The Safety Net: Is This 6.5% Yield Rotten?

“Go ahead, bite the Big Apple, don’t mind the maggots.”

– The Rolling Stones

In their hit song “Shattered,” The Rolling Stones sing about the dark side of living in 1970s-era New York City.

Had the song been written today, Mick Jagger (who studied at the London School of Economics) could have been talking about Apple Hospitality REIT (NYSE: APLE).

Apple Hospitality has almost nothing to do with New York City. It’s a real estate investment trust with a portfolio of 236 hotels in 33 states.

It leases land to companies like Marriott and Hilton for their various hotel brands. Tenants include a Courtyard Marriott in Carolina Beach, North Carolina, a Hampton Inn & Suites in Davenport, Iowa, and a Hilton Garden Inn in Des Plaines, Illinois.

It also has one property in the Big Apple – the Renaissance New York Hotel 57 on East 57th Street in Manhattan.

The company merged with another REIT owned by Apple’s corporate parent in 2014 and then had a 50% reverse stock split in May of 2015. Since then, it has paid a $0.10 per share monthly dividend.

At today’s prices, that comes out to a 6.5% yield.

With a monthly dividend and a yield of more than 6%, it’s not hard to see why an investor might think Apple Hospitality looks delicious.

But will its dividend make investors see red?

Questionable Leadership

The company paid a higher dividend before its merger, but comparing the dividend before and after the merger may not be an “apples to apples” comparison.

In the first six months of 2016, it paid shareholders $105 million in dividends. Meanwhile, it generated $156.6 million in funds from operations (FFO). FFO is a measure of cash flow used by REITs.

That gives us a payout ratio of 67%.

Payout ratio is the percentage of cash flow paid out in dividends. I want to see a payout ratio of 75% or less to be confident that the dividend is safe.

Next year, with FFO expected to grow, the dividend should remain in my comfort zone – below a 75% payout ratio.