One of the big draws of investing in REITs is that these companies typically generate stable cash flow backed by long-term leases. That gives them the funds to pay dividends to their investors.
However, a REIT's income stream is only as solid as its tenant base. If lessees can't make their rent payments, the REIT won't be able to pay dividends. Because of that, investors need to consider the credit quality of a REIT's top tenants.
Three that get a significant portion of their rent from tenants with junk-rated credit are retail REITs Retail Value (NYSE: RVI), SITE Centers (NYSE: SITC), and RPT Realty (NYSE: RPT). That makes them riskier REITs that investors should avoid.
Not much value in the rent roll
Retail Value currently owns 14 shopping centers in the U.S. and another 12 in Puerto Rico. On a positive note, it counts Walmart (NYSE: WMT) as its largest tenant. The retail giant currently leases 10 locations from Retail Value, which contributes 6.5% of its annual base rent (ABR). While the company counts several other financially sound retailers among its top-25 tenants, it leases a significant amount of its space to those with lower credit quality.
Of its top-25, 13 have received a junk credit rating by at least one of the three major rating agencies. Overall, these financially weaker tenants contribute 22% of its ABR. Among the most concerning ones are theater operator AMC Entertainment (NYSE: AMC) and department store JCPenney, which contribute 1.7% and 1% of its ABR, respectively. The latter already filed for bankruptcy this year, while the former reportedly is on the brink of doing so.
Centered around financially strapped tenants
SITE Centers owns interests in 148 shopping centers around the country. It counts A-rated retailer TJX Companies (NYSE: TJX) as its top tenant, at 6.1% of its ABR. Unfortunately, there's a sharp dropoff after that as 12 of its top 25 tenants have a junk rating from at least one of the major credit rating agencies. Overall, these tenants contribute 22% of its ABR.
Like Retail Value, which it spun off in 2018, SITE Centers counts AMC Entertainment as one of its largest tenants at 1.7% of its ABR. It also has specialty retailers Petco, Party City (NYSE: PRTY), and Jo-Ann's among its top 25, contributing a combined 3% of its ABR. All three have a rating of CCC+/Caa or below from at least one of the major credit rating agencies, implying these companies have extremely high-risk credit.
Weakness at the top
RPT Realty owns 49 shopping centers. Like SITE Centers, financially strong TJX Companies is its top tenant, at 4.6% of its ABR. However, 11 of its top 25 tenants -- which provide 19% of its ABR -- have junk-rated credit.
One of those weaker links is Jo-Ann Fabrics. The craft store leases four locations from RPT Realty, contributing 1.1% of its ABR. The REIT also leases 15 sites to troubled Ascena Retail (NASDAQ: ASNA), which comprises 1% of its ABR. Ascena Retail -- which operates Ann Taylor, Lane Bryant, Justice, and other retail brands -- has already shuttered its Dressbarn brand and is battling landlords over $302 million in rent because of that closing. Given its financial issues and low credit quality, the retail group could file for bankruptcy to restructure its debt and other leases, which could impact top landlords like RPT Realty.
Too much exposure to credit-strapped tenants
The retail apocalypse has claimed many victims over the past few years. That trend will likely continue in those to come, with lower-credit-quality retailers the most at risk. That could have an outsized impact on these three REITs since they have considerable exposure to financially weaker tenants, which is why investors should stay away from them.