Real estate investment trust (REIT) Global Net Lease (NYSE:GNL) cut its dividend by 25% in late March. That's obviously not good news for investors. Interestingly, though, Wall Street continues to be a little leery of the REIT's dividend, with the stock still offering a double-digit yield when peers are in the mid-single digits. The truth is, there are problems in the net lease space today as the entire sector deals with the impact of the COVID-19 pandemic.
But Global Net Lease isn't likely to end up being the poster child for a troubled industry. It's really the exception.
A problem before the problem
Global Net Lease's name is pretty descriptive. It owns net-lease assets, which means its lessees are responsible for most of the operating costs of the properties they occupy. Generally, this is a pretty conservative business approach for a real estate investment trust, which can just sit back and collect rent (a bit of an oversimplification, but you get the idea). The REIT basically makes the difference between its financing costs and the rents it charges. As long as the company buys decent assets at reasonable prices and is careful with the leverage it takes on, it should be a boring income investment. Look no further than industry bellwethers like Realty Income (NYSE:O) and National Retail Properties (NYSE:NNN) as evidence: The pair have increased their dividends annually for 27 years and 30 years, respectively. Realty Income's dividend yield is roughly 5.5% today, with National Retail's sitting at about 7.4% (both are high by historical standards because of COVID-19 related concerns).
But Global Net Lease, as its name implies, has a global focus. Neither Realty Income nor National Retail has much foreign exposure. Roughly one-third of Global Net Lease's rent roll comes from Europe. The thing is, the net lease model doesn't operate any differently in Europe than it does in the United States (which makes up the rest of the REIT's portfolio). For an example of this, look at W.P. Carey (NYSE:WPC), which has a similar U.S./Europe portfolio breakdown. Carey's dividend has been increased annually for 23 years, or every year since its IPO, and its yield is around 7.5% today.
The reason for Global Net Lease's dividend cut and still-exceptionally-high dividend yield isn't that it's a net-lease REIT. It isn't that it invests globally. The problem is specific to Global Net Lease.
Too much going out the door
In 2019 Global Net Lease's funds from operations, which is like earnings for an industrial company, came in at $1.69 per share. Adjusted FFO, which the REIT believes is a better representation of its dividend-paying ability, came in at $1.85 per share. And yet the company ended the year with a dividend run rate of $2.13 per share. No matter which FFO number you use, its payout ratio was more than 100%. That's sustainable over a short period of time, but not a long one.
For reference, Realty Income's payout ratio was 83% in 2019 using the final monthly dividend rate as a run rate and the lower of FFO or AFFO. National Retail Properties' payout ratio was around 75% using the same approach. And W.P. Carey's payout ratio was 90%, using conservative figures. (Note that Carey is in the middle of shutting down an asset management business, so its funds from operations figures are weaker than usual right now.) All of these REITs could afford their dividends; Global Net Lease couldn't.
In fact, even at the new lower dividend of $1.60 per share, Global Net Lease's FFO Payout ratio (using the more conservative payout ratio approach applied to the other three REITs above) looks kind of tight at 95%, assuming it can earn the same amount in 2020 as it did in 2019. With COVID-19 around, however, that's far from certain -- the company even highlighted the coronavirus as the reason for its dividend cut. This, of course, helps explain why the yield is so high: Wall Street is obviously taking a wait-and-see approach here, thinking that the dividend cut could be a sign that the troubles at Global Net Lease are deeper than they appear.
Not a sign of the times
In the end, Global Net Lease's dividend cut is not a harbinger of things to come for the net-lease sector as a whole. It really speaks to a REIT that couldn't support the dividend it was paying. Sure, it blamed COVID-19 for the cut, but a dividend reduction was already in the cards here. If you are looking at Global Net Lease, you should probably step back and take a look at other net lease REITs instead, like W.P. Carey, Realty Income, and National Retail. Simply put, there are better options available.