Evaluating the Legal and Financial Risks in REITs: The CTO Realty Case Study

The real estate investment trust (REIT) sector has long been a magnet for income-seeking investors, offering high dividend yields and steady cash flow. However, the case of CTO Realty Growth, Inc. (NYSE: CTO) underscores the critical importance of scrutinizing both legal vulnerabilities and financial metrics when assessing dividend sustainability. This article delves into the legal challenges and financial discrepancies surrounding CTO, offering insights into how investors can navigate similar risks in the REIT space.

Legal Risks: A Class Action Over Misleading Metrics

CTO Realty has become the focal point of a securities class action lawsuit (O'Connor, Jr. v. CTO Realty Growth, Inc., No. 25-cv-01516) alleging violations of the Securities Exchange Act of 1934. The lawsuit, spanning the period February 2021 to June 2025, accuses the company of inflating its Adjusted Funds From Operations (AFFO) by excluding recurring capital expenditures—a key metric used to justify its dividend policy. Additionally, the complaint highlights a “sham loan” at the Ashford Lane property, which allegedly masked a tenant's financial collapse.

The catalyst for this legal storm was a June 2025 report by Wolfpack Research, which claimed CTO relied on aggressive share dilution to cover a $38 million dividend shortfall since 2021. The report also noted that CTO's cash flow was insufficient to cover recurring capital expenditures and dividends after its 2021 REIT conversion. Following the report's release, CTO's stock plummeted 5.42%, closing at $17.10 per share.

Investors now face a critical decision: join the class action to seek compensation or opt out to pursue individual claims. Lead plaintiff motions are due by October 7, 2025, with law firms like Timothy L. Miles and Berger Montague leading the charge. The outcome of this case could set a precedent for corporate accountability in the REIT sector.

Financial Metrics: AFFO vs. Reality

CTO's financial statements paint a mixed picture. For 2024, the company reported a net loss of $0.35 per diluted share but maintained a dividend of $0.38 per share, yielding 9.21% as of June 2025. While AFFO per share rose 4.7% year-over-year to $2.00, this metric excludes critical expenses like recurring capital expenditures, which peers typically include. Wolfpack Research argues this exclusion inflates AFFO by $38 million annually, creating a misleading narrative of financial health.

The company's 2025 outlook projects AFFO per share between $1.93 and $1.98, but this relies on assumptions such as $100–200 million in new investments and $17.5–18 million in general and administrative expenses. However, with only $8.4 million in cash reserves, CTO's ability to fund its $14 million quarterly dividend and $5.7 million in recurring capital expenditures remains questionable.

Dividend Sustainability: A House of Cards?

CTO's dividend yield, while attractive, is underpinned by a fragile financial model. The company's payout ratio is negative (-1.58), indicating it pays out more in dividends than it earns. This has been sustained through share dilution, which increased the number of outstanding shares by 70% since December 2022. Such practices erode shareholder value and raise red flags about long-term sustainability.

Moreover, the lawsuit and Wolfpack's findings have cast doubt on the credibility of CTO's financial reporting. If the company is found to have misrepresented its AFFO or asset valuations, it could face regulatory penalties, further damaging investor confidence.

Investment Implications and Recommendations

For income-focused investors, CTO's case serves as a cautionary tale. High yields can mask underlying risks, particularly when tied to non-GAAP metrics like AFFO. Here are key takeaways:

1. Scrutinize AFFO Definitions: Compare a REIT's AFFO methodology with industry peers. CTO's exclusion of recurring capex diverges from standard practices, signaling potential manipulation.
2. Assess Capital Structure: Evaluate a company's reliance on dilution. CTO's 70% share increase since 2022 highlights a dangerous trend of funding dividends through shareholder dilution.
3. Monitor Legal Risks: Securities lawsuits can trigger liquidity crises and reputational damage. Investors should track developments in cases like O'Connor v. CTO and consider legal counsel if necessary.
4. Diversify Exposure: Avoid overconcentration in high-yield REITs with opaque financial practices. Diversification mitigates the impact of individual company risks.

Conclusion

CTO Realty's legal and financial challenges underscore the need for rigorous due diligence in REIT investing. While high dividend yields are enticing, they must be supported by transparent, sustainable cash flows. Investors should prioritize companies with clear governance, conservative capital structures, and alignment between management incentives and long-term value creation. In the case of CTO, the risks outweigh the rewards—until the company addresses its legal and financial credibility, prudence dictates caution.

For those already invested, the class action lawsuit offers a potential avenue for redress, but the broader lesson is clear: in the REIT sector, the devil is in the details of the numbers—and the law.