsighted and that higher dividend yields do not necessarily lead to higher investment results.
Indeed, recent Robeco simulations show that while a strategy focusing on high dividend yield could have worked within the broader real estate sector over the last 20 years, returns would have been heavily concentrated in the first few years. Such a strategy would also have resulted in sharper drawdowns and higher volatility.
More specifically, we found that a REIT-only high dividend yield (HDY) strategy, one which invests solely in listed real estate investment trusts (REITs) and avoids other types of real estate stocks (non-REITs), would have underperformed a standard equally-weighted allocation to the broader real estate sector.
REITs are companies that focus on developing and renting a portfolio of properties while benefiting from specific favorable tax regimes in many countries, provided they distribute most of their earnings. Meanwhile, a HDY strategy focused on non-REITs would have consistently outperformed the broader real estate universe. But this outperformance would have largely been regionally-biased and dependent on the specific timing of some positions in certain countries.
A high dividend yield may not always reflect bright company prospects
These results confirm that dividend yield should not be taken as a standalone selection variable and that a lower one does not necessarily mean lower expected returns. The main reason is that a high dividend yield results from the combination of a stated current dividend (numerator) and a share price (denominator), integrating market views on future earnings and dividend growth.
As a consequence, a high dividend yield may not always reflect bright company prospects. For example, it could be the temporary outcome of a sharp drop in the stock price triggered by a worsening outlook for the business.
Also, high dividend payouts may not always reflect sound financial management. To lure investors, management teams might be tempted to increase a company’s financial leverage, and by making use of often low debt financing costs, improve its earnings and therefore dividends. High dividend payouts might also come at the expense of critical maintenances. Finally, they might also be the outcome of one-off assets sales, and therefore unsustainable over the long run.
The Robeco Sustainable Property strategy aims to capture opportunities offered by oft-underappreciated long-term cash-flow generation in the property sector. As such, our analysis focuses on property companies’ ability to generate sustainable free cashflows over the longer term. From this perspective, the resulting dividend yield of our portfolio is an output – not a driver – of our investment process. As a consequence, this resulting dividend yield can be lower than the strategy’s benchmark.
Yet as our research shows, higher dividend yields do not necessarily lead to higher long-term returns. So, while we do acknowledge the importance of dividends and dividend yield for property investors – the fact that a HDY approach appears to work within non-REITs confirms they should not be ignored – we believe it should not be overstated.