Real estate investment trusts (REITs) often make great dividend stocks. Commercial real estate tends to generate steady rental income, enabling REITs to produce lots of stable cash flow. That gives them funds to pay attractive dividends and expand their real estate portfolios.
However, not all REIT dividends are on solid ground. Three REIT dividends in danger of a reduction are Gladstone Commercial (NASDAQ: GOOD), Global Net Lease (NYSE: GNL), and WashREIT (NYSE: WRE). Here's why those seeking a stable income stream might want to avoid these high-yielding REITs.
Not enough flexibility
Gladstone Commercial is a diversified REIT that focuses primarily on office properties and industrial real estate. The company leases space in its 120-property portfolio to 107 different tenants in 19 industries. That diversity enables Gladstone to generate very stable cash flow, which it uses to pay an enticing dividend. At a 6.7% dividend yield, it's more than double the REIT sector's average.
One reason Gladstone yields that much is that it has a high dividend payout ratio. The company pays a monthly dividend of $0.12515 per share, which adds up to $1.5018 per year. However, it only generated $1.56 per share of FFO in 2020, implying a 96% dividend payout ratio. While REITs can technically distribute up to 100% of their FFO, the higher the payout ratio, the less cash the REIT retains to expand its portfolio.
Because Gladstone has such a high payout ratio, it has had to issue lots of stock to finance acquisitions. That has diluted the impact of these additions. Since 2015, Gladstone has grown its assets from $991.6 million to $1.46 billion, which has increased its revenue from $83.8 million to $133.2 million. However, FFO has barely budged on a per-share basis, only rising from $1.54 per share to $1.56 per share. Given the impact its tight payout ratio has had on FFO growth, Gladstone might have to reduce its dividend to retain more cash to fund acquisitions.
Another cut seems possible
Global Net Lease has a lot of similarities with Gladstone Commercial. It's also a diversified REIT that primarily owns office buildings and industrial real estate. Likewise, its portfolio generates steady cash flow, which it uses to pay an even higher-yielding dividend at 8.6%.
Again, the primary reason for that high yield is Global Net Lease's high payout ratio. In 2020, the REIT generated $1.79 per share of adjusted funds from operations (AFFO) and paid out $1.73 per share in dividends, implying a 97% payout ratio. Given that tight payout ratio, it cut its dividend from $0.5325 per share each quarter to $0.40 per share early last year.
However, even at that lower rate, Global Net Lease still distributes about 90% of its AFFO. That's still too high, which is why it might need to reduce its payout again. That would enable it to retain more cash so that it's not diluting investors to finance acquisitions.
A strategic shift could yield a dividend change
WashREIT is also a diversified REIT. It currently owns office, multifamily, and retail properties in the Washington, D.C., metro area. Those assets generate relatively steady cash flow that adequately supports its dividend, which currently yields 4.9%. It tallied $1.45 per share in core funds from operations (FFO) last year while paying out $1.20 per share in dividends, implying a decent 82% payout ratio.
However, that is all about to change. The company recently agreed to sell the bulk of its office portfolio and has a deal in place for its retail assets. Those assets currently generate 49% of its income. Because of that, FFO is about to take a big hit.
While WashREIT intends on redeploying the proceeds from asset sales to expand its multifamily portfolio to fast-growing cities in the southeast, it will take some time to put that capital to work. Because of that, the REIT might need to reset its dividend in the near term to reflect its smaller portfolio.
Too risky for those seeking steady income streams
Gladstone Commercial, Global Net Lease, and WashREIT pay high-yielding dividends mainly due to their high dividend payout ratios. That's a dangerous situation because it puts them at a higher risk of a payout reduction if their income streams decline. Because of that, investors seeking a steady income stream should steer clear of these REITs, especially when there are better high-yielding REITs available.