One of the main draws of an investment in most real estate investment trusts (REITs) is that they typically generate attractive dividend income. These dividend payments usually provide the bulk of the return from a publicly traded REIT.
Unfortunately, not all REIT dividends are safe. Several REITs seem to be at risk for a reduction or suspension because of either weak market conditions or financial profiles. Here's a look at three REITs where the danger of a reduction looms large, currently making them unfit as REIT investments.
Warning signs for REIT dividends
Before digging into the REITs most at risk of a dividend reduction, we need to consider the biggest contributing factors to a payout cut. Three major red flags are:
- An elevated leverage ratio. REITs need to borrow money to help finance acquisitions and development projects to support dividend growth. However, where they get into trouble is when they take on too much debt to fund expansion. Two metrics to watch are a debt-to-EBITDA ratio above six times and a debt-to-capitalization ratio well above 50%.
- An uncomfortably high dividend payout ratio. The IRS requires that REITs distribute 90% of their taxable income to maintain their REIT status. However, most generate more cash flow, known as funds from operations (FFO), than net income, which makes that number the one to watch. If a REIT pays out more than 100% of its FFO, its dividend probably won't last much longer.
- An abnormally high dividend yield. While most REITs offer above-average yields, a payout above 10% is a major sign of caution. Because of that, REITs with the highest dividend yields are usually ones to avoid.
Three REIT dividends at greatest risk
This year has been a tough one for REIT investors because of the impact the COVID-19 outbreak has had on tenants' ability to pay rent. A significant portion of tenants withheld rental payments in April, which forced many REITs to reduce or suspend their dividends to preserve their financial resources. More payout reductions seem likely, with the REIT dividends at Brookfield Property REIT (NASDAQ: BPYU), Host Hotels & Resorts (NYSE: HST), and Vornado Realty Trust (NYSE: VNO) appearing ripe for a reduction.
Brookfield Property REIT
Brookfield Property REIT and its sibling Brookfield Property Partners (NYSE: BPY) operate a diversified commercial real estate business, including core retail and office portfolios. Unfortunately, tenants in both sectors have struggled to pay their rent due to stay-at-home orders meant to slow the spread of COVID-19.
Most of Brookfield's office tenants paid their April rent. However, Brookfield CEO Brian Kingston wrote in the company's first-quarter letter to investors that rent collection was "down significantly" in its retail business. That's due in many cases to "an unwillingness to pay rent until the full scope of the virus' impact could be assessed."
This issue has investors nervous that Brookfield won't be able to maintain its dividend. The yield has risen to an eye-popping 15.5% as the payout ratio rose to an unnerving 100.1%. While Kingston assured investors that "we continue to have more than sufficient resources to pay our stated quarterly dividend," its yield and payout ratio suggests that this sky-high REIT distribution is at risk.
Host Hotels & Resorts
The COVID-19 outbreak has had a significant effect on travel, which has impacted occupancy at hotels. Those market conditions forced hospitality REIT Host Hotels & Resorts to suspend operations at 35 of its hotels while operating the other 45 at reduced capacity. Overall, the company reported occupancy of 29% in March and just 12% in April. Because of that, its open hotels are barely generating enough revenue to cover the incremental costs of staying open.
While the REIT stock will pay its first-quarter dividend, that could be its last payment at the current rate. Host Hotels & Resorts warned in its first-quarter earnings release that it anticipates temporarily suspending or paying a nominal dividend for the foreseeable future. That would enable it to retain up to $141 million of cash each quarter that it could use to help offset corporate and interest costs, which would run $120 million to $140 million a month if it closed all its properties.
Vornado Realty Trust
Vornado Realty Trust is a diversified real estate investment trust that operates office, retail, and hospitality properties in New York City, Chicago, and San Francisco. While the company's office portfolio has held up well during the pandemic, its other operations have struggled. Its tenants only paid 83% of what they owed Vornado in April, with retail collection at just 53%. Meanwhile, the company had to temporarily close the Hotel Pennsylvania in New York City and postpone all trade shows at theMART in Chicago through the end of this year.
In light of these issues, the company warned in its first-quarter earnings release that the effect of COVID-19 on its financial condition and operating results "remains highly uncertain, but the impact could be material." It could experience lower rental income and occupancy levels, which could impact its cash flow and affect its ability to pay its debt and make a dividend distribution to shareholders.
While Vornado currently plans to maintain its dividend, its payout ratio rose to a concerning 97% of FFO during the first quarter. That makes it seem at risk for a reduction if market conditions in the cities where it owns real estate don't return to some sense of normal soon.
These REITS are too risky for income-seeking investors to buy
REIT shares and dividends have been under tremendous pressure this year because of the COVID-19 outbreak. While Brookfield, Host Hotels & Resorts, and Vornado have resisted the urge to join their peers in reducing their ordinary dividend, they might not be able to maintain them if market conditions don't improve soon. Because of that, a potential shareholder might want to reconsider buying those dividend stocks and instead look to several other lower risk REITs that pay attractive dividend income.
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