If you are like most dividend investors, an 11.5% yield is like a flame to a moth -- you can't help but look, mouth watering, and glide on over for a closer examination. But yields that high, when S&P 500 Index ETFs are only offering yields of around 1.5%, need to be treated with extreme caution. Here's why Global Net Lease (GNL 0.61%) and its huge 11.5% dividend yield may not be as safe as investors would like.
A solid model
Global Net Lease doesn't do anything particularly outlandish property-wise. For starters, it is a net lease REIT (real estate investment trust), which means it owns single-tenant assets for which the lessee is responsible for most of the costs of the property they occupy. Any single investment comes at a high risk because there's only one tenant, but across a large enough portfolio (Global Net Lease owns over 300 properties), the risk is pretty low. This is the same investment tactic used by dividend stalwarts like Realty Income and W.P. Carey, both of which have increased their dividends annually for decades.
Global Net Lease, as its name implies, also has a particular focus on geographic diversification. Roughly 60% of its rents come from North America, with the rest derived from Europe. W.P. Carey takes a similar approach, and Realty Income is increasingly putting money to work across the pond. So, again, nothing out of the ordinary, highlighting the fact that diversification is good for your portfolio and good for REIT portfolios.
And while Global Net Lease tends to have a heavier focus on industrial and office assets than either W.P. Carey or Realty Income, its portfolio isn't so out of line that you should instantly feel concerned. That said, the REIT's 40% or so of rent from office assets is about twice that of W.P. Carey. Realty Income, meanwhile, chose to spin off its office properties not too long ago. Office properties can be more difficult, time consuming, and expensive to retenant in the case of a vacancy.
Still, from a portfolio standpoint, Global Net Lease isn't outlandishly out of line with similar net lease peers. However, that doesn't mean there aren't risks to worry about.
1. A history with a cut
As noted above, W.P. Carey and Realty Income both have long histories of annual increases under their belts. Not so for Global Net Lease, which cut its dividend 25% in 2020. Clearly, that's not a great outcome, even though you could easily lay the blame for the cut on the coronavirus pandemic. And yet it is hard not to notice that the company's first-quarter 2022 adjusted funds from operations (FFO) of $0.43 per share remains well below the pre-cut dividend of $0.5325. That cut had to happen, and the business clearly hasn't improved anywhere near enough to bring the old payout back.
2. A tight ratio
In fact, the first quarter's adjusted FFO was just slightly above the current quarterly dividend of $0.40 per share. That's an adjusted FFO payout ratio of 93%. For comparison, W.P. Carey's adjusted FFO payout ratio was roughly 81% in the first quarter. Realty Income's ratio was 75%. Clearly, the dividend security is much better at W.P. Carey and Realty Income than it is at Global Net Lease, which is paying out far more of its cash flows as dividends. This is a big part of the reason Global Net Lease yields 11.5% and why W.P. Carey and Realty Income yield 5.1% and 4.3%, respectively.
3. Leveraged up
Realty Income has a debt-to-equity ratio of 5.4 times. W.P. Carey is just a touch higher at 5.9 times. Global Net Lease's debt to equity ratio is nearly 8.1 times. Debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) follows the same trend, with Realty Income's ratio at roughly 0.6 times, W.P. Carey at about 0.9 times, and Global Net Lease at 1.5 times.
You can look at leverage in many different ways, but the big takeaway here is that Global Net Lease makes much greater use of leverage, and, just as important, leverage limits a company's flexibility during difficult periods. If you are worried about a recession, Global Net Lease doesn't appear anywhere near as well positioned balance sheet-wise as Realty Income or W.P. Carey.
It'll muddle through, but at what cost?
So, if you are wondering if high-yield Global Net Lease is in trouble, the answer is really yes and no. It is highly likely that the REIT manages to deal with a recession if one comes to pass, as many on Wall Street expect. The question is what will muddling through such a difficult period look like? With a high degree of leverage, an elevated payout ratio, and a history of cutting its dividend, the answer is that income investors could end up very unhappy here should Global Net Lease struggle. If a reliable stream of passive income is what you are after, you'll probably want to stick to lower-yielding peers.
