Real estate trusts taking the cash out of their dividends

I don’t have to tell you that 2009 has been a horrible year for real estate investment trusts — and we’re only in mid-March. The SPDR Dow Jones Wilshire REIT exchange-traded fund (Symbol: RWR) is off 31% this year and a whopping 60% over the past 12 months. That’s pushed the trailing one-year dividend yield over 11%, or a historically huge margin of 8 percentage points more than the yield of the 10-year U.S. Treasury bond. And that’s got some people sniffing around looking for bargains.

But beware: some of those fat dividends are less than meets the eye. A growing number of REITs are turning to one of the less-welcome strategies of the leveraged buyout crowd. Instead of paying dividends in cash, they’re paying with more shares of stock. That dilutes the ownership of stake of existing shareholders and ultimately waters down the value of future dividends. And shareholders still have to pay tax on the full value of the dividend just like they did when it was actual cash. The move also conserves cash for REITs in the present credit-constricted environment, of course.

Mall owner Simon Property Group (SPG) was the latest to announce a so-called pay in kind strategy. The company said that despite an election among shareholders, who overwhelmingly wanted cash, its upcoming 90 cents a share dividend would consist of about 9 cents a share of actual money plus 81 cents worth of stock. The REITWrecks blog, written by an anonymous former Wall Street financier, has been tracking the trend and lists another half-dozen trusts opting to pay in kind.

Another danger for the REIT sector is the possible bankruptcy of another mall giant, General Growth Properties (GGP). Standard & Poor’s lowered its ratings on some of the company’s debt to the lowest possible level of “default.” Hedge fund manager William Ackman, who bought up a huge chunk on General Growth shares, told Bloomberg, that selling off the company’s properties in bankruptcy would “take down the entire REIT industry,” without providing much explanation. Presumably, a fire sale of malls at depressed prices would prompt investors to mark down their views of the value of properties across the industry. Ackerman wants a more orderly reorganization — one that doesn’t wipe out the value of his equity investment.

So if not now, then when? What signs are you looking for that it’s safe to return to the REIT sector?

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