From a high-level view, Global Net Lease (GNL 1.30%) has an attractive business approach, owning a portfolio of net lease assets diversified by property type and geography. But when you dig down a little, the story starts to get a lot less compelling. This helps explain the massive 14% dividend yield this real estate investment trust (REIT) sports today. Here's what you need to know before considering this stock for your dividend portfolio.
Spreading things around
Global Net Lease owns net lease properties, which means its tenants (usually one per property) are responsible for most asset-level operating costs. Across a large enough portfolio, it is a fairly low-risk investment approach in the REIT space. With a little over 300 properties, Global Net Lease is large enough that the risk from a vacancy at any single property is fairly low.
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On top of the net lease focus, the REIT is diversified by property type, asset location, and tenant quality. For example, industrial properties make up roughly 56% of the business, office 41%, and retail 3%. North America is 65% of the business, with Europe rounding things out to 100%. About 60% of Global Net Lease's tenants are investment grade. Although office properties are under pressure today, with remote work still a material headwind to occupancy, the overall portfolio is fairly balanced.
So far, so good. The problem starts to show up when you look back at the dividend. The first big change took place in mid-2019 when Global Net Lease shifted from monthly dividends to quarterly dividends. This can be a way to retain cash, at least temporarily. Then, in early 2020, amid the coronavirus pandemic, the dividend was cut roughly 25%. That move happened in April, which was fairly early in the pandemic, suggesting that there was already material stress on the dividend before the illness started to spread.
What things look like now
Even after that cut, investors appear to be worried about the safety of Global Net Lease's dividend. That's highlighted by the huge 14% dividend yield on display today. The question for dividend investors attracted to such lofty payments: Is the risk worth the potential reward? The answer is probably not.
For starters, Global Net Lease's funds from operations (FFO) in 2022 tallied up to $1.63 per share. The dividend for the year was $1.60. That equates to an FFO payout ratio of 98%. That high of a payout ratio doesn't leave much room for adversity. Even when you look at adjusted FFO, which takes out items a REIT believes to be one-time in nature, the numbers are still fairly weak, with $1.67 per share in adjusted FFO leading to a still-high adjusted FFO payout ratio of nearly 96%.
The worry about adversity isn't immaterial, either. The 41% of the portfolio dedicated to office properties is likely to be a headwind on the revenue front. And roughly 30% of the debt on the company's balance sheet is variable rate (up from around 11% at the end of 2021), which means it is exposed to rising interest rates. That's a potential risk on the cost front.
Meanwhile, if you look at the fourth quarter and use the FFO and adjusted FFO, dividend coverage looks even weaker. FFO in the quarter was $0.24 per share versus a $0.40 dividend, meaning FFO didn't cover the payout. Adjusted FFO was $0.41 per share, which leads to a worrying payout ratio of 98%. In other words, even using what is usually the best possible view of things (adjusted FFO), the company ended the year with a particularly weak payout ratio.
A dividend cut in 2023 would not be at all shocking unless Global Net Lease's business starts to see some quick and material improvement. But given rising interest rates and the pressure on office properties, material improvement seems unlikely. In fact, a glass-half-empty view would suggest that it's just a matter of time before there's another dividend cut.
Not worth the risk
Sometimes buying a stock with a lower but more sustainable dividend is a better option than taking on the risk of a dividend cut. When you look at Global Net Lease's results, the dividend clearly looks at risk. That, of course, helps explain the high yield. All but the most aggressive investors should probably err on the side of caution here.
