A double-digit dividend yield can be very alluring. It suggests that the stock can produce lots of dividend income.
Unfortunately, more often than not, a super high yield indicates that the market sees a dividend cut in the future. I believe that's the likely fate for the big-time payouts of Medical Properties Trust (MPW +1.21%) and Brandywine Realty (BDN +3.77%). Here's why income-focused investors should avoid these two high-yielding real estate investment trusts (REITs).
Not healthy enough to survive
Medical Properties Trust is one of the top dividend payers in my portfolio. That's why it pains me to say it, but I think its big-time dividend (it currently yields more than 11%) is on the chopping block.
NYSE: MPW
Key Data Points
Two factors have soured my view on the sustainability of its dividend. For starters, the healthcare REIT has a high dividend payout ratio. The company expects to generate $1.29 per share of adjusted funds from operations (FFO) at the low end of its 2023 guidance range. With its current dividend payment at $0.29 per share each quarter ($1.16 annualized), its dividend payout ratio is around 90%. While it could pay out up to 100% of its adjusted FFO, most REITs target a payout ratio below 80%. A lower payout ratio gives them more financial flexibility.
The company's adjusted FFO is facing some temporary headwinds from delinquent tenants. One of its largest tenants isn't currently paying any rent, though partial payments will resume in September, with full payments starting next March. Meanwhile, another tenant recently emerged from bankruptcy. Medical Properties Trust agreed to defer 30% of that tenant's 2023 rent into next year when it will collect that money with interest. While the future receipt of full rent will help boost the REIT's cash flows, it still might not be enough to preserve the dividend.
Medical Properties Trust's other issue is its balance sheet. On a positive note, it expects to bring in $1.4 billion in cash from asset sales and loan repayments, which is enough to repay its 2023 and 2024 debt maturities. However, it has another $1.4 billion of debt maturing in 2025 and nearly $2.7 billion coming due in 2026 that it will have to address. With interest rates rising, it will become a lot more expensive to refinance these borrowings. As a result, the company could find its best course of action is to reduce or suspend its dividend and reallocate that cash toward paying off debt. While I hope that's not the case -- and the company believes it can maintain its payout -- a payout cut isn't off the table, either.
The towering payout seems likely to fall
Brandywine Realty is in a similar situation, putting its 16%-yielding payout at a high risk of a reduction. The office REIT expects its payout ratio to be between 95% and 105% of its cash available for distribution this year. That leaves no margin for error.
It also means the company isn't retaining any cash to fund its 2023 capital plan. That budget requires $310 million to fund its dividend ($99 million) and capital projects ($211 million in joint venture contributions, capital expenditures, and development projects). The company expects to bridge the $162 million shortfall in cash flow after interest payments by selling assets ($120 million) and utilizing balance sheet cash ($42 million).
While the company's capital projects will provide incremental rental income in the future, the office market continues to face headwinds from hybrid and remote work. That issue could continue weighing on office demand, driving up vacancies and pushing down rents, impacting Brandywine's cash flow.
Meanwhile, Brandywine has maturing debt that will be more expensive to refinance. Last December, the company issued $350 million of 7.55% notes due in 2028 to refinance a similar amount of 3.95% notes that matured this year. Future refinancings will increase its interest expense, reducing its cash flow. That will likely push its dividend payout ratio even higher.
Given all its headwinds, it seems like a lock that Brandywine will eventually reduce its dividend. That would enable it to retain more cash to fund capital projects and repay debt.
Too high-risk for income-seeking investors
The double-digit dividend yields of Medical Properties Trust and Brandywine Realty are warning signs to investors that the market believes cuts are forthcoming. Given their high dividend payout ratios, tenant issues, and weaker balance sheets, they will likely eventually reduce their payouts. Doing so would enable them to retain more cash to shore up their financial situations. Because of that, income-focused investors should avoid these REITs until there is more clarity on the future of their dividends.
