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Real Estate Investment Trust REIT on double exposure business background

Avoid These 3 REITs at All Costs

May 15, 2020 by Matthew DiLallo

Real estate investment trusts (REITs) can be a great way to build wealth via real estate. These vehicles enable investors to own an interest in a portfolio of income-generating commercial real estate that throws off dividend income and delivers a capital gain as they grow their market capitalization.

However, not all REITs are worthwhile investments, and some should be avoided outright.

The characteristics of the worst REITs

Before we dive into which REITs to avoid, we should identify the characteristics found in poor performers. The three most common traits of money-losing real estate investment trusts are:

  1. Excessive leverage. While debt is important for helping finance real estate acquisitions and developments, too much can weigh a REIT down. One way to determine whether a REIT has too much debt is to compare its leverage ratio to others in the sector. As a rule of thumb, a debt-to-EBITDA ratio of more than six times or a debt-to-capitalization ratio well above 50% are red flags.
  2. An unsustainable dividend payout ratio. REITs must pay out 90% of their taxable income to maintain their REIT status. However, their funds from operation (FFO) is usually much higher than ordinary income, which is why it's the more important number to consider when it comes to REIT dividends. If the FFO payout ratio, however, crosses above 100%, it's a huge red flag since the REIT can't deliver any dividend growth.
  3. Focusing on real estate that lacks upside. For a REIT to grow shareholder value, it needs to hold commercial real estate that can increase its rental income. That's nearly impossible to do if it concentrates on markets with too much supply (e.g., high vacancy rates) or focuses on owning properties leased to tenants in struggling industries (e.g., retail).

Three REITs to avoid

REITs that have more than one of those traits are more likely to underperform, which is why investors should avoid them. Three that currently stand out because they have multiple issues are RPT Realty (NYSE: RPT), Retail Properties of America (NYSE: RPAI), and Acadia Realty Trust (NYSE: AKR). Here's why a real estate investor should avoid these REITs at all costs.

RPT Realty

RPT Realty is a retail-focused REIT. Like many REITs concentrated on that sector, its tenants have been struggling with the retail apocalypse as more consumers do their shopping online. That's forcing retailers to shutter locations, which has impacted occupancy at most retail centers.

Unfortunately, market conditions in the retail sector have gone from bad to worse this year due to the COVID-19 outbreak. Many states forced nonessential retail businesses to close to help slow the spread. Because of that, these stores have struggled to pay rent. RPT Realty was only able to collect rent from 57.8% of its tenants in April. While it has been working with delinquent tenants, including deferring some rent, many could go out of business because of how much it disrupted their operations.

Given these tenant issues, RPT Realty elected to suspend its dividend so that it can retain cash and help bolster its balance sheet. That will allow it to take some of the pressure off of its financial profile, which has an elevated leverage ratio of 6.4 times debt-to-EBITDA. That tight financial situation, lack of a dividend, and focus on faltering retail are all reasons why investors should steer clear of this REIT.

Retail Properties of America

Retail Properties of America is another retail-focused REIT that's struggling with the dual headwinds from the retail apocalypse and the COVID-19 outbreak. With many of its tenants forced to close their locations to slow the spread of the virus, they chose not to pay rent in April. Overall, the REIT only collected 52% of its rent last month, as tenants are holding back payment so that they can preserve cash even though some are still open for business.

That forced Retail Properties of America to suspend its dividend so that it can also enhance its liquidity during these challenging times. The real estate investment trust also plans to reduce its investment in development projects so that it can strengthen its balance sheet. On a positive note, the company's leverage ratio wasn't too concerning at 5.7 times debt-to-EBITDA at the end of the first quarter. Still, given its focus on struggling retail and lack of dividend yield, this REIT isn't worth an investor's time.

Acadia Realty Trust

Acadia Realty Trust also focuses on owning retail rental property. Because of that, it, too, has been affected by both the retail apocalypse and COVID-19. In April, only 50% of its tenants paid rent. Because of that, Acadia joined many of its peers in suspending REIT dividends.

That payout might come back in some form as nonessential retailers are allowed to reopen. However, Acadia and its peers will likely struggle to create value for REIT investors in the coming years as both COVID-19 and the retail apocalypse claim more casualties, which will keep the pressure on the vacancy rate and rental income. Add that to its higher leverage ratio of 6.3 times debt-to-EBITDA, and Acadia Realty appears likely to deliver underwhelming results for REIT shareholders.

Better REITs are available

The one-two punch hitting retailers is having a major impact on REITs focused on leasing space to the industry. Because of that, investors are probably better off avoiding most REIT shares in that sector, especially this trio, given that they're no longer considered a dividend stock and have higher leverage ratios. Instead, investors should focus their attention on the best REITs, which are those that boast strong financial profiles, dividends, and growth prospects since they could generate outsized returns for a REIT investor.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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