5 REITs That Will Likely Cut Their Dividends

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Co-produced by David Ksir

Today there are many opportunities to buy highly discounted REITs (VNQ) at 60-70 cents on the dollar, but at the same time, the risk of a dividend cut is often quite high.

A cut can be painful for income-oriented investors, which rely on dividends to fund their lifestyle. Not only will it lower your income, but it could also result in painful losses.

For this reason, it’s typically better to stay away from REITs that are at high risk of cutting their dividend in the near future and instead focus on those that are likely to grow it.

Today I highlight 5 REITs that are likely to cut their dividend in the near future:

BrightSpire Capital (BRSP)

BrightSpire is a mortgage REIT (mREIT) which means that its main business is providing loans backed by real estate. In addition to its $3.4 Billion loan book, the company also holds a small $800 Million net lease portfolio which comprises 5 office buildings, 4 retail properties, and 1 industrial park.

Nearly 100% of the company’s loans have floating rates, based either on SOFR or one-month LIBOR, which means that as interest rates increase, so does BrightSpire’s interest income.

The flip side of that is that the borrower (a property owner) has to pay the higher interest which puts it under financial pressure, especially during tough economic conditions like today.

With real estate values dropping, there is a risk that borrowers might default on their loans and simply hand over the keys to the mortgage REIT. The risk is particularly high for distressed office buildings.

Depending on how much property values drop, the mortgage REIT might be fine from a valuation perspective as it gets the property at a significant discount compared to the value at underwriting.

But from a cash flow perspective, which is what we’re really interested in with regard to the safety of the dividend, each default will hit the REIT hard and on two fronts.

Firstly, it will obviously lower interest income and secondly, it might require the company to incur additional costs in order to (1) increase its occupancy and/or (2) sell the property.

It is true that this may be somewhat offset by the rent collected from the foreclosed buildings, but for distressed office buildings with high vacancy, the overall cash flow impact of a loan default is likely to be negative.

The issue for BRSP is their high 32% exposure to offices, many of which are distressed.

A closer look at their loan book reveals that three office loans are very risky. Two of these are loans on troubled properties in Long Island which BrightSpire attempted to sell, but the process got disrupted by the failure of New York-based Signature Bank.

A third loan is on an office building in Washington D.C. which is leased to the government. The issue there is extremely low occupancy of 51% which will only get worse with large lease expiration in the second half of this year. In fact, BRSP has already begun the foreclosure process and plans to convert the building to residential use, which will require large amounts of capital and will negatively impact the REITs ability to sustain its dividend.

Moving down the loan book, there are four other office loans, some of which had LTVs as high as 79% at origination. Since office values have compressed significantly over the past year and a half, it’s very likely that at least some of these loans are “underwater” and will eventually be placed on non-accrual status.

A $0.20 dividend seemed reasonable compared to $0.25 in distributable earnings in Q2 2023, but I worry that with just a few defaults, distributable earnings could fall drastically and the now 12% dividend could get cut very easily over the rest of this year.

I see a dividend cut for BRSP as quite likely.

Blackstone Mortgage Trust (BXMT)

Much like BrightSpire, BXMT is another mortgage REIT with high office exposure at 34% of their portfolio, followed by multifamily at 27% and hospitality at 19%.

BXMT enjoys several advantages compared to BRSP:

• It is eight times bigger with a loan portfolio of more than $25 Billion
• Its collateral is generally considered higher quality – 91% of office properties are A-class
• It has a more experienced management team – though I do prefer BRSP’s internal management team over BXMT’s external one.

Still, the mREIT is facing the exact same challenges!

So far, the dividend remains covered with 97% of the portfolio performing and no defaults, but the risk profile is gradually getting worse with more properties getting the 4- and 5-rating.

And the thing is that over the past five quarters, while collecting on all of their loans, BXMT has averaged just ~$0.73 per share in distributable earnings (DE) and it paid a quarterly dividend of $0.62 per share. That’s an average payout ratio of 85%, during the good times.

Remember, the first impact of higher interest rates for an mREIT is higher interest income which translates into higher DE initially. But the true impact is only felt later once defaults start. I’m not comfortable with the company paying out 85% of earnings at a time when earnings are elevated due to higher rates, but so is risk.

If just a couple of office properties default on their payments, BXMT could easily see its distributable earnings drop significantly and be forced to cut its now 12% dividend.

Remember that even Blackstone itself has already defaulted on some of its office properties. I see a dividend cut as quite possible for BXMT.

Global Net Lease (GNL)

While I do think that the two aforementioned mREITs could, under the right circumstances, get through this tough period without a dividend cut, for GNL, I see the cut as only a question of time.

GNL, as the name suggests, is a net lease REIT that focuses heavily on industrial properties (55%), but also offices (40%).

Most of their properties are single-tenant with long leases (8 years on average) and well-established investment-grade tenants such as McLaren, FedEx (FDX), or Whirlpool (WHR).

This may seem like a positive, but the problem is that it gives the tenants a lot of bargaining power, especially when negotiating their leases. This results in poor rent growth and high incentives to retain tenants.

And the worst part is that even prior to offices falling out of favor, the REIT’s performance has been horrible, with FFO per share falling almost on a yearly basis from $1.98 in 2017 to just $1.56 this year.

Declining FFO per share has largely been a consequence I think of an external management team, whose interests were not well aligned with shareholders:

This may change after the management team is internalized as part of the merger with The Necessity Retail REIT (RTL). Still, I don’t think internalizing the management team will be enough to turn things around for GNL.

Renegotiating leases on their mediocre single-tenant office buildings will likely prove difficult and with a payout ratio already above 100% and a history of cutting the dividend even during the good times (in 2019 and 2021), I don’t think we’ll have to wait for too long for another dividend cut.

Easterly Government Properties (DEA)

DEA is a REIT that focuses on single-tenant buildings (primarily offices) leased to various government agencies. With 98% of rent backed by full faith and credit of the U.S. government, the stock hasn’t sold off as much as some of its peers.

But I think this perceived safety is only temporary.

Sure, the government will pay its rent for as long it is contractually obligated to, but when leases expire there is no guarantee that they will renew. In fact, with the ever-increasing budget deficit, it is likely that the government will try to cut costs and consolidate its space, which will inevitably put pressure on occupancy.

DEA is not well positioned for this risk as many of their properties are build-to-suit which would make re-leasing to a non-government tenant very difficult and costly.

The REIT is currently paying a quarterly dividend of $0.265 per share (yield of 7.5%) and management has stated on their latest earnings call that they expect to keep it.

But the thing is that with a core FFO of just $0.29 in Q2 2023, the dividend has been barely covered and when we account for recurring maintenance costs, the payout ratio is already above 100%.

On top of that, the REIT is spending a lot of cash on their FDA development project in Atlanta which is already a drain on cash, even though it’s still in the design phase. With construction expected to start later this year, more cash will be needed and DEA could easily be forced to cut their dividend.

I see a dividend cut for DEA as quite likely.

Sabra Health Care REIT (SBRA)

Sabra is a healthcare REIT that primarily owns Skilled Nursing Facilities (SNF*) and Senior Housing. The REIT leases its properties to only a small number of tenants which exposes it to concentration risk as its top 5 tenants account for 38% of revenues. Moreover, many of these tenants are relatively small privately-owned companies which make it harder to analyze their strengths.

The healthcare sector has been hit very hard during Covid and it has been slow to recover. There are many issues, but from Sabra’s perspective, it mainly comes down to two metrics.

First off, occupancy has remained stubbornly low as SNF still sits at just 73.3%:

Secondly, tenants have been struggling with increasing operating expenses, which has significantly impacted their margins and lowered rent coverage. This is evident from a very low coverage of top 10 tenants of just 1.57x.

In Q2 2023, the company reported AFFO per share of $0.33 (down 15% from $0.39 a year prior) and management didn’t provide any guidance. Instead, they simply stated that they see the current quarterly run rate as sustainable. That doesn’t sound very optimistic.

And the thing is that even at $0.33 per share, the current quarterly dividend of $0.30 is barely covered with a payout ratio of 90%.

With low occupancy, that’s unlikely to materially improve any time soon, and very low tenant coverage, it’s not difficult to imagine that some tenants will struggle to meet their obligations. And since the margin for error is extremely small, given the high payout ratio, if anything goes even slightly wrong for Sabra, management will have no choice but to cut the dividend.

I see a divided cut as likely for Sabra over the rest of this year.

Bottom Line

It’s no surprise that out of more than 200 REITs, some will struggle and cut their dividend, especially at a time of economic weakness. But not all REITs are created equal and now is a great time to buy some of them at highly discounted levels.

The key is to be selective and try to stay away from REITs that are poorly positioned and at risk of a dividend cut.