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Danger Lurks for These High-Yield Dividend Stocks

By Brent Nyitray, CFA – Jun 26, 2020 at 8:43AM

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These two REITs have issues beyond the economic fallout from the COVID-19 pandemic.

The COVID-19 crisis has been a trial by fire for the real estate investment trust (REIT) sector. Mortgage REITs were the first casualties, then the crisis moved to retail and mall REITs.

Many mall REITs were overleveraged before the coronavirus crisis grabbed hold of the economy and were suffering from a loss of share to online retailers. Then office REITs were hit by stay-at-home orders as many smaller businesses were unable to make the rent.

For two REITs in particular, there are further issues beyond the COVID-driven recession. Both are suffering from issues that were exacerbated by the pandemic and won't go away once it is over. Both these companies have higher dividend yields than their peers, which can be a signal that something is amiss. A yield that looks too good to be true often is. 

Picture of office buildings

Image source: Getty Images.

Social distancing meets online shopping

Simon Property Group (SPG 0.70%) is a mall REIT with a dividend yield that advertises trouble on the horizon. Simon is in the midst of a soap opera-like dispute with Taubman Centers (TCO) in which Simon agreed to purchase Taubman for cash prior to the COVID-19 crisis. In hindsight, it looks like Simon grossly overpaid, and now it wants out of the deal (or maybe just a chance to renegotiate).

Merger agreements are not the easiest things to break, and it is highly unlikely the company will be able to persuade a judge that the COVID-19 pandemic gives Simon the proper justification for pulling out. So the best case for Simon is a renegotiation. The worst case is a judge forcing Simon to buy Taubman as agreed, and the company buys a bunch of underperforming malls with bad blood between the companies.

Retail bankruptcies are an additional headache, and there have been reports that Simon and Brookfield Property Partners would be interested in buying bankrupt retailer J.C. Penney. This would keep an anchor tenant in place, which could help prevent an exodus by other mall stores. Smaller retailers are often permitted to break the lease if an anchor tenant leaves. Simon has bought bankrupt retailers before; the company purchased Forever 21 earlier this year and Aeropostale in 2016. Investor reaction to these buyout reports has not been positive for Simon.

Simon is trading with a 12% dividend yield, which is higher than comparable mall REITs like The Macerich Company at about 4.7%. The high yield indicates that a cut is probably coming, and the Taubman headache isn't going away. Even after malls reopen, retailers will still struggle as social distancing limits traffic and many people may simply decide it is too risky to go shopping in a crowd. Mall REITs were already in trouble, and CBL and Associates Properties is trading below $1 per share, a signal that bankruptcy is imminent. 

Escape from New York

SL Green Realty (SLG 2.58%) is Manhattan's largest office landlord. The pandemic has made office space vulnerable, particularly in dense urban areas like New York City. For a time, it was the epicenter of the crisis, at least in the beginning, and New York City is only now beginning to reopen.

The past few months have proved that the work-from-home concept is viable, and the civil unrest in New York has persuaded many residents to move out to the suburbs. This trend looks robust, and we are already seeing a decline in New York City residential real estate prices.

Employers are almost certainly going to follow their employees, choosing smaller, cheaper suburban locations. SL Green announced May rental receipts were 91.1% for office and 54.7% for retail. The retail properties should remain stressed due to less tourism, higher unemployment, and social distancing.

Finally, SL Green has been experiencing declining funds from operations for the past four years, and it looks like this year will be no different. It has some breathing room, as 2019 funds from operations covered the dividend twice. SL Green is probably nowhere near having to cut its dividend, but its 7.1% dividend yield (compared to other office REITs like Boston Properties that yield at about 4.4%) indicates that investors are at least somewhat concerned. 

The flight to the suburbs was already in place before COVID-19, but the pandemic is certainly accelerating that trend. Instead of urban office REITs, perhaps consider homebuilders or suburban housing REITs like American Homes 4 Rent.

Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Simon Property Group, Inc. Stock Quote
Simon Property Group, Inc.
$89.75 (0.70%) $0.62
SL Green Realty Corp. Stock Quote
SL Green Realty Corp.
$40.16 (2.58%) $1.01
Taubman Centers, Inc. Stock Quote
Taubman Centers, Inc.

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