From Trevor Schuesler and Bryce Lin
The Illusion of Income: Why Headline Yields May Mislead
In today’s market, cash flow-focused real estate funds have captured significant attention from yield-seeking investors. The largest mainstream retail funds are often lauded for their attractive and steady distributions. However, a closer look shows that these magical funds might be pulling their distributions “out of a hat.” Today’s investor must be able to discern between sleight of hand and durable growing income streams.
When Yield is Not Really Yield
When evaluating real estate funds, it is critical to distinguish between yield generated from recurring rental revenues and yield manufactured through financial engineering. Ideally, distributions should be primarily funded through net operating income (NOI) from cash-flowing properties. When rental income drives cash flow, distributions are more sustainable and likely to grow over time, reflecting the underlying health and appreciation of the real estate portfolio.
Unfortunately, not all funds adhere to this ideal. Some managers employ tactics that artificially bolster distributable cash flow, creating an illusion of stability or outperformance. Though not all bad, these tactics include:
1. Return of Capital Distributions
Some funds return investor capital, including newly raised capital, under the guise of yield. While permissible, this erodes principal and masks underperformance, ultimately reducing Net Asset Value (NAV) and long-term returns.
2. Financing to Inflate Yield
Funds may refinance stabilized assets, extract excess loan proceeds, and distribute those proceeds as pseudo-income. This typically raises leverage and debt service without boosting underlying earnings, thereby increasing risk to the portfolio.
3. Capitalizing Expenses
Overly aggressive capitalization of routine repairs can artificially inflate NOI and cash flow. This distorts true operating performance.
4. Management and Incentive Fees in Units
Fund managers may take internal fees including management and incentive fees in fund units instead of cash. Though this practice may positively align interests, it leads to dilution of existing investors and may overstate cash yields generated from the underlying properties.
Characteristics of Truly Durable Yield
Investors seeking consistent, reliable, and growing distributions should focus on funds with the following attributes:
1. High-Quality Real Estate Portfolios: Funds should invest in properties that are well-located, demographically supported, and in sectors with favorable long-term trends. Strong underlying real estate fundamentals support stable occupancy and rental growth.
2. Operationally Driven Cash Flows: The majority of distributions should be derived from property-level rental income after debt service, operating expenses and general & administrative costs are paid.
3. Conservative Leverage: A moderate loan-to-value (LTV) ratio protects the fund in market downturns and ensures that debt service does not consume a disproportionate share of cash flow. Additionally, the inherent interest rate risk in a fund should be considered as well as the potential for volatility if not managed well.
4. Disciplined Valuation Practices: Funds that use third-party appraisals, reflect fair market value adjustments promptly, and avoid opaque NAV smoothing practices demonstrate greater integrity and provide investors with a more dependable picture of current values and yields. However, appraisals should not be used in isolation given their backwards looking nature may provide lagged valuations.
A Real-Life Comparison of Yield
BREIT and SREIT are the two largest non-traded REITs and play the role of Houdini and Copperfield in our example of a modern-day real estate illusion. These stalwarts of retail investor portfolios offer a compelling track record of returns and strong current distribution rates. At 5.0% and 5.7% respectively, they far surpass the 4.0% yield of the FTSE Nareit All Equity REITs Index. However, a closer look reveals a disconnect between headline yields and the yield generated from properties.
Current Yields & Definitions1
| BREIT | SREIT | |
| Distribution Rate | 5.0% | 5.7% |
| Cap Rate | 3.8% | 4.1% |
| AFFO Rate | 2.4% | 3.3% |
1. Distribution Rate | Annualized Quarterly Distribution ÷ NAV
2. Cap Rate | NOI ÷ NAV
3. AFFO Rate | Adjusted Funds From Operations ÷ NAV
Distribution rates are commonly reported on marketing materials and websites and can be helpful in knowing what cash distribution has recently been paid. However, they do not need to be tied to rental revenue, cash flow from operations, or any measure of financial performance at the property level which can make them misleading.
Current cap rates on real estate transactions are in the mid-5% range 2—meaningfully higher than where BREIT and SREIT are currently marked. Applying a 5.5% cap rate to BREIT’s current holdings would reduce gross asset value (GAV) by 30% and NAV by 60%, erasing ~$33B in investor equity—more than the total value created since BREIT’s 2017 inception.3
AFFO is a key metric that offers a more accurate reflection of a fund’s operating cash flow and is widely used by REITs to assess a fund’s dividend sustainability. Ideally, a fund’s distribution rate should closely align with its AFFO Rate. When the distribution rate significantly exceeds the AFFO rate—as is the case for both BREIT and SREIT—it raises concerns about the sustainability of those payouts. The AFFO payout ratio for these two funds of around 2x suggests that without meaningful growth in rental income, maintaining current distribution levels could prove challenging, putting the expectations of more than 300,000 investors at risk.
Conclusion
Headline yields can be alluring, but a discerning investor must dig deeper. Sustainable cash flow should come from the rental income produced by well-located, professionally managed real estate, not from financial manipulation or excessive risk-taking.
Funds that prioritize operational cash flow, maintain conservative leverage, and embrace transparency are better positioned to deliver reliable, growing distributions over time, ultimately compounding wealth and protecting capital across market cycles.
In a market awash with options, distinguishing between real and artificial yield isn’t just prudent—it’s essential. Because when it comes to income investing, your yield should be more than a magic trick.
Endnotes
1 Distribution Rate, Cap Rate and AFFO rate are annualized based on data from 10/1/24-12/31/24.
2 ncreif.org/__static/jdj5jdewjdndanz4dtz1ngrhwjhlmmzk/NPI-1Q2025-PressRelease(2).pdf.
3 Markdown is estimated based on a change in cap rate from 3.8% to 5.5% and a leverage ratio of 49%. $33B value destruction is based on a 31% markdown on a starting GAV of $106B. We estimate the total value (distributions and appreciation) created for shareholders since inception and as of 12/31/24 is $26B.