Real estate investment trusts (REITs) are higher-yielding investments by nature. These entities must distribute 90% of their taxable income to shareholders to maintain their special tax status. That's why the typical REIT currently yields nearly 3%, more than double that of the average stock in the S&P 500.
Some REITs offer even higher yields. While that might seem appealing, investors need to determine whether those payouts are sustainable, because a high yield can also be a sign of a dividend yield trap. With that possibility in mind, here's a look at whether Gladstone Commercial (NASDAQ: GOOD), Global Net Lease (NYSE: GNL), and Sabra Health Care REIT (NASDAQ: SBRA) are compelling income options or dividend yield traps.
Too good to be true?
Gladstone Commercial is a diversified REIT that primarily owns office and industrial properties. The company pays a monthly dividend that currently yields 6.5%. Overall, the REIT has a solid dividend track record -- it hasn't missed or reduced its cash distribution since its initial public offering in 2003.
However, there's one big red flag with Gladstone Commercial. The REIT pays out nearly all its income to support its high-yielding dividend. For example, in 2020, Gladstone produced $1.56 per share of funds from operations (FFO) while paying out a total of $1.50 per share in dividends, giving it a 96% payout ratio.
While a REIT can technically distribute 100% of its FFO, most pay much less. That's because doing so allows them to retain cash to reinvest in expanding their portfolio. However, since Gladstone pays out nearly everything it takes in, the REIT has barely grown in recent years, only increasing its FFO from $1.54 per share in 2015 to $1.56 per share last year.
So, while the company could continue paying its current dividend, it might better serve investors by retaining more cash and using that to fund new acquisitions.
Is another cut on the way?
Global Net Lease is also a diversified REIT that primarily concentrates on office properties and industrial real estate. Further, as its name suggests, the REIT takes a global approach while focusing on net lease real estate.
The company pays a much higher-yielding dividend at 8.8%. That's despite cutting its annualized rate from $2.13 per share to $1.60 per share last year to preserve its liquidity during the pandemic.
However, even at that reduced rate, the REIT still has a high dividend payout ratio of around 90% of its adjusted funds from operations (AFFO). Because of that, like Gladstone, Global Net Lease has struggled to grow its AFFO per share over the years, which is why it might need to make another dividend cut to retain even more cash to fund growth.
Is it healthy yet?
Sabra Health Care REIT, as its name suggests, is a healthcare REIT. The company has a diversified portfolio of properties in that sector, including skilled nursing/traditional care facilities, specialty hospitals, and senior housing. It net leases most of its properties, though it does operate a portion of its senior housing portfolio under a management structure.
The company currently pays a hefty dividend that yields 7%. That's even after cutting its payout last year to preserve cash amid the pandemic. On a positive note, that reduction put Sabra's payout ratio at a reasonably comfortable 75% of its AFFO in the second quarter.
That lower payout ratio alone makes Sabra less of a dividend yield trap.
Meanwhile, the company recently announced plans to sell its 49% interest in a managed senior housing joint venture. That business has experienced pandemic-related hardships, impacting its occupancy and net operating income (NOI). By selling its stake, Sabra will improve its already solid balance sheet, giving it additional flexibility to finance future acquisitions to grow earnings. Because of that, the dividend looks to be on solid ground these days.
Not all high yields are traps
On the one hand, questions remain about the long-term sustainability of the high-yielding dividends currently paid by Gladstone Commercial and Global Net Lease. The biggest issue is that they have high dividend payout ratios, which limits their abilities to retain earnings that they could use to help fund acquisitions. Because of that, there's a high risk they could reduce their dividends, making them potential dividend yield traps.
On the other hand, Sabra's dividend doesn't look like a trap. The REIT already reduced its payout to a comfortable level last year. Meanwhile, it recently started the process of selling its interest in a joint venture, which will improve its financial flexibility. That makes it a potentially appealing option for yield-seeking investors.