Three signs danger lurks for a dividend
Very rarely is there one key characteristic that indicates a warning sign for investors but rather a combination of several factors that, when combined, signal danger is ahead. The most common identifiers are:
- High payout ratios: Since REITs are required to pay 90% or more of revenues as dividends, it's fairly common to see high dividend payout ratios that range from 70% to 90% as it relates to the company's funds from operations (FFO) or adjusted funds from operations (AFFO). However, when payout ratios exceed 100%, it can signal a warning to investors that the dividend may not be sustainable in the long run.
- Too much debt: Debt is a normal part of REIT investing. For most REITs, their debt leverage or debt-to-earnings ratio (debt-to-EBITDA) remain below 6.0x, meaning their debt-to-earnings is at healthy or stable levels. The lower the debt-to-EBITDA, the better financial position the company is in. When debt levels rise above 6.0x, it could be a signal of troublesome times ahead and the inability to maintain debt obligations or dividend payouts.
- Negative market conditions: A REIT's goal is to grow its revenues and FFO year over year. In a strong real estate market, this is fairly easy to achieve, but when market conditions shift, it can place the REIT in a particularly tough position. If a REIT is exposed to negative market conditions, revenues decrease and can leave the company unable to maintain dividend payouts or debt obligations.
Warning signs are high for American Campus Communities
The coronavirus pandemic has impacted student housing in big ways this year, meaning American Campus Communities, a REIT that specializes in on- and off-campus student housing, has been hit hard. Lease rates, collection rates, and rental rates are all below annual averages, pushing its funds from operations down 30% from the same quarter the previous year.
The company appears to be highly leveraged, even before COVID-19 challenges, with a debt-to-EBITDA ratio of 7.1x just prior to the onset of the pandemic and a debt-to-EBITDA ratio of 8.1x at quarter's end 2020. There is hope for future improvements, but if the company isn't able to improve its revenues and net operating income in the next few quarters, it's very likely that a dividend cut is in order, particularly as 2021 and 2022 debt maturities come due.
Will the retail apocalypse take Regency Centers next?
Regency Centers is one of largest retail REITs specializing in open-air retail centers in high-density urban and suburban markets. A number of retail REITs have paused dividend distributions earlier in the year, but Regency Centers has maintained its dividend payout despite a very challenging few quarters. Right now, payout ratios are hovering just below the 100% threshold, which could indicate trouble ahead if revenues remain down. October saw an 87% rental collection rate, including tenants on a rent deferral program, but as case rates surge as we enter the holiday shopping season, the outcome and impact it will have on Regency Centers' tenants is uncertain.
Will Boston Properties debt be too much to handle?
Boston Properties, one of the leaders among office REITs, is feeling the pinch as work-from-home orders continue to dominate the office sector, particularly as preferences shift outside of high-density urban markets, which dominate its portfolio. Thankfully, its relatively low payout ratio of 60% has allowed the company to maintain dividends despite a decrease in revenues and net operating income in Q3 2020. The real warning sign here is the company's debt, which is currently 7.32x, well above the 6.0x ratio. Boston Properties has no debt maturities for the remainder of 2020 but has $850 million due in 2021. While it maintains ample liquidity for the time being, a decrease in lease-up rates, lower rental rates, and declining revenues over time can put pressure on the company to maintain dividends in the future. I don't see dividends disappearing anytime soon, but it is a REIT to watch closely.
Unfortunately, undesirable market conditions are putting these companies in a tough position, despite high-quality portfolios. Keep an eye on the three REITs above and consider the potential threat of dividend cuts or temporary suspensions before buying.