Sometimes a high dividend yield is an opportunity, and sometimes it is a red flag. Real estate investment trusts (REITs) generally have high dividend yields, so it can be tough to determine whether that yield is sustainable. The key to determining sustainability is whether the dividend is covered by earnings and whether earnings are going up in general, or down. Here is one REIT with what looks like a sustainable dividend and another whose dividend is somewhat shaky.
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Simon Property is a top mall REIT and benefits from strong consumer spending
Simon Property Group (SPG -0.55%) is an operator of malls, premium outlets, and The Mills shopping centers.The company also owns a noncontrolling interest in Taubman Group and an interest in numerous retailers in North America and Europe. As of the end of 2022, the company had an ownership interest in 230 properties containing 184 million square feet.
Despite the rapid rise in interest rates, consumer spending has been robust as wage inflation has pushed up incomes. This has translated into higher sales. Retailer sales per square foot rose to $753, an increase of 5.6% compared to a year ago. Occupancy has been increasing since the COVID-19 pandemic, rising to 94.9% compared to 93.4% a year ago.
In 2022, funds from operations (FFO) rose 3.8% compared to a year ago. REITs generally use funds from operations to describe earnings in lieu of earnings per share because depreciation and amortization is such a large deduction from net income reported under generally accepted accounting principles (GAAP). Since depreciation and amortization is a noncash charge (that is, the company doesn't write a check for it), earnings per share tend to understate the cash-flow generating capacity of the company.
Simon recently hiked its dividend, and at current prices the stock yields 6%. The $7.20 dividend per share is easily covered by the company's FFO per share of $11.87. Rising interest rates will continue to be a headwind for the REIT sector in general, but Simon is one of the best-performing retail REITs out there and consumers are in great shape.
Annaly is a holdout in a peer group that has cut their dividends
Annaly Capital (NLY 0.94%) is a mortgage real estate investment trust (REIT) that invests in mortgage-backed securities, mortgage servicing rights, and whole loans. Mortgage REITs are different than REITs like Simon in that they don't develop properties and lease them out. Annaly invests in real estate debt; in other words, mortgages.
Last year was particularly difficult for the mortgage sector in general, as the Federal Reserve hiked the federal funds rate in order to cool down inflationary pressures. Rates rose rapidly, and mortgage-backed securities are especially sensitive to volatility. As rates rose, mortgage-backed securities fell in value, and the interest rate hedges that Annaly had weren't enough to fully offset the losses on the portfolio. As a result, book value per share fell from $31.88 at the end of 2021 to $20.79 at the end of 2022.
Annaly has a fantastic dividend yield of 16.9%, but that yield might just be too good to be true. Most mortgage REITs were forced to cut their dividends last year, and Annaly's yield is out of step with that of peers like AGNC Investment (AGNC -1.55%). Annaly's quarterly dividend of $0.88 was barely covered by earnings available for distribution of $0.89.
Annaly has some exposure to nonguaranteed mortgages, and if the U.S. hits a recession and the real estate market goes south, some of these loans which are underwritten based on projected rental income could start taking credit losses. Annaly's problem is that its ultra-high dividend is barely covered, and everything needs to go right for it to be sustainable.
