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Are These 3 REITs Yield Traps?

Jul 11, 2020 by Matthew DiLallo

High dividend yields are alluring. Unfortunately, like a siren's call, these big-time yields often ensnare investors with the promise of a big payout that turns out to be nothing more than a trap. One of the key signs of a dividend yield trap is when a payout rises into the double digits.

Three REITs that currently offer investors yields above that level are Annaly Capital Management (NYSE: NLY), The GEO Group (NYSE: GEO), and Preferred Apartment Communities (NYSE: APTS). Here's a look at whether their double-digit-yielding payouts are too good to be true.

Still a trap after the recent reduction?

Mortgage REIT Annaly Capital Management currently yields 13.6%. That big-time payout comes even though the company recently reduced its dividend by 12%, cutting the rate from $0.25 per share each quarter to $0.22 per share. While that reduction should have put the company's payout on a more sustainable foundation, its double-digit yield suggests that the market has concerns that the new level might still be a trap.

The main reason Annaly reduced its dividend to the current level is that it only generated $0.21 per share of core earnings during the first quarter. On a positive note, the company sees that number ticking higher in the second quarter, expecting earnings to exceed the dividend. However, given how low mortgage rates are these days, Annaly's earnings could remain under pressure in the coming quarters as more homeowners refinance. Because of that, the REIT might need to trim its dividend again, suggesting that it still might be a dividend yield trap.

This REIT dividend isn't secure

Specialty REIT The GEO Group currently pays an eye-popping dividend that yields 16.9%. The company, which operates prisons and other secure facilities, recently declared its latest payment, putting off a reduction for now.

However, risks to the dividend remain. For example, fellow specialty REIT CoreCivic (NYSE: CXW) recently suspended its dividend -- which at the time yielded more than 20% -- because it plans to explore its strategic options, including potentially leaving the REIT sector. One reason that the prison operator is considering making a change is that investors no longer want to own private prison companies, which has put downward pressure on their public market valuations. On top of that, GEO Group's dividend payout ratio is currently at an elevated 84%. Given these issues, dividend investors should avoid this REIT at all costs.

Is another cut in the cards?

Residential REIT Preferred Apartment Communities currently yields just a shade over 10%. That big-time yield comes even though the REIT recently slashed its quarterly dividend by 33% to conserve cash. That drove down its dividend payout ratio to a much more conservative 65%.

However, Preferred Apartment Communities still has a double-digit yield because the market remains concerned about its ability to keep paying dividends due to its weak financial profile. For starters, COVID-19 has impacted its ability to collect rent from some tenants, namely within its retail portfolio. On top of that, the company has a lot of debt.

On a positive note, Preferred Apartment Communities is looking to bolster its balance sheet by selling its student housing portfolio. While an earlier deal fell through, it has put these assets back on the market. If this portfolio fetches a good price, Preferred Apartment Communities would be able to pay off some debt and relieve a bit of the pressure on its balance sheet. That move would also put its reset dividend on a firmer foundation. Because of that, this REIT's big-time payout might not be the trap that its yield seems to suggest.

Be careful with big yields

Investors buy REITs for their above-average dividend yields. However, some REIT dividends are a bit too good to be true. Because of that, investors must carefully analyze whether a REIT's payout is sustainable before buying shares so they don't fall for what could turn out to be a trap.

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Matthew DiLallo owns shares of Annaly Capital Management. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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