Everyone loves a high dividend yield stock when it's paying out loads of cash, but nobody loves it when their quarterly financial rewards suddenly start to get a bit stingier without warning. That's why investors need to approach such companies quite carefully, as the temptation of buying a few shares needs to be tempered by the unpleasant reality that high dividend yields are typically quite risky.
In that vein, there are two passive income investments that are too risky to approach right now despite their ludicrously juicy yields. Here's why you should avoid both of them for the moment.
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1. AFC Gamma
With an outrageously high forward dividend yield above 15.7%, even savvy investors are likely to at least take a closer look at AFC Gamma (AFCG -0.68%). But there's good reason to be very cautious. Its line of business is lending to cannabis companies, which typically can't get access to capital from traditional financial institutions in the U.S. due to a federal marijuana prohibition. In exchange for its loans, AFC gets a claim on the real estate equity of its debtors, so if they end up defaulting, it can seize the property as collateral.
At present, the company is profitable, and its loans have a weighted average yield to maturity of 21% (!) across its currently funded commitments worth $421 million. Unfortunately, in the fourth quarter, it reported net income of $2.9 million, a shocking decline of 71% from a year prior. The reason for the steep fall is that it set aside more than $8.1 million of its $21.4 million in interest revenue to provision for expected future losses on its loans. In other words, it expects its debtors to start having a lot of trouble paying up, and soon.
That's completely understandable, given the ongoing drawback in the cannabis industry that's seen share prices and cannabis selling prices collapse, pressuring company margins severely in the process. But it raises another issue: Commercial real estate prices started to crater after first-quarter 2022. Getting to seize the collateral of delinquents means getting hold of equity in properties that will be harder to sell to buyers at the same price as their value at the time of AFC's underwriting of the loans.
Until there's some tangible improvement in either the commercial real estate market or the cannabis market, AFC is likely to experience more defaults, and it'll likely need to keep setting aside more money to prepare for that possibility. The market will likely continue to punish its share price, even if its dividend yield is super high. So, for now, it's probably best to look elsewhere for a dividend stock.
2. Sabra Health Care REIT
Sabra Health Care REIT (SBRA -0.36%) buys nursing facilities, housing for seniors, and behavioral care centers with the aim of renting out the spaces, delivering steady dividends to investors with the leftover money it brings in. And given that its forward yield is currently 10.1%, it might not be as outrageously mouth-watering as AFC Gamma, but it's still a better idea to pump the brakes on making a purchase in this real estate investment trust (REIT).
Its top line was $628.1 million in 2022, but it wasn't profitable, which is a red flag for a business that investors are considering for dividend income. The culprit for its unprofitability was the losses it claimed on its investments in unconsolidated joint ventures, which were responsible for $88.3 million in losses. Management points to trouble with finding enough staff as the culprit, but it's still another red flag regardless of the cause.
The final red flag is that Sabra sold off $158.7 million worth of its properties to pay down some of the debt in its revolving credit facility in 2022, incurring losses totaling $12 million. For each property it sells, that's less money coming in as rent, so it's possible that the company's top line will shrink. With so many red flags in hand, there's not much reason to invest in Sabra when there are better, less risky opportunities elsewhere in the market.
