It's hard for dividend investors to find desirable yields in today's low-yield world. So, a nearly 11% dividend yield might sound extremely attractive. But with the S&P 500 Index yielding around 2%, you need to ask why Global Net Lease's (NYSE:GNL) yield is more than five times higher.
Here's a quick look at Global Net Lease's huge dividend and why investors should be cautious about this net lease real estate investment trust (REIT).
A little background
Global Net Lease is an interesting REIT. First, as its name implies, it uses a net lease approach. So, it owns properties and leases them out under generally long-term contracts (the weighted average lease term is around eight years) that require the lessee to pay most of the operating expenses of the property. Often, it buys a property and leases it back to the previous owner, providing that company a way to free up capital while still retaining use of the asset.
Further, Global Net Lease takes a highly diversified approach to its property and country exposures. For example, the U.S. market accounts for around 60% of its portfolio, and the rest comes largely from Europe. Office assets are roughly half the portfolio, industrial about 40%, and the rest invested in retail properties. Investment-grade tenants are about 70% of the total. This is a fairly unique breakdown, with only Carey coming close to this kind of diversification. That said, Realty Income has recently started to reach overseas, as well, though it has a more intense focus on retail assets and is still largely a domestic U.S. play.
While Global Net Lease's approach sets the company apart from most of its peers, except perhaps Carey, there are some things investors should be worried about -- most notably, the dividend. Why, for example, would Global Net Lease offer a nearly 11% yield when Carey offers 4.5% and Realty Income 3.4%?
Not so safe
Despite global diversification and a portfolio that's split between multiple asset classes, Global Net Lease doesn't come close to matching Carey when you examine the companies' balance sheets. For example, Carey's financial debt-to-equity ratio is around 0.45 times, with Global Net lease coming in with a ratio of 1.10 times. Carey covers its interest expenses three times over, while Global Net Lease only manages interest coverage of 1.4 times.
These are important numbers when you look at a dividend-paying stock. Too much leverage can quickly lead to a situation in which management has to make a choice between paying its debtors or returning cash to investors via dividends. Investors usually lose.
But that's not the only troubling metric to consider. Global Net Lease's adjusted funds from operations (AFFO), which is similar to earnings for an industrial company, came in at $0.47 per share in the second quarter, down nearly $0.05 from the year-earlier period. It sold some assets, so the drop can be explained away. The real problem is that it pays a quarterly dividend of $0.5325 per share. In other words, AFFO isn't enough to support the dividend. A REIT can pay out more than AFFO for a little while, but not for very long. This is a big warning sign that the dividend isn't sustainable.
In fact, the REIT recently shifted from monthly dividends to quarterly dividends. That doesn't change the amount investors get, just the frequency. But this change isn't innocuous. By keeping that cash in-house for a few extra months, Global Net Lease is increasing its liquidity. If the payout ratio weren't flipped the wrong way, and leverage wasn't so high, this wouldn't be a concern. However, based on the situation, it looks like Global Net Lease made this decision from a position of weakness, and that should trouble investors.
Comparing Global Net Lease to Carey again provides some context. Carey pays dividends quarterly and has for a long time. More important, its second-quarter AFFO (to compare like periods) of $1.22 per share handily covered its dividend of $1.034 per share (the AFFO payout ratio was roughly 85%). If you had to pick the REIT with the stronger dividend, Carey would win, hands down.
Worried about a cut
Going back to that fat 11% yield, it should be pretty clear that Wall Street is worried, for good reason, that it isn't sustainable. Global Net Lease has an interesting story, but when you dig into the details, most dividend investors should avoid this name. That said, if you like the diversification this REIT offers, you might want to keep an eye on W. P. Carey, and even Realty Income, as it starts to reach overseas. Although both of these REITs have had good runs lately and are a little pricey today, they could be good alternatives to keep on your watch list for deeper consideration during a pullback.