Big sure dividends: can you have your cake and eat it too?
Is this headline true or just click bait?
Is it possible to own a big dividend stock that is also safe?
If you’re one of my regular readers, you’re forgiven for doing a double take on today’s title. After everything, my regular sermon warns against buying “sucker yields”.
As I wrote in a October 3, 2016, article for Forbes:
“A ‘sucker-yield’ is based on quantifiable, seemingly ridiculously high returns, when the underlying security has a flawed or vulnerable business model. Companies that fall under the definition of ‘zero-yield’ typically have earnings histories unpredictable and unreliable with dangerous dividend payouts.
Over the years I have predicted a number of these wealth saboteurs who will eventually collapse. Several even burned.
For example, we know that the oversupply of shopping centers in the United States was developed during the Covid-19 closures. As a result, a number of shopping center real estate investment trusts ((REITs)) have had to reduce and/or suspend their dividends.
Washington Prime, for its part, eventually filed for bankruptcy and withdrew from the NYSE. Last March, I compared it to the classic Queen song in “Another One Bites The Dust”:
“…our projections for WPG’s inability to generate cash flow to support its necessary redevelopment spending materialized for the reasons we expected. The last article on WPG, which focused on the dividend cut that we were extremely confident would happen in 2020, pandemic or no pandemic, is here.
And, of course, he did.
Another opportunity to avoid
Another zero return that I tried to steer investors away from was Diversified Healthcare Trust (DHC), formerly known as Senior Housing Properties Trust. In 2019, I explained:
“On an AFFO [adjusted funds from operations] base, the dividend has a higher risk, above 108%, which suggests that this REIT is a “zero return”… I would be careful to jump in that frying pan when you know it will most likely burn you.
About 90 days later, management announced a massive 61% dividend cut. The quarterly cash out went from $0.39 per share to just $0.15 per share.
The point I want to make here is that many “big dividends” can be dangerous. That’s why it’s important to always do research when selecting stocks for your portfolio.
This is especially true these days in the residential mortgage REIT ((mREIT)) sector. We recommend avoiding names such as Annaly Capital Management, Inc. (NLY), which we said in March should be avoided at all costs.
I also beat the table about Global Net Lease, Inc. (LNG). This externally managed net lease REIT crashed in 2022, with shares down 26%.
And no, this is not a buying opportunity.
In March 2020, I explained that GNL:
“…the equity multiple is 11.4%, almost 3 times that of peers. This means he is forced to buy lower quality properties or invest in properties with shorter lease terms. So, as Mr. Market pointed out, the payout ratio remains tight, especially for a REIT invested more than 40% in office properties. »
Yes, an 11% dividend yield is intoxicating. But it will take 2.5 years of dividends to recoup this year’s paper losses so far.
There is absolutely no way this big dividend is safe. Not even close.
But that doesn’t mean there aren’t other opportunities out there that are…
SACH: 9.5% dividend yield
Sachem Capital Corp. (SACH) is a commercial MREIT specializing in the origination of short-term, high-yield real estate loans. Historically, it targets the fix-and-flip and property development markets.
All of its loans are secured by first mortgages with maximum conservative loan-to-value ratios of 70%. And they all require a personal guarantee by the principals of the borrowers.
One of SACH’s key differentiators is its agile approach to origination. The company can close a loan in just five days…compared to competitors taking over six months.
This is because due diligence is more focused on the value of the collateral than on real estate cash flows or borrower credit.
SACH continues to diversify its holdings, including larger loans from established developers. And it’s also expanding its lending operations across the United States.
The FPI has a presence in 14 states, with a heavy concentration along the East Coast.
In Q1-22, it generated approximately $10.3 million in revenue, up approximately $4.6 million from Q1-21, or 80.3%. This jump is mainly attributable to an increase in lending transactions.
Net income was approximately $3.4 million, or $0.10 per share. That’s about $2.2 million, or $0.10 per share for Q1-21.
Adjusted earnings, meanwhile, were $4.5 million, or $0.13 per share, compared to $2.2 million, or $0.10 per share.
At $0.13 per share, SACH was able to maintain its dividend of $0.12 per share and there is a bit left. Keep in mind that most mREITs pay out 100% of their base earnings.
We therefore consider SACH’s 9.5% dividend yield to be safe, all things considered.
Keep in mind that this is a small cap with a market share of $182 million. It is therefore much more sensitive to mood swings in the market.
There are also only four analysts following it, but their consensus growth estimates are very attractive:
- 19% in 2022;
- 25% in 2023.
And our conservative model has SACH returning 30% over the next 12 months. We are happy to hold a healthy portion of it in our small cap portfolio, recognizing that it is designed for higher risk profiles.
KREF: 8.5% dividend yield
KKR Real Estate Financing Trust Inc. (KREF), another commercial MREIT, has a purpose-built wallet. Ninety-nine percent are senior secured loans and 74% belong to the multi-family and office sub-sectors.
Its $6.8 billion loan portfolio is positioned in the most liquid real estate markets with an average loan size of approximately $131 million.
KREF is managed externally by KKR & Co. Inc. (KKR), which also owns 23%. We see that as a positive, along with his deep experience as a private equity sponsor. (It has $471 billion in assets under management overseen by 135 real estate professionals.)
As black stonemonitoring (BX) of Blackstone Mortgage Trust (BXMT), KREF’s access to KKR’s broader credit platform is a huge competitive advantage. It is easily large enough to justify most of the fees paid to the external advisor.
And that’s not to mention the sourcing, underwriting and fulfillment benefits that this partnership brings to KREF.
In Q1-21, the smaller REIT issued three senior loans totaling $534.5 million. Their weighted average assessed loan-to-value (LTV) ratio was 69%. And their coupon was LIBOR +3.4%.
This level of leverage is around 500 basis points higher than BXMT – which we consider a closer peer than the most diversified Starwood Real Estate Trust (STWD) – but still within the “safe zone” of less than 70%.
KREF’s $5.3 billion portfolio is 97.8% performing loans with a weighted average risk rating of 3.1 (on a five-point scale). This matches its risk ratings in Q3 and Q4-20.
Also keep in mind that hospitality and retail loans make up around 6% of the portfolio. This is the lowest amount in its peer group, excluding Broadmark Real Estate (BRMK).
KREF also has strong liquidity of $571.1 million. This includes $209.3 million in cash and $335 million in spare capacity on its corporate revolving credit facility.
Since listing, it has maintained prudent risk management practices generally targeting a 3x to 4x leverage ratio on new senior loans. And we expect its total leverage ratio to stay within that range over the next few quarters.
As for its debt ratio, it should be in the low range of 2x.
Subsequent to quarter end, KREF issued 6.9 million Series A 6.5% Cumulative Redeemable Preferred Shares at a liquidation price of $25 each. The result was net proceeds of $167.1 million.
It also generated net income of $29.2 million, or $0.52 per diluted share of common stock, for the quarter. That’s slightly better than the $28.8 million, or $0.52 per share, it brought in for Q4-20.
And distributable income was $29.8 million, or $0.47 per share, covering the dividend of $0.43.
In mid-April, KREF paid a cash dividend of $0.43 from the first quarter. Another thing to know is that the dividend reflected an annualized return of 8.5% at last check.
The shares are now trading at $20.46, with a price-to-earnings (P/E) ratio of 12.1x and a dividend yield of 8.4%. While we think its “big” dividend is safe, we consider it more suited to your high yield enhancement strategy, and not so much a total return game.
Don’t be too cute, friends…
I want to be clear: I am not advocating “big safe” dividend yield choices for everyone. As I explain in The smart REIT investor’s guide:
“A REIT that returns 10% almost always means that investors perceive very little growth, or even worse, a potential reduction in dividends.”
But I put my money where my mouth is. Most of the REITs I own (and recommend) will, over many years, show 6-10% annual FFO growth.
My personal investment strategy is to anchor my portfolio with safe dividend growth stocks…and then include a narrower mix of “big safe” dividend names as yield enhancers.
This is my “anchor and buoy” plan: a strategy that has worked well for me. For proof, look at the annual returns of around 20% of the sustainable income portfolio since 2013.
Of course, I encourage readers not to put all their eggs in one basket.. And if I can save you from sinking ships, I’ve done my job.
There’s nothing wrong with owning “big safe” dividend stocks. Do not forget that :
“Companies that fall under the definition of ‘zero return’ typically have unpredictable and unreliable earnings histories with dangerous dividend payouts.”