Real estate investment trust (REIT) VEREIT (VER) cut its dividend in 2020, which is not a good thing. But that cut was, in some ways, the final step away from the company's previous incarnation, American Realty Capital Properties. With its past now fully behind it, VEREIT is ready to start showing the world what it can do. That's why I'm not selling anytime soon.
Giving in to my demons
I watched as real estate investment trust American Realty built itself into a giant in the net-lease space, with a portfolio rivaling that of even industry bellwether Realty Income at one point. Net lease REITs own properties, but their tenants are responsible for most of the operating costs of the assets. American Realty had a huge double-digit yield, and since I'm a sap for dividend stocks, I bought in -- in part because the net-lease asset class tends to be a pretty conservative corner of the REIT sector. That was a mistake, and it slapped me in the face very quickly.
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The problem is that American Realty built itself with a series of rapid-fire acquisitions. I didn't think through the implications of that well enough, which became abundantly clear when the REIT announced an accounting error. It was a small one dollar-and-cents-wise, but it was caused by an overly aggressive culture. The entire leadership team changed because of it, and the dividend was suspended. Ouch.
I try not to act in haste, and frankly the damage was done, so I stuck around to see what would happen next. The board, to its credit, brought in a well-known fixer, Glenn Rufrano. Mr. Rufrano quickly got to work, laying out a set of goals investors could hold the REIT to. It wasn't rocket science, but the list was important: strengthen the balance sheet, streamline the portfolio, reinstate the dividend, and deal with the fallout from the accounting scandal. It took several years, and the pandemic was a tough road bump along the way, but VEREIT has executed on each of these goals.
The next phase is the exciting one
Although that was a very brief and truncated overview of a big, multiyear effort, it brings the story all the way up to today. VEREIT is finally ready to grow its business, and is well positioned to do so. For starters, the portfolio is diversified across the retail (45% of rents), restaurant (21%), office (17%), and industrial (17%) property types. That gives it multiple levers to pull as it looks to invest in new assets.
Then there's the balance sheet, which is investment-grade again after the hard work put in by Rufrano and his team. VEREIT further strengthened its financial position recently by buying back some of its 6.7% preferred shares. That's money that could have been put toward acquisitions, of course, but management sees reducing the costs associated with this security as a bigger net benefit right now. And with property markets still working through the upheaval of the pandemic, buying the preferred has definitely led to a more certain outcome.
Meanwhile, the 2020 dividend cut left the REIT with an adjusted funds from operations (FFO) payout ratio of just about 50% in the third quarter. That's a very modest payout ratio, and leaves ample room for growing the dividend and some free cash for investing in new assets. Basically, the cut set a new baseline and signaled that VEREIT was getting ready to chart a new course.
Then there's the portfolio, which is holding up fairly well in the face of the pandemic. To put a number on that, the REIT collected 97% of its rents in December. It also announced that it expects to exceed the high end of its near-term acquisition goal of between $150 million and $300 million between the fourth quarter of 2020 and the third quarter of 2021. In the final quarter of 2020 it had already inked $180 million worth of deals. It is still selling assets, so the net change in the portfolio will be smaller, but it looks as if VEREIT is starting to grow its business again -- but this time in a more sustainable and structured manner. That will, in turn, help to get the dividend growing.
Time to see what's under the hood
I've stuck with VEREIT for a long time. First it was because I didn't want to be rash. Then it was because I believed in the plan new CEO Rufrano had laid out. I'm not about to sell now as the REIT starts to chart a new course that, I expect, will be filled with news about portfolio and dividend growth. And given the foundation that VEREIT has today, this shouldn't be a short story -- it's far more likely to be a long and exciting novel.
