Please ensure Javascript is enabled for purposes of website accessibility

This High-Yielding REIT Just Got Riskier

By Reuben Gregg Brewer - Nov 10, 2019 at 1:15PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

REIT Colony Capital sports a hefty 7% yield, but there are big changes afoot that investors need to understand before pulling the trigger here.

Colony Capital (NYSE: CLNY) is a real estate investment trust (REIT) that has a huge 7% yield, more than three times what you would get from an S&P 500 Index fund. That yield is also more than twice what the REIT universe is offering, using Vanguard Real Estate Index ETF as a proxy. While dividend investors might find the high yield alluring, you need to step back and dig into the story before making a final call. A lot is changing as we speak.

What it was and what it will be

Although originally founded in 1991, Colony Capital as it existed at the start of 2019 was essentially created in 2017 via the merger of three business. Although there were some other assets included in the mix, after the mergers it was basically a diversified REIT with notable assets in the healthcare, hospitality, and industrial sectors. But what set it apart from other REITs was that Colony created and managed separate REITs focused on these sectors. 

A spinning roulette wheel

Image source: Getty Images

This allowed it to invest in these assets, while also taking money from outsiders who invested along with it. In that way it's also an asset manager. That's pretty much what Colony has always been, however, so this isn't as odd a business model as it may seem. That said, the asset management mentality is notable because Colony has a fairly fluid business approach -- it wants to buy and sell assets, but is open to moving to the places where it sees the most value. 

Because of the merger, 2017 was basically a throwaway year -- there was just too much going on for the company to steady itself. In fact, its CEO described 2017 as "disappointing" in the fourth-quarter earnings release. So 2018 was the first clean year for the "new" Colony -- and it didn't start well. The REIT slashed its dividend from $0.27 per share per quarter at the end of 2017 to just $0.11 in 2018, and it hasn't budged since. That's a huge 60% dividend cut that investors were not pleased to see, sending the shares down, somewhat appropriately, about 60% for the year. That dividend cut, however, wasn't exactly a surprise given that the REIT's funds from operations (FFO), similar to earnings for an industrial concern, in 2017 were negative.  

2018 didn't exactly show huge promise for this odd amalgam of an REIT either. So the company did something drastic: In mid-2019 Colony bought a company called Digital Bridge. This wasn't an out-of-the-blue decision; the two companies had previously partnered on a real estate fund focused on digital assets. But the purchase was a massive game changer. 

Why is this so big?

Along with the merger, Colony also announced that the CEO of Digital Bridge would eventually take over the reins at the combined company. And, even more important, Colony was going to jettison its historical asset focus and shift to digital real estate. Basically, Colony decided that it was going to hit the reset button and hand the company over to a new CEO. To be fair, Colony has always been a buyer and seller, shifting into areas that it sees as the most desirable. But this is a massive change.

The new Colony is going to hone in on cell towers, data centers, and other digital-tied assets (like fiber optic cable). These are areas that have caught the attention of investors in recent years, and appear to hold great opportunities for growth. That growth is expected to be multiples of what is expected in the company's previous focus areas, most notably healthcare and hospitality. So, on the surface, this is a good move.

And to be fair, Colony isn't the only company trying to shift toward digital assets. For example, Iron Mountain (IRM -4.65%) is doing something similar, as it increasingly focuses on data centers. Only Iron Mountain, which yields 7.4%, isn't selling everything it currently owns -- it is using the sizable and stable document storage business it operates as a foundation to build out its data centers. That's a much more measured approach, though the change will clearly take longer to implement. 

This comparison, however, highlights the problem for Colony: It has to sell most of what it owns so it can go out and buy all the assets that it wants to own instead. Although the REIT has already made some progress on that front, it is a huge effort with a lot of moving parts. Now add in a new CEO and the risk and uncertainty here starts to head even higher. This isn't really Colony Capital anymore. It is, for all intents and purposes, a new company emerging from the ashes of the old Colony Capital -- which is currently being blown up, though perhaps dismantled would be a more polite description. 

Good idea, but more time is needed

Colony Capital has changed a lot over the last few years, but the direction shift announced in July of 2019 was something different. Colony is planning on becoming a completely new company. There is a lot that has to change for it to achieve this goal, and it will be hard to assess if this is a good move or not until it's further along in the process.

Despite the attractive dividend yield, most investors will be better off sitting on the sidelines here. If you really like the idea of shifting to the digital real estate space, you would be better off looking at a company like Iron Mountain. Or, perhaps even better, just buying an REIT that is already fully focused on digital real estate.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Iron Mountain Incorporated Stock Quote
Iron Mountain Incorporated
IRM
$51.02 (-4.65%) $-2.49

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
328%
 
S&P 500 Returns
116%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/19/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.