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Are These 3 REITs Yield Traps?

May 23, 2020 by Matt Frankel, CFP
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It's getting a little tougher to find yield traps in the real estate sector. In the wake of the COVID-19 pandemic, many of the REITs that we'd expect to be in danger of cutting their dividends have already done so. Some have done this out of necessity, while others have suspended their dividends as more of a precautionary step to preserve capital.

With that in mind, there are still some dividend-paying REITs that have at least one major red flag, and this is especially true in the post-COVID market. Here are three in particular that have some of the troubling signs, so let's take a closer look.

Simon Property Group (Yield: 15.2%)

In full disclosure, leading mall REIT Simon Property Group (NYSE: SPG) is the only one of these three that I own in my stock portfolio. And I even added shares recently. So that should give you some clue about whether I personally think it's a yield trap.

Having said that, there are certainly some troubling signs. Aside from the fact that the current dividend yield is more than 15%, there are a few other red flags with Simon:

  • Brick-and-mortar retail is a declining industry. Simon is the best-in-breed mall operator, but this is certainly still a concern.
  • FFO and revenue are likely to fall dramatically due to the COVID-19 pandemic. Simon closed all of its properties in mid-March and about half are still closed.
  • One company-specific red flag is this language from Simon's first-quarter earnings report: "Simon intends to maintain a common stock dividend paid in cash and expects to distribute at least 100% of its REIT taxable income." To me, this doesn't exactly imply that Simon anticipates keeping the dividend at its current level.

On the other hand, Simon looks to be financially strong. The company has nearly $9 billion of liquidity, which is excellent financial flexibility for a business with a $17 billion market cap. And the company owns some of the most valuable retail real estate in the world and has the business efficiency advantages that come with scale.

Ventas (Yield: 9.8%)

Healthcare real estate is typically one of the most stable subsectors, but that hasn't been the case during the COVID-19 pandemic. While most healthcare businesses remained open, healthcare REITs with exposure to senior housing or elective medical procedures have been hit pretty hard.

Ventas (NYSE: VTR) is one of the worst performers, and it isn't hard to see why. In its senior housing communities, move-in rates were 25% of normal levels in April, while move-outs remained at their typical pace. And there's no telling when demand will rebound -- in simple terms, people are hesitant to put their older relatives in senior housing facilities, many of which have been COVID-19 hotspots. In fact, as of May 3,942 residents in Ventas' senior housing properties had tested positive for the coronavirus.

However, Ventas doesn't seem to be in serious trouble business-wise. The company has $3.2 billion in cash and equivalents on hand, tenants in Ventas' medical office properties paid 96% of expected rent in April, and the company was quite profitable in the first quarter. And its 81% FFO payout ratio leaves some wiggle room if income takes a hit.

Host Hotels & Resorts (Yield 6.9%)

It shouldn't come as a big surprise that hotel REITs have performed quite poorly. After all, barely anyone has been traveling in recent months, and it could take a long time for demand to return to pre-pandemic levels.

Host Hotels & Resorts (NYSE: HST) is one of the few hotel REITs that hasn't suspended or cut its dividend yet. However, with 12% occupancy across its portfolio in April, there's reason to believe the company's FFO could plummet in the second quarter and beyond.

Although it has the lowest yield on this list, that doesn't mean Host Hotels & Resorts isn't a yield trap. In the first quarter, the company's FFO payout ratio was 87%, which doesn't leave much room to sustain the dividend with declining revenue. With $2.5 billion in cash, the company has the liquidity to make it through the tough times, but I wouldn't be at all surprised if the dividend ends up being put on pause.

Are they yield traps?

None of these three are clearly in financial danger, but one (or more) of them could certainly decide to cut or suspend their dividends for liquidity purposes during the pandemic. The main reason that all three have been beaten down and now have such high dividend yields is because they all have many unknowns for the time being. For example, a wave of retail bankruptcies -- which we've already started to see -- could cause Simon's revenue to take a hit. A long-tailed drop in senior housing demand or travel demand could do the same for Ventas or Host Hotels & Resorts. And in these situations, the dividends could be on the chopping block.

While I'd hesitate to call any of these three dividend yield traps, at least in the obvious sense of the word, I wouldn't suggest buying them simply because of their dividends. If you want safe and reliable dividends, there are certainly better options in the real estate sector. On the other hand, if you have a high risk tolerance and are willing to ride out the ups and downs (including a potential dividend cut), these could be good speculative plays.

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Matthew Frankel, CFP owns shares of Simon Property Group. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.