Some investors look at the dividend yield of a stock as somewhat of an icing on the cake when deciding to make an investment or not. With real estate the talk of the town during rising interest rates (for now), those same investors are looking at the VNQ dividend when considering purchasing the Vanguard REIT ETF.
With a dividend rate of 4.66% according to Yahoo Finance, REITS are among the highest yielding assets classes out there. However, most investors will simply pile in all of their cash into these high-yielding REIT’s without understanding why these companies can pay such a high dividend.
Like everything else markets, Stony Brook Securities takes out time to understand the reason behind everything we can. There are specific reasons why REIT dividends and specifically the VNQ dividend pay out so much. It might not be what you think or a great investment strategy. Let’s find out exactly what is going on here.
What is a Real Estate Investment Trust?
REIT’s are interesting investment choices. They are an asset just like stocks and are traded on various stock exchanges such as the New York Stock Exchange. Just like other businesses have niches or industry’s that they focus their attention on, these real estate trusts focus a majority of their attention on different parts of the real estate market. For the most part, you can think of REIT’s as publically traded landlords.
This makes sense and was probably pretty obvious.
Across the board, REIT dividends (like the VNQ dividend) are very high compared to all other asset classes. But there is a specific reason for this.
A company like Apple sells products. When they sell a product, they make money, and after all of the expenses are paid, they have a profit and can do whatever they like with that profit. They can buy back stock or reinvest those profits in new products or hire more employees or pay for new facilities.
Real estate investment trusts, on the other hand, are the beneficiary of no income tax. Fortunately for them and unfortunately for you and I, those taxes that are not paid at the corporate level because they are a REIT where the tax is passed on to the individual investor. How might you ask?
REIT’s are obliged to distribute at least 90% of their profits to their shareholders in the form of dividends. This is why REIT dividends (we will get to the VNQ dividend) are so high.
However, those yields being so high might not be the greatest thing ever. REIT dividends are not qualified dividends. This means that those dividends collected, or in this case, the VNQ dividend is not taxed at the long-term capital gains tax of 15%. Those dividends are taxed as normal income and not at the capital gains rate.
There is an obvious trade-off here. The yields are higher, but the taxes are also higher.
Before we make a final decision of if the VNQ dividend makes it a more attractive investment, we have to look at VNQ by itself.
Like all other potential investments or trade, we must make sure that the asset we are considering is liquid enough.
VNQ Stock Liquidity
The first order of business to find out if an asset in liquid enough is to look at its stock liquidity. In order to know an asset has strong stock liquidity, we must look at the two following points:
- Bid/ask spread
We need to look and see if the stock bid/ask spread is only a few pennies wide or less. If this does not happen, we will need to take a loss to enter the trade. This is something we do not do.
We see a bid/ask spread here of only one penny wide. For a stock, it does not ever get better than this. Nice!
What about volume? We should see volume in the thousands. What kind of volume has VNQ shown in the last 50 days on average?
The second number in the yellow is the average volume for VNQ’s stock over the last 50 days. This number sure looks like a few million to me!
Stock liquidity checks out here in VNQ…but what about options?
VNQ Options Liquidity
We also have a checklist for options liquidity. It goes as follows:
- Expiration cycles
- Bid/ask spreads
- Open interest count
Let’s get to it!
Volume. We expect to see a few thousand contracts traded per day. What does that number look like for VNQ?
That does not look like a few thousand to me. This is very bad news for those who were interested in moving forward with this stock.
Expiration cycles…we should see not only monthly but also weekly expiration cycles. We want to see both of these because we want to know there is enough demand to have more than the average monthly expirations. Only those options markets with enough demand are afforded the opportunity to have weekly options expirations.
We only see monthly expirations here. This tells us there is no demand for weekly options, and judging by the lack of total options volume, demand for any options in this REIT.
Next, we move on to bid/ask spreads of the options market. Just like stock, the smaller the bid/ask spreads, the better they are because there is more competition for them.
Wide…too wide. Again, no market maker is going to set better markets because there is no demand for any contracts here. It makes perfect sense as to why these options markets are the way they are. No demand equals no competition equals no liquidity.
Finally, we look for the amount of open interest. If we see open interest in the thousands we know there are a lot of institutions hedging their positions via the over the counter derivatives (options). What do we find?
We do see some options have a strong open interest in the thousands which makes this a rare asset with very poor liquidity and demand but decent size bets made (open interest).
However, three out of our four checks for options liquidity failed, meaning the options market for VNQ is not liquid enough for us. This does mean that although the stock liquidity was excellent, we should NOT be trading or investing in this assets.
Does the VNQ Dividend Put it Over the Hump?
Here are the VNQ dividend payouts from 2015 to present.
|Date||Payout $||Payout %|
Looking at this chart right here of the VNQ dividends over the last 2 years, I am surprised by just how little the dividend is.
While Yahoo Finance currently has the VNQ dividend at 4.66%, I almost don’t even believe that.
I see numbers up here that are much lower than 4.66%.
The reason for this is because investors and dividend collectors are at the mercy of the RIET’s performance. Remember, REIT shareholders get a payout of about 90% of the profits from the company as a dividend.
Sometimes the company makes a lot of money; sometimes it doesn’t. This is why the dividend payments are very inconsistent.
This is also why we cannot trust what the dividend yield says because there is no knowing ahead of time when the REIT is going to do well or not.
Is the Vanguard REIT ETF a Solid Investment?
Let’s think about what we have spoken about so far.
First, we wanted to know if VNQ was liquid enough for us.
We first checked the stock liquidity, and it turned out that the stock is indeed liquid enough
We then looked at options liquidity, because we cannot improve our position or hedge our risk without a solid and liquid options market. We, unfortunately, found out that the options market for VNQ was not liquid.
But people said, “Wait!, the VNQ dividend is high and all REIT’s pay large dividends!”
REIT’s pay higher than normal dividends because to be a REIT you must pay out 90 plus percent of your profits out to shareholders in the form of dividends.
REIT dividends and specifically the VNQ dividend is a non-qualified dividend which means it does not get recognized as a capital gain…which means recipients must pay full tax on the dividends from REIT’s rather than 15% capital gains tax.
When viewing the dividend rate of a REIT, the simplest and fairest thing to do would be to cut the yield in half, as a normal tax bracket of 30% would be double that of the capital gains tax which REIT dividends are not.
As investors, we are responsible for digging into everything and not just listening to what financial media spits in our face all day every day. There is a reason why it is not as publically known that REIT dividends are non-qualified dividends, with that reason being that REIT’s would rather you see the yield and instantly invest rather than realizing their dividends will not be taxed as capital gains.
VNQ was not liquid enough for us to invest or trade because it’s options market did not have the properly liquidity for us to commit capital to. At the same time, the VNQ dividend is only half of what they claim it is because the dividends are not taxed as capital gains.
For these reasons…I’m out.