Real estate investment trusts, or REITs, are known for their dividends. In an ideal world, a REIT would pay one that steadily increases.
Unfortunately, not all REITs can maintain their dividend payments, let alone grow them over time. Several are currently at risk of having to cut their dividends, which they could announce as soon as this month. Here's what puts these dividends at risk as well as a few REITs where near-term cuts seem most likely.
Three factors that put a REIT dividend at risk for a reduction
While most REITs aim to deliver regular dividend growth, not all achieve that goal. Many are lucky if they can even maintain their dividends. That's because they have characteristics that impact dividend safety. Several factors can force a REIT to reduce its dividend, including:
- A high dividend payout ratio. REITs must pay at least 90% of their taxable net income via dividends to comply with IRS regulations. However, many distribute more than that number since it's usually lower than their cash flow, as measured by funds from operations (FFO). Thus, the warning sign is when a dividend payout ratio approaches 100% of a REIT's FFO.
- A weak balance sheet. REITs rely on debt to help finance growth. Because they need access to credit, a REIT will ideally have an investment-grade rating backed by healthy leverage metrics, such as a debt-to-EBITDA ratio of less than 6.0 times. When a REIT's balance sheet starts to weaken, it'll often reduce its dividend so that it can shore up its financial situation.
- High exposure to a challenging tenant base. If a REIT's tenant base can't afford to keep paying rent, it might not be able to maintain its current dividend rate.
These factors don't automatically mean a REIT is about to cut its dividend. However, there are warning signs that a dividend reduction could be forthcoming, which is why a REIT investor needs to keep an eye out for these troubling characteristics.
Three high-risk REIT dividends
This year has been a tough one for REIT investors. Many have already reduced or suspended their payouts due to the impact the COVID-19 outbreak is having on their tenants' ability to pay rent. Meanwhile, many more are at risk of a reduction. Three that currently stand out are Brookfield Property REIT (NASDAQ: BPYU), Vornado Realty Trust (NYSE: VNO), and Healthpeak Properties (NYSE: PEAK). Given their current troubles, any one of these REITs could announce a dividend reduction this month.
Brookfield Property REIT
Brookfield Property REIT currently yields more than 10%. Anytime a dividend yield reaches the double digits, it's a sign that investors are concerned about the payout's sustainability.
Several factors drive the market's current concern about Brookfield's payout. For starters, the company, which is the REIT equivalent to an investment in Brookfield Property Partners (NASDAQ: BPY), has a concerning dividend payout ratio. During the first quarter, the companies generated $0.33 per share of FFO but paid out $0.3325 per share in dividends. That already-worrisome payout ratio will likely deteriorate even further during the second quarter because many of Brookfield's tenants -- especially at its malls -- didn't pay rent due to the COVID-19 outbreak.
So far, Brookfield has resisted cutting its dividend even though most other REITs with retail exposure have made that move. It has opted to maintain its payout due to its long-term view and substantial liquidity. It recently used that liquidity to launch a $1 billion share buyback program at a 17.3% premium. While that move suggests Brookfield will maintain the dividend, it seems to be at high risk of a reduction right now.
Vornado Realty Trust
Diversified REIT Vornado Realty Trust currently yields around 7%. That payout is on suspect footing due to the makeup of its portfolio. It owns several assets with income variability, including a temporarily closed hotel, a trade center that had to cancel its shows, and parking garages. The company noted on its first-quarter call that these assets would experience a $9 million monthly income hit (about 6% of its overall revenue). On top of that, some office tenants and a significant portion of those in retail aren't paying rent. These issues will impact the REIT's rental income this year.
Because of that, Vornado Realty's dividend might be in trouble, which is one implication of CEO Steven Roth's comments on the REIT's first-quarter conference call. He said: "Without telegraphing any intention, we will, as we must, reevaluate our third- and fourth-quarter dividend based upon financial and economic conditions at that time." Thus, if conditions remain weak, the REIT might reduce its payout.
Healthcare REIT Healthpeak Properties has also experienced some issues with rental collections due to the pandemic. While most of its life sciences tenants are paying rent, some medical office building tenants aren't because of the shutdown of elective procedures and surgeries. Meanwhile, the company's senior housing business has been under pressure because of the outsized impact of COVID-19 on that population. As a result, its rental income will decline in the coming quarters.
That's a concern because Healthpeak Properties has an elevated payout ratio. It was 91% during the second quarter, and the company expects it to exceed 100% in the near-term. With many of its healthcare REIT peers recently reducing their dividends, Healthpeak might opt to join them rather than outspending cash flow in the near term.
REIT dividends have been coming down this year because of the COVID-19 pandemic. Unfortunately, that trend appears poised to continue, given that several REITs still have concerning financial metrics and high exposure to financially-strapped tenants. Because of that, investors will likely see more REIT dividends reduced this month, with this trio standing out as some of the most likely candidates.
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