Sell Alert: 2 REITs That Likely Will Cut Their Dividends

In a recent article, I explain that most dividend cuts in the real estate investment trust (“REIT”) sector are the result of:

1. Poor management
2. Overleverage
3. Or the growing need for capex.

Therefore, most dividend cuts can be avoided by simply screening for those red flags.

Poor management is the easiest to spot. If a REIT is constantly raising more equity, despite trading at a discount to its net asset value, you know that a dividend is coming. The manager is simply trying to grow the company to earn more fees, but it is dilutive to shareholders. A good example that fits into this category are Global Net Lease (GNL). Just look at all the equity raises and the performance of their stock…

Overleverage is a bit trickier to identify because high leverage, on its own, does not mean that the company will cut its dividend. If the underlying properties are growing their cash flow and the debt has long maturities, the REIT could very well even benefit from the high leverage, leading to more dividend hikes. It only becomes problematic when the debt has short maturities, a variable interest rate, and/or the underlying properties are struggling. The Necessity Retail REIT, Inc. (RTL) has too much leverage at 55%, its debt is not structured safely, and its properties are average at best, so I expect a dividend cut. That’s what the market is pricing as well:

Finally, if a REIT owns properties that are at risk of obsolescence, it will have to reinvest heavily in them, growing the need for capex, and this will often also lead to dividend cuts. In recent years, most mall REITs, including Macerich (MAC), Simon Property Group (SPG), Tanger Factory Outlet (SKT), CBL & Associates Properties, Inc. (CBL), and Pennsylvania REIT (OTC:PRET) had to cut their dividend because the growth of Amazon (AMZN) changed the retail landscape. They had to reinvest in their properties to diversify away from traditional retail:

Knowing this, we can now try to identify other companies that are likely to cut their dividend in the future.

At High Yield Landlord, we are very selective, and while we also suffer dividend cuts once in a while, we have been able to avoid most of them so far.

In what follows, we highlight 2 more REITs that we expect to cut their dividend in the future:

Office Properties Income Trust (OPI)

Recently, quite a few office REITs cut their dividend.

First, it was SL Green (SLG). It cut its dividend by 13% in November.

Then, it was the turn of Gladstone Commercial (GOOD). It cut its dividend by 20%, ruining a near-20 year track record of steady dividend payments.

Finally, just the other day, Vornado Realty Trust (VNO) slashed its dividend by nearly 30%!

They are cutting their dividends because the rise of remote work is causing great pain to the office sector.

Many companies are deciding to rent less space because their employees can work remotely at least part of the time using Zoom (ZM), Slack, and other technologies. Moreover, many companies are also deciding to only rent flexible office space via WeWork (WE) or IWG (OTCPK:IWGFF):

This will force most office landlords to reinvest in their properties to make sure that they remain desirable in a changing environment.

The Class A, new-built office buildings will be the least impacted, and I suspect that the older single-tenant office buildings will be the most impacted in the long run. They can rapidly go from 0% to 100% vacant, and it would require a lot of capital to transform these properties into the office buildings of the future.

Realty Income Corporation (O) knows this, and so it got rid of all these properties in 2021 as it spun them off into a separate REIT called Orion Office REIT (ONL).

ONL set its dividend very low from the start at just 22% of its FFO because it knew that it couldn’t afford to pay more as it will have to reinvest heavily in its properties over time to keep them desirable.

But one of its close peers, Office Properties Income Trust (OPI), is today paying closer to 61% of its funds from operations (“FFO”) in the form of dividends.

The yield is high at nearly 14%, and many individual investors are buying it, thinking that the dividend is safe because the payout ratio is low compared to many other REITs.

But they forget that a 61% payout ratio based on FFO can rapidly turn into a >100% payout ratio once you adjust for the growing capex need.

If ONL is paying out only 22% of its FFO, I think that OPI very likely can’t afford to pay 3x more. Therefore, a dividend cut is likely coming.

	ONL	OPI
Payout Ratio	22%	61%

Click to enlarge

Today, its average remaining lease term is only 6 years, which is low for single-tenant office buildings, and nearly 30% will expire in the next 24 months alone!

The management tries to sell the story that this provides an opportunity to increase rents, but I am not buying it. I expect the vacancy rate to spike up and tenants to demand significant capex in order to resign new leases.

Besides, OPI also has more debt than average, and its management has a poor track record, suffering significant conflicts of interest.

I think that it is only a question of time before OPI cuts its dividend and the cut could be very significant. I am staying away from it.

Omega Healthcare Investors, Inc. (OHI)

Let me start by saying that I am less certain that OHI will cut its dividend.

OHI is in many ways a much better REIT than OPI.

It is well-managed, it has a decent balance sheet, and the company has a fantastic track record. It has actually paid a steady dividend for ~20 years, avoiding dividend cuts even during severe crises:

But here are the issues:

• Its payout ratio is too high at 92%.

• That’s based on its FFO. It is even higher based on AFFO!

• Its credit rating is just above junk, and all it would take is a few tenant issues, and credit agencies could downgrade it. This would lead to a higher cost of capital, putting even more pressure on the dividend.

• Well… OHI just issued a warning on the health of some of its tenants. Skilled nursing facilities are higher cap rate / riskier properties, and in Q3 (Q4 not yet released), 12% of its tenants did not pay their rent. Things could get worse, as many of its tenants are struggling to make money and rent coverage ratios are very low, leaving little margin of safety.

In a recent investor presentation, the management said that the impact “will result in both our dividend payout ratio and our near-term leverage being higher than our historical range during this period of time.”

Yet, they seem hesitant to cut the dividend because they don’t want to ruin their 2-decade track record of steady dividend payments. It is one of the key arguments that has historically allowed them to raise capital at a premium to NAV.

But it is exactly this hesitancy that may run them into more trouble. It increases the risk of a credit downgrade because they are overpaying, which worsens the financial health of the company.

If they manage to restructure leases and return to growth, OHI could be a strong performer in the coming years, but before that, there is high risk of a dividend cut. Unless you have a higher tolerance for risk, you better stay away from it. Some other healthcare REITs pay a comparable dividend yield at >8%, but have stronger fundamentals. Global Medical REIT (GMRE) is one example that I recently highlighted in a YouTube video.

Bottom Line

To recap: the biggest telling signs of a coming dividend cut are poor management, overleverage, and the growing need for capex.

If you want to seek alpha and outperform the market, you should first and foremost make sure that you avoid dividend cutters in the REIT sector. They are typically some of the worst performers and by simply avoiding those, you can do quite a lot better than the REIT indexes (VNQ).

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.