13% Dividend Yield For Suckers At Global Net Lease (NYSE:GNL)

We don’t usually write about Global Net Lease (NYSE:GNL).

However, GNL is one of the largest positions within the Invesco KBW Premium Yield Equity REIT ETF (KBWY). One simple way for a REIT to have a high enough yield to get included in the ETF is to run high leverage on mediocre properties. That ramps up FFO and AFFO, which gives the appearance of being able to sustain a large dividend. When bond yields rip higher, as they have in 2022, those REITs face a major challenge in refinancing their debts. It is a huge headwind to growth in AFFO per share.

How can KBWY be performing so well when many of the REITs are heavily exposed to rising rates? We will explore that by exploring GNL.

GNL’s share price is only down 21.2% year-to-date at $12.24. It also paid out $1.60 in dividends already this year, which offsets about half of the decline. That leads to a total return of about negative 11% year-to-date, which is excellent for this environment. Therefore, we’re going to dive in to see how GNL is winning in this environment.

To be clear, we’re going to say some negative things about GNL. These statements represent our opinion and projections, rather than being matters of fact. An article that does not include opinions and projections is just a verbal quote page. You clicked this article to get my take on the REIT. If my opinion offends someone, that’s life.

The Bull Case

There is precisely one viable bull case for investors. GNL may trade at a substantial discount to NAV. It’s small enough that I don’t put much confidence in consensus analyst estimates. However, there’s a good shot that it does indeed trade at a large discount. If that’s the case, then a buyout remains a possibility. If the external manager was sent packing, the odds of a buyout might improve. Blackwells Capital is trying to remove the manager.

Will they succeed? Who knows. If they did succeed, it could certainly be bullish in my view.

Dividend Cuts

If they don’t succeed, GNL is on the road to another dividend cut. They “could” maintain the dividend for a while, but consensus estimates for AFFO are garbage. You can be suspicious right away because the consensus analyst estimates call for the trend lower to suddenly reverse next year. Why would it reverse? I treat these cases as “guilty until proven innocent”.

If AFFO per share falls, as it has trended down almost every year, that’s bad for dividend sustainability.

Fortunately, GNL knows how to cut dividends. They did it in 2019 and in 2020. So far, the dividend decreased from a monthly rate of $.18 ($.56 per quarter) in early 2019 to a quarterly rate of $.53. In 2020, it was reduced to $.40. Investors should expect another reduction, but I’m not convinced they do.

AFFO and Revenue

We can pull some consensus analyst estimates for total AFFO and revenue to see if the REIT is growing:

It’s clear that the REIT has been growing.

While the “per share” data that an investor with a set number of shares would care about is declining, the company as a whole is increasing.

If total AFFO is growing but AFFO per share is falling, then the share count must be growing at a faster rate than AFFO. That’s just math.

We know analysts projected a slight improvement in AFFO per share for 2023 (from $1.73 to $1.78) and an even bigger improvement in AFFO per share for 2024 (from $1.78 to $1.88). However, when looking at the total REIT, the projected AFFO is only expected to increase slightly from 2023 to 2024. Therefore, the volume of shares outstanding would have to fall from 2023 to 2024.

AFFO Per Share Vs. Total AFFO

If we use the estimated value for total AFFO and divide it by the AFFO per share, we get a rough estimate for the implied number of shares outstanding in the consensus estimate.

On 6/30/2022 there were 104.1 million shares outstanding.

• For 2023 = $194.09 million / $1.78 = 109 million shares
• For 2024 = $194.56 million / $1.88 = 103.5 million shares
• For 2025 = $235.9 million / $1.83 = 128.9 million shares

Well, clearly there is a problem there. It is highly unlikely that those share counts are what actually happens for those periods. The estimates are so wildly different it makes me think that some analysts have inputs for some years and not for others.

If Shares Are Issued

Could they issue shares and pay down debts? No. Even using the $1.73 estimate for AFFO per share, which would be the lowest AFFO per share for any of these years, shares would trade at only 7.07x AFFO. Alternatively, that would be a 14% “AFFO yield”. Therefore, issuing new shares to pay down debt would clearly be dilutive.

What if they issue equity and new debt to fund purchases? No.

That new debt would easily be running over 5%. Potentially over 6% to account for credit spreads on a risky REIT. Even if the REIT was buying properties at an 8% cap rate and funding the deal exclusively with debt, it would only be slightly accretive. Toss in issuing a small amount of equity and it becomes dilutive.

That Revenue Growth Would Need Portfolio Growth

Increases in rental rates for GNL are pretty small. They could slightly increase revenue year-over-year, but I do not believe they could generate 4% growth in revenue. Not if they had roughly zero net increase in real estate (acquisitions equal to sales). Perhaps they could do it if they sold their better properties and bought weaker properties (to get higher cap rates). However, putting that idea aside, they don’t get 4% revenue growth annually (from existing leases). Yet the estimates are calling for 6.2% in 2023 and 4.2% in 2024.

If we assume shares outstanding would increase from 104.1 million to 109 million (nearly 5%) and that new debt would be employed to maintain the existing leverage, then GNL could absolutely hit $410 million of revenue in 2023. It wouldn’t be good for shareholders, but it would get them there.

Getting to the 2024 figures is a bigger problem. They absolutely would not get 4.2% growth in revenues while reducing shares outstanding by more than 5%. Not happening unless they drove leverage up materially. They would need to be buying real estate and buying back shares. That’s just a bad thesis.

Interest Expense Projections Are Trash

The first part of the article could be considered the “less convincing” argument.

If you want to see the problem with projections, look at the interest expense projections:

As we look at the estimates for 2023 to 2025, they are simply terrible.

GNL Doesn’t Provide a Great Table

Normally I would just look for the debt maturities in the supplemental. I might find them nicely laid out with the amount of variable-rate debt and fixed-rate debt due each year. If I’m lucky, I may also get the relevant rates for each part of the debt. GNL doesn’t offer that. Maybe that is why analysts decided to just not do the work.

To determine the projected interest expense we simply pull GNL’s Q2 2022 10-Q (sorry, no Q3 yet). Page 16 gives us this table. It’s organized by currency, but doesn’t seem to have any other sorting mechanism:

Using that table, we add up the maturities due in each year. This gives an estimate of how much GNL will need to refinance at current market rates. However, this isn’t all of GNL’s debt. GNL also has a revolving credit facility (floating rate) and senior notes. The senior notes have a fixed interest rate and don’t mature until 2027, so we will ignore them.

The revolving credit facility has a balance of $558.9 million as of Q2 2022 (using exchange rates from 6/30/2022 for debts in foreign currencies).

Each year we will need to reset the rate of interest for GNL’s revolving credit facility and for any debts that are maturing. I won’t drag investors through all of the math. The short version is that I’m assuming on average the new interest rates for GNL will be at least 300 basis points higher on anything that must be rolled over.

Given the change in floating rates, I think that makes sense. If GNL’s credit had improved, GNL might get better terms on loans. I don’t think that would be a fair assumption, so we’re not going to make it.

We’re simply adding 300 basis points to any floating rate debt or expiring debt.

By my math, if GNL does not reduce debts, the run-rate for interest expense will increase by:

• 2023: About $24 million. That is $16.8 million on the revolver, $3.3 million from the floating portion of various loans, and $4.1 from two loans maturing in June and August needing to be refinanced.
• 2024: About $6.9 million. That accounts for the full-year run rate on loans that matured in 2023 and a partial year on loans maturing in 2024.
• 2025: About $5.7 million. That accounts for the full-year run rate on loans that matured in 2024 and a partial year on loans maturing in 2025.

For this analysis, I’ve simply assumed that on average the rates on debts increase by 300 basis points.

Let us assume that $95.95 million is a good estimate for 2022. Just to have a steady starting point. Then the following table summarizes the difference in projections:

The difference in interest expense alone would reduce AFFO per share (compared to 2022) by:

• $.23 to 2023
• $.30 in 2024
• $.35 in 2025

Is GNL really going to find a method to generate enough additional Net Operating Income to maintain AFFO per share? I find it extremely unlikely. It is entirely possible that GNL may modify their amount of debt or that short-term rates may increase a bit more or less than 300 basis points. My estimates are not expected to be exact. They don’t need to be exact. They just need to demonstrate that the consensus view is clearly wrong.

Theoretically, if the increase in average interest rates on their debts came in at 400 basis points instead, the reductions for each year would be $.31, $.40, and $.47.

Garbage AFFO

Should I bother to point out that the “AFFO” definition used by the company added back $10 million of stock-based compensation in 2020 and $11 million in 2021?

Or that it also includes adding back the “non-cash portion of interest expense” worth $7.8 million in 2020 and $9.9 million in 2021?

We consider both of those to be “garbage adjustments”.

The first is “garbage” because we wouldn’t let a REIT issue new shares and pretend it was revenue. Paying an expense with shares does not cause it to stop being an expense. There is an argument for modeling this long-term as dilution rather than a simple cash expense, but that argument could also be made for issuing shares and pretending it was revenue. We take the simple route of rejecting the adjustment. If the adjustment is small, it doesn’t matter, but if it is large (relative to total AFFO), then it matters.

We reject removing non-cash portions of interest expense because when new loans replace old loans, we believe new expenses will occur and be amortized through this same line.

Removing those adjustments would’ve reduced AFFO in 2020 by 11% and AFFO in 2021 by 12%. Without those adjustments pumping up AFFO, AFFO per share would’ve been about $1.59 in 2020 and $1.56 in 2021. Those are both below the $1.60 dividend.

Projections for 2022 are even lower than 2021.

The 2023 projections currently show a recovery in AFFO per share because analysts did their jobs poorly. Interest expense alone is enough to absolutely destroy those expectations.

Conclusion

The only intelligent long-term bull case for GNL is getting a buyout. In the short-term, speculation of a buyout being more or less likely could push the share price up or down. If GNL does not get a buyout, the increase in interest expense should create a substantial reduction in AFFO per share. It should be a headwind in each year, making growth in AFFO per share for any of those years quite unlikely unless interest rates fall materially from today’s level.

It appears many investors may be focusing on the dividend yield without recognizing the necessary reduction.

The reduction in AFFO per share wouldn’t simply stop after 2025 either. 2026 doesn’t have the same exposure to maturities. However, 2027, 2028, and 2029 have material maturities on fixed-rate debt. If the REIT was generating strong growth in AFFO per share prior to interest expense, then that growth could offset the headwinds from interest expense. However, that isn’t the case. AFFO per share consistently trended down even as rates were falling over the prior several years. Back then, interest rates were a tailwind. Today, they are a substantial headwind for REITs that carry significant amounts of floating-rate debt or near-term maturities.

We get around this by picking REITs that are driving growth in AFFO per share through growth in revenue per share without taking on high amounts of leverage. If GNL’s debt level was dramatically lower and the REIT was generating solid growth in “per share” metrics, this wouldn’t be an issue. GNL will finally be able to generate dramatic growth in a “per share” metric. Unfortunately for shareholders, it will be “interest expense per share”.