8 REITs That Could Cut The Cheese

I’ll admit this is a click-bait title. But before you turn away, the actual article is anything “butt.”

No really. Let me explain…

I’m sure many of you now have flatulence on the mind. In which case, here’s an excerpt from The Definitive Fart Book (1961):

“Funny, everybody does it, but nobody wants anybody to know they’re the somebody who: cut the cheese, passed the gas, let one rip, shot a bunny, copped a pop, popped a bubble, cranked a smoker, pinched an egg, etc.…”

I don’t know about you, but I don’t recognize some of those terms. Maybe they’re regional things. Or maybe they’ve “passed” in popularity since the 1960s.

Regardless, my title and the article it’s attached to is about a very different kind of cheese altogether.

In modern-day slang, “cheese” is a synonym for money. In case you’re wondering, I believe it has something to do with welfare benefits and how they used to include actual cheese allocations.

(Though maybe you should look it up yourself just to be sure.)

Regardless, someone ran with it… someone else accepted it… and it’s now commonly understood and accepted lingo.

As such, it seems perfectly permissible to use it in place of dividends. Ipso facto, I’m going to highlight real estate investment trusts (REITs) that are likely to cut their dividends.

Eight of them, in fact.

Read on to see which ones are at risk.

Risk-Related Research

I’ll admit, the idea behind the article should be credited to Barron’s writer Al Root. He recently penned an article titled “8 Companies That Could Cut Their Dividends,” where he explained:

“… some significant companies will cut their dividends in 2024. It’s inevitable. Outside of financial crisis, 1% to 2% of all dividend payers cut dividends each year… the key is to identify them and stay away until the payout is slashed.”

In that same article, Wolf Research strategist Chris Senyek pointed out eight companies that are likely to “cut the cheese.”

• Vail Resorts (MTN)
• Hasbro (HAS)
• Whirlpool (WHR)
• Wendy’s (WEN)
• Cracker Barrel Old Country Store (CBRL)
• Legget & Platt (LEG)
• LCI Industries (LCII)
• Kohl’s (KSS).

Senyek estimates that these eight companies will pay out roughly 100% of estimated 2024 free cash flow as dividends. Compare that to the S&P 500’s average payout ratio of 55%.

Reading all of that, of course, made me think about REITs that are in the same risky situation. So here’s my list of eight REITs that could “cut the cheese.”

Now let’s discuss eight of them…

Healthcare Realty Trust (HR)

HR is an internally managed real estate investment trust (“REIT”) that specializes in the development, acquisition, financing, and management of healthcare properties with a portfolio that primarily consists of medical outpatient buildings which are located around leading hospital campuses throughout the U.S.

Healthcare Realty has a market cap of approximately $6.2 billion and a roughly 40.0 million SF portfolio comprised of 700 properties located across 35 states and concentrated in 15 high-growth markets.

The company owns and operates medical properties that are for the most part associated with the delivery of outpatient medical services and looks to grow its portfolio through development and acquisition.

HR is the first REIT with a primary focus on medical outpatient buildings and has built a portfolio consisting primarily of multi-tenant medical properties that are on-campus and associated with top healthcare systems.

The proximity of HR’s properties to leading healthcare systems is critical to the relationship between physicians and hospitals. As of September 30, 2023, 72% of their medical properties were on or adjacent to a hospital campus, 21% were affiliated, and 7% were off-campus.

I removed the 2022 merger related special dividend from the chart below in order to normalize their dividend history. HR’s most recent dividend cut was made in the fourth quarter of 2022 when its quarterly dividend went from $0.325 to $0.31 per share.

Annualized, the dividend in 2022 came in at $1.28 per share (excluding the special dividend) whereas the annual dividend paid in 2023 came in at $1.24, representing a cut of approximately 3%.

What is more concerning is that analyst projections for 2023, 2024, and 2025 have HR’s dividend exceeding their free cash flow or adjusted funds from operations (“AFFO”).

Analysts expect the dividend rate to remain constant at $1.24 per share but expect AFFO per share in 2023 will decline by -13%, then increase by 3% in 2024, and then fall -1% in 2025.

This would translate into AFFO payout ratios of 106.90%, 104.20%, and 105.08% in the years 2023, 2024, and 2025, respectively.

The stock pays a high dividend yield of 7.47% but we are concerned that the expected payout is higher than the free cash flow / AFFO generated by operations and we are not confident the dividend can be sustained.

Currently the stock is trading at a P/AFFO of 14.28x, compared to its average AFFO multiple of 20.05x.

We have a speculative buy rating on HR given the valuation the stock is currently trading at, but caution investors that the current dividend could be cut if HR is unable to improve operations and return to growth.

We rate Healthcare Realty Trust a Spec Buy.

Easterly Government Properties (DEA)

DEA is an office REIT that specializes in the development and acquisition of Class A office properties that are primarily leased to U.S. Government agencies which serve essential and necessary functions.

The office REIT has a market cap of approximately $1.2 billion and an 8.9 million SF portfolio comprised of 90 operating properties with a weighted average age of 14.2 years and a weighted average remaining lease term of 10.4 years. As of their latest update, DEA’s portfolio was 97.5% leased.

DEA looks for U.S. Government agencies that have the most critical and enduring missions and then identifies the most important buildings within these agencies for potential acquisition.

Their largest tenant is the Department of Veteran Affairs (“VA”) which makes up 28.5% of their annual lease income, followed by the Federal Bureau of Investigation (“FBI”) and the Drug Enforcement Administration (“DEA”) which makes up 17.0% and 9.0% respectively.

Based on annual lease income, 51% of DEA’s portfolio is made up of office properties, 27% of the portfolio consists of VA Outpatient centers, 9% of the portfolio is made up of labs, and 5% is made up of courthouses.

In the chart below you can see that DEA’s dividend was equal to or greater than its AFFO per share in 2017, 2018, 2019, and 2020.

What’s more concerning is that analysts expect the dividend to be maintained at $1.06 per share through 2025, while they project AFFO per share to fall by -23% in 2023, increase by 1% in 2024, and then fall by -2% in 2025.

If this pans out, it will translate into an AFFO payout ratio of 109.28% in 2023, 108.16% in 2024, and then 110.42% in 2025. Way too high for my comfort level.

DEA pays a dividend yield of 8.28% that is not covered with their 2023 expected AFFO and analysts see this trend continuing with the 2025 expected dividend of $1.06 exceeding their expected 2025 AFFO per share by approximately 10%.

Shares are currently trading at a P/AFFO of 13.19x, compared to its average AFFO multiple of 19.38x.

Even with the discounted valuation we maintain a Hold based on enhanced dividend risk.

We rate Easterly Government Properties a Hold.

Omega Healthcare Investors (OHI)

OHI is a healthcare REIT that invests in Skilled Nursing Facilities (“SNF”) and Assisted Living Facilities (“ALF”) by providing capital and / or financing to 65 national and regional healthcare providers in the United States and the United Kingdom.

The healthcare REIT went public in 1992 and has currently has a market cap of approximately $7.0 billion and a portfolio comprised of 883 properties containing 86,201 beds located across 42 states and the U.K.

Their leased properties are primarily structured on a triple-net basis, and by facility type, approximately 73% of OHI’s portfolio consists of Skilled Nursing and 27% consists of Senior Housing.

Approximately 82.5% of OHI’s portfolio is made up of rental properties, 10.9% is made up of from real estate loans interest income, 2.9% is described as other, and 1.7% is made up of real estate tax and ground leases.

OHI pays a 9.31% dividend yield that is not covered by its 2023 AFFO with an expected payout ratio of 101.52%.

The healthcare REIT has not increased its dividend since 2020 but AFFO per share fell by approximately -12% in 2022 and is expected to fall by another -5% in 2023.

Analysts are calling for 4% AFFO per share growth in 2024 and 2025 which would translate into an AFFO payout ratio of 97.81% in 2024 and 94.37% in 2025, assuming the dividend remains unchanged.

We like the long-term prospects for skilled nursing and assisted living real estate as the “silver tsunami” should be a demand catalyst for years to come.

However, we’re uneasy with OHI’s 2023 expected AFFO payout ratio of 101.52%.

We believe there is a reasonable chance for the payout ratio to come down under 100% with analysts’ projections for AFFO per share to increase by 4% in 2024 and 2025.

While we are hopeful, we are keeping a close eye on OHI quarterly reports to ensure adequate dividend coverage is in place. OHI is set to report its 4Q-23 earnings on February 7^th after the market closes.

Currently OHI is trading at a slight discount, with a current P/AFFO of 10.87x, compared to its average AFFO multiple of 11.26x.

We rate Omega Healthcare a Spec Buy.

Service Properties Trust (SVC)

SVC is an externally managed REIT (managed by RMR Group) that invests in hotels and net lease retail properties that are primarily service-oriented.

For more on the external manager RMR Group please see my recent article discussing the external manager in more detail.

Service Properties has a market cap of approximately $1.29 billion and a portfolio that holds 221 hotels with approximately 37,700 rooms located in the United States, as well as Puerto Rico and Canada.

Measured by service level, 40.1% of their hotels are full service, 37.3% are extended stay, and 22.6% are select service.

In addition to their hotel properties, SVC has a 13.4 million SF portfolio consisting of 761 net lease retail properties located across 46 states within the U.S.

Their largest net lease tenant is TravelCenters of America which made up 67.8% of their annualized minimum rent and reported rent coverage of 2.26x.

SVC has not yet fully recovered from the pandemic in 2020 when its AFFO fell to $0.67 per share, down from $3.23 per share the previous year, representing a -79% decline. In 2020, SVC was forced to cut its dividend from $2.15 per share to $0.57 per share.

The following year AFFO fell another -49% to $0.34 per share and the dividend was cut to just $0.04 per share in 2021.

In 2022 earnings (AFFO) rebounded to $1.50 per share and the dividend was increased from $0.04 to $0.23 per share, only to be followed by a tough year in 2023 as analyst estimates show AFFO declining by -80%, to just $0.30 per share.

If analysts’ estimates are correct, it would put the 2023 AFFO payout ratio at 266.67%!

Even worse is that analysts are expecting SVC to generate negative cash flow (‘AFFO’) per share in both 2024 and 2025.

With the current obscenely high payout ratio and analysts’ future projections we believe there is a likely chance for another dividend cut on the horizon.

On top of everything else, SVC is currently trading at a premium compared to its normal trading multiple. Currently shares are trading at a P/AFFO of 28.53x, compared to their average AFFO multiple of 9.20x.

The current above average trading multiple is not due to the price running away, but rather the deterioration of earnings.

We advise investors avoid Service Properties Trust.

Ares Commercial Real Estate (ACRE)

ACRE is an externally managed mortgage REIT (“mREIT”) that specializes in the origination and management of commercial real estate (“CRE”) debt-related investments.

The mREIT has a market cap of approximately $544 million and a loan portfolio that has $2.2 billion in outstanding principal balance.

ACRE offers a variety of financing solutions but primarily holds senior mortgage loans with approximately 98% of their loan portfolio consisting of senior loans.

In addition to senior loans, the specialty finance company offers subordinate financing, preferred equity, and mezzanine loans.

For all of its debt products, ACRE typically holds its loans for investment in order to generate interest income rather than securitizing and selling the debt instruments.

By region, ACRE’s largest presence is in the Mid-Atlantic / Northeast which represents 29% of their loan portfolio, followed by the Southeast which represents roughly 24%.

By property type, ACRE’s largest type of collateral is office properties which represents 39% of its loan portfolio, followed by multifamily which represents approximately 26%.

Like most mortgage REITs, ACRE typically pays out close to 100% of its earnings.

When measured against their adjusted operating earnings per share (“EPS”), ACRE had a dividend payout ratio above 90% in 6 years between 2014 and 2022, and analysts expect the dividend payout ratio to go as high as 302.22% in 2023.

The high payout ratio is due to deteriorating earnings with EPS going from $1.55 in 2022, to an expected $0.45 per share in 2023, representing earnings decline of approximately 71%.

Analysts expect earnings to rebound with an estimated increase of 126% in 2024 and a 13% increase in 2025.

However, after accounting for the lofty growth projections, the estimated EPS in 2025 comes to $1.15 per share, compared to the expected dividend of $1.27 per share, representing an expected EPS dividend payout ratio of 110.43% in 2025.

ACRE currently pays a 13.08% dividend yield and trades at a P/E of 20.72 compared to its average P/E ratio of 10.63x. While the P/E ratio is double the normal average, the current ratio is high due to the expected earnings decline in 2023.

The price has not run away, but earnings are expected to fall sharply in 2023 and then rebound with a 126% increase expected in 2024. Using the expected EPS in 2024 of $1.02 per share would give a forward P/E ratio of approximately 9.89x.

We rate ARES Commercial Real Estate a Hold.

Granite Point Mortgage Trust (GPMT)

GPMT is an internally managed mREIT that specializes in the origination and management of a portfolio of debt-related instruments which primarily consists of senior loans that are floating-rate and collateralized by CRE properties across the United States.

The mREIT has a market cap of approximately $301 million and a $3.1 billion loan portfolio comprised of 77 investments. The portfolio has an outstanding principle balance of $2.9 billion and $3.1 billion in total loan commitments.

GPMT’s entire investment portfolio consists of loans, 99% which are senior loans and 98% that are floating rate. The mortgage REIT originates loans for multiple property types including Office, Multifamily, Retail, Hotel, and Industrial.

The majority of their portfolio is made up of loans for office and multifamily properties which represent 43.7% and 32.5% of GPMT’s portfolio respectively.

At the end of 3Q-23, GPMT’s loan portfolio had a realized yield of 8.4% and a weighted average stabilized loan-to-value (“LTV”) of 63.3%.

In addition to being a serial dividend cutter, GPMT’s earnings have been eroding away since 2019.

In 2019, GPMT reported adjusted operating earnings (“EPS”) at $1.40 per share. EPS fell by -16% to $1.17 per share in 2020, then fell by -15% in 2021, and then fell by -72%, to just $0.28 per share in 2022.

The dividend followed suit with a dividend cut of -61.31% in 2020, a dividend cut of -5% in 2022, and a dividend cut of -15.79% in 2023. In 2019 GPMT paid a dividend of $1.68 per share, compared to just $0.80 per share in 2023.

In spite of the multiple dividend cuts, the mortgage REIT’s dividend payout ratio has been absurdly high since 2019.

In each year between 2019 and 2023, GPMT had a dividend payout ratio over 100% with the exception of 2020 when they slashed the dividend by -61.31%, pushing the dividend payout ratio down to 55.56%.

So far, GPMT has demonstrated a past track record of value destruction. EPS fell in 2019 (-8%), in 2020 (-16%), in 2021 (-15%), and in 2022 (-72%). Analysts expect 2023 EPS to increase by 14% but then fall by nearly 40% in 2024.

All in all, analysts expect 2024 EPS to come in at $0.20 per share compared to $1.40 per share reported in 2019.

The stock pays a 13.77% dividend yield that we believe is unsustainable and trades at a P/E of 18.63x, compared to its average P/E ratio of 12.25x.

We recommend that investors avoid Granite Point Mortgage Trust.

Global Net Lease (GNL)

GNL is an internally managed net lease REIT that specializes in the acquisition and management of a diversified portfolio of commercial properties with a focus on sale-leaseback transactions on mission critical, single tenant properties.

Its portfolio is made up of multiple asst types including single-tenant net lease properties, single-tenant mission critical office properties, and single-tenant Industrial properties and distribution centers.

In total, its single tenants properties represent approximately 73% of its portfolio when measured by straight-line rent (“SLR”).

In addition to its single-tenant properties, GNL invests in multi-tenant retail properties with a focus on open-air retail properties that are typically anchored by a grocery store or power center.

GNL has a market cap of approximately $2.0 billion and a 66.8 million SF portfolio comprised of over 1,300 properties spread across 11 countries including the United States, the United Kingdom, Germany, Finland and the Netherlands.

The majority of Global Net Leases’ SLR is derived from the United States and Canada with 80.9% coming from these two countries, while the countries in Europe generate approximately 19.1% of its SLR.

At the end of the third quarter, GNL’s portfolio was 96% leased to 815 tenants with a weighted average lease term of 6.9 years. Additionally, 58% of its SLR is derived from investment grade tenants.

Since 2017, GNL had a blended average AFFO growth rate of negative -3.65%. Management has done an effective job of eroding AFFO per share over the years.

To illustrate, the list below shows AFFO growth or declines for each year between 2017-2023:

• 2017 – AFFO per share fell -7%
• 2018 – AFFO per share increased +1%
• 2019 – AFFO per share fell -13%
• 2020 – AFFO per share fell -3%
• 2021 – AFFO per share fell -1%
• 2022 – AFFO per share fell -6%
• 2023 – AFFO per share is expected to fall by -8%

Since 2017 to 2023, GNL has diluted its AFFO per share in 6 of the years, while AFFO per share increased in only 1 year, and only by 1%.

One point to keep in mind that applies to all REITs (and C-Corps for that matter) is that the quality of the dividend is only as good as the quality of earnings.

If cash flow / AFFO per share experience consecutive years of declines, depending on the severity, GNL will either be forced to cut its dividend, slow the growth of its dividend, or maintain its dividend at unsustainable payout rates. None of which are good options.

Over its recent history, GNL has exhibited the ability to both cut its dividend and stay at an unsustainable payout ratio, which is a troubling sign.

In 2017 and 2018 GNL’s did not increase their dividend. In 2019 they cut the dividend by -16.67%, followed by a divided cut in 2020 of -2.39% and a dividend cut in 2021 of -7.65%. The dividend was not increase in 2022 and was cut by -2.88% in 2023.

Even with the multiple dividend cuts, GNL has been unable to achieve a conservative AFFO payout ratio. It exceeded 100% in 2014 and 2018 and exceeded 90% between 2019 and 2022. Analyst expect the 2023 AFFO payout ratio to come in at 100.65%.

While GNL is trading at a steep discount, with a current P/AFFO of 5.79x, compared to its average AFFO multiple of 9.35x, and pays a high yield of 15.91%, we are concerned over the high AFFO payout ratios which could potentially lead to a dividend cut down the road.

We rate Global Net Lease a Hold.

AFC Gamma (AFCG)

AFCG is an externally managed mREIT that specializes in institutional lending to the commercial real estate (“CRE”) sector with a specialized focus on loans issued to state-licensed cannabis operators.

The mREIT was founded in 2020 and primarily originates, underwrites, structures, and invests in senior secured CRE loans and other types of debt securities.

In addition to its primary focus on financing senior secured CRE loans, the company offers direct loans and bridge loans that typically range between $5 million and $100 million.

AFC Gamma, like most cannabis REITs, was formed in order to fill the void in cannabis lending due to the lack of traditional financing available, given the legal status of cannabis on the national level.

However, unlike other cannabis REITs, AFCG significantly changed its business model recently by expanding its investment criteria to include multiple types of CRE outside of cannabis, as well as offer additional types of loans instead of their prior sole focus on first lien mortgage loans issued to cannabis operators.

The expanded investment guidelines enable the company to issue first lien and subordinate loans to operators outside of the cannabis industry.

We are concerned that this mortgage REIT made drastic changes to its investment strategy just several years after being formed.

AFC Gamma paints a picture of simply taking advantage of other opportunity sets in CRE sectors since traditional banks have been pulling back from CRE lending.

Is that really why they overhauled their original investment thesis to invest outside of the cannabis sector, where they don’t have the same expertise or deep industry knowledge?

Do the new opportunity sets require the company to add risk by issuing subordinate loans?

Or was its original business model failing, forcing AFCG to expand its investment criteria and move up the risk curve?

AFCG was formed in 2020 and went public the following year so we don’t have a lot of historical data to look at.

However, from the information we have, adjusted operating earnings per share (“EPS”) fell from $2.51 in 2022 to $2.05 in 2023, representing a year-over-year decline in earnings of approximately 18%.

Analysts expect EPS to increase by +1% in 2024, but then fall to $1.99 per share by 2025, compared to earnings of $2.51 per share in 2022.

In its short history, AFCG has already cut its dividend when it reduced the quarterly rate from $0.56 per share in 1Q-23, to $0.48 per share in 2Q-23, representing a dividend cut of approximately 14.28% compared to the prior quarter.

Even after the dividend cut, AFCG’s dividend payout ratio came in at 97.56% in 2023, up from 88.84% in 2022. Analysts expect AFCG 2024 dividend payout ratio to improve slightly to 92.75% but then increase to approximately 96.5% by 2025.

In addition to its high dividend payout ratio, the company appears to lack direction, going from a specialty cannabis mREIT to a specialty lender outside of their core competencies.

Additionally, we are concerned that AFCG “new strategy” now takes on extra risk with the origination of subordinate debt.

Currently AFCG pays a 16.76% dividend yield but we question whether it can be sustained. As previously mentioned, the company is already paying out almost all of its earnings so there is little room for error.

At the same time, it appears that the company is still “finding itself”, which does not increase our confidence in management’s planning and execution or the safety of AFCG’s dividend.

AFCG is trading at a P/E ratio of 5.82x, compared to its short-term average P/E ratio of 9.28x. While the discount and high yield are enticing, we think investors might be setting themselves up for a sucker yield and recommend that they avoid AFCG for the time being.

We recommend that investors avoid AFC Gamma.

Who’s The Sucker?

In my new book, I explain sucker yield as follows:

As I explain. “Companies that feature sucker yields tend to have unpredictable and unreliable earnings histories filled with unsafe dividend payouts.”

The next term is “SWAN“.

My portfolio is custom-built for SWANs and I have zero “sucker yields” in it.

That’s by design by the way.

I hope you enjoyed my “cut the cheese” article and I look forward to your comments below.

Happy SWAN Investing!

Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: written and distributed only to assist in research while providing a forum for second-level thinking.