It's easy to fall in love with a high dividend yield, making excuses for why a company can continue to pay you even in the face of contradictory facts. Right now, investors looking at The GEO Group (NYSE: GEO), American Finance Trust (NASDAQ: AFIN), and Macerich (NYSE: MAC) should tread very carefully. Here's a quick look at why you should be worried about the dividends from these three real estate investment trusts (REITs).
1. One important customer
The GEO Group owns and operates prisons. That makes the government, at various levels, its primary customer. That's a positive in that Uncle Sam can raise taxes to ensure it can keep paying the rent, making for a reliable tenant. However, it also means politics can play a big role in The GEO Group's performance. And right now, the policy winds are blowing against the REIT's business.
Specifically, as the company noted in its fourth-quarter 2020 earnings release, "On January 26, 2021, President Biden signed an executive order directing the United States Attorney General not to renew U.S. Department of Justice ('DOJ') contracts with privately operated criminal detention facilities." The GEO Group counts two agencies of the DOJ, the Federal Bureau of Prisons and U.S. Marshals Service, as customers. But the bigger issue is that this could mark a material shift in the way the government, at all levels, makes use of for-profit prison operators.
The company has already cut the dividend and noted it needs to trim debt. With a huge 12.9% yield, investors are betting there's more bad news to come. That's likely because the company declared a first-quarter dividend (the second consecutive quarterly cut), but made a point of highlighting that the board had the discretion to make further changes. Right now, most investors should probably assume there will be more bad news ahead.
2. Barely covered
American Finance Trust owns retail assets with a service focus, which is perfectly fine. It makes use of the net lease structure, in which lessees are responsible for most of the costs of a property -- that's good too, as it reduces risk. However, there are some very clear negatives here that investors should worry about. And one could put the hefty 8.2% yield at risk.
The first big concern is that American Finance Trust is externally managed. This can create conflicts of interest between what's best for the manager and what's best for shareholders. As an example, the REIT cut its dividend in 2020 because it was at risk of paying out more than its adjusted funds from operations (FFO), a metric similar to earnings for an industrial company. That makes total sense.
However, it continued to buy new assets despite the clear headwinds it was facing, noting that the percentage of investment-grade tenants in its portfolio dropped from 82% at the end of 2019 to 62% at the end of 2020.
You could argue that American Finance Trust is investing opportunistically, which might very well be true. However, even after the dividend cut, the adjusted FFO payout ratio was roughly 85% in the fourth quarter. That's pretty high and suggests investors should be worried that management is pushing the accelerator pedal, perhaps a little too hard. There are other net lease REITs with high yields and better dividend track records.
3. A long recovery
Macerich owns some of the best-positioned malls in the country, with locations in highly populated areas with wealthy residents. That's important today, because malls are facing material headwinds. As 2020 began that was largely driven by the so-called "retail apocalypse" but very quickly expanded to include the coronavirus pandemic. There are a lot of moving parts here, but, basically, retailers are struggling and closing stores as consumers shift more toward online shopping. Highly leveraged names are falling into bankruptcy, and the pandemic sped up the pain.
Macerich has already cut its dividend twice. The dividend in the second quarter of 2020 was $0.10 per share in cash and $0.40 in company shares, down from $0.75 per share in cash. The third-quarter dividend was $0.15 per share in cash, which is the level where it's stayed since that point. The yield is around 4.2%. That's not all that high, but there's a caveat here.
Macerich's leverage is two to three times higher than its key peers. And there are reports it's hired an outside advisor to help it negotiate with lenders over its revolving credit facility. That's not usually a good sign and suggests lenders are getting nervous.
Now add to this the fact that a recovery in the mall REIT space is likely to be slow and drawn out, since retenanting a mall can take a material amount of time. The risks are higher than they may seem here. Macerich could very well hold the current dividend, but most investors would probably be better served looking at other options in the space.
Sometimes, a big yield is a warning sign that a company's business is in flux, as is the case with The GEO Group. Other times, you need to dig into the story a little, like with American Finance Trust, where a high yield coupled with management decisions is suggesting risk is on the rise. And then there are times when you have to weigh all of the options in front of you, and even a more modest yield may not be worth the risk, like with Macerich.