The average equity REIT currently yields 3.7%, according to NAREIT, which is more than double what stocks in the S&P 500 pay. However, some offer even bigger dividends. While those larger payouts are enticing, they're not always sustainable. That's why investors need to be on the lookout for potential dividend yield traps.
Three REITs that currently stand out for their big-time yields are SL Green Realty (NYSE: SLG), Empire State Realty Trust (NYSE: ESRT), and Brookfield Property (NASDAQ: BPY)(NASDAQ: BPYU). Here's a look at whether those payouts might be yield traps.
A yield almost as high as its office buildings
Office REIT SL Green currently yields 7.3%, which is well above the REIT average. Its yield has risen sharply this year because of a nearly 50% decline in its stock price. That's mainly due to concerns about the New York City office market -- where it's the largest office landlord -- because many office employees are working from home due to the COVID-19 outbreak. The market is worried this will become permanent, which would weigh on office occupancy and rental rates.
So far, the vast majority of its tenants continue to pay their rent (it collected 96% of its office rents during the turbulent second quarter). Meanwhile, it continues to secure new and renewal leases, including signing 280,000 square feet during the second quarter. It has less than 10% expiring of its contracts by the end of 2021, suggesting that its rental income shouldn't be under too much pressure. Because of that, the REIT should continue to generate steady rental income to support its dividend. It also has lots of cushion, given its low payout ratio of 52% during the second quarter.
Meanwhile, SL Green has a strong balance sheet, backed by more than $1 billion in cash. It also has investment-grade credit and a manageable amount of debt maturing over the next 18 months. With a low payout ratio and lots of cash, SL Green's high-yielding dividend doesn't look like a trap.
Standing tall like its iconic office building
Empire State Realty Trust -- which owns the landmark Empire State Building, among other properties in the New York metro area -- currently yields 6.3%. Driving up that yield has been a more than 50% plunge in its stock price this year due partly to the same concerns as SL Green.
However, the office REIT fared reasonably well during the second quarter. It collected 84% of the rent it billed in the period (86% from office tenants and 75% from retailers). While the underage had some impact on its FFO, it still generated $0.14 per share, which was more than enough to cover its $0.105 per share dividend. Meanwhile, rental collection rates improved in July, and it reopened the Empire State Building Observatory toward the end of the month, which generates lots of revenue for the company. It also continued to sign new leases during the brutal second quarter, suggesting that work-from-home trends aren't dampening demand for office space.
Meanwhile, the REIT has a cash-rich balance sheet. It ended the second quarter with $873 million in cash after it repurchased $52 million of its beaten-down stock. Add it all up, and this REIT dividend seems to be on solid ground.
The liquidity to maintain, but risks remain
Brookfield Property has one of the biggest yields in the REIT sector at more than 11%. While a payout in the double digits is usually a sign of a trap, Brookfield believes it can maintain its payout despite the impact of work-from-home on its office portfolio and the retail apocalypse on its retail properties.
That's largely because of its strong balance sheet. The company had $6 billion of liquidity at the end of the second quarter, including $1.5 billion in cash. Because of that, the company had the confidence to launch a $1 billion program to buy back some of its beaten-down shares -- they're down about 33% this year -- and maintain its quarterly payout of $0.3325 per share.
However, unlike SL Green and Empire State, Brookfield isn't currently generating enough FFO to maintain its payout. That number plunged from $0.38 per share in the year-ago period to $0.18 per share during the second quarter. Not only were its core office and retail businesses under pressure from COVID-19, but it also experienced issues in its private equity investments, as gains on property sales declined, and its hospitality properties lost money due to closures. Because of that, there's some concern that Brookfield's dividend might be a trap if FFO doesn't bounce back quickly since it can't continue paying out more cash than its properties produce.
Not all high yields are traps
All three of these REITs have maintained their high-yielding dividends this year even though COVID-19 has affected rental collection rates. It seems reasonably likely that SL Green and Empire State Realty will be able to continue paying their dividends since they have lots of cushion thanks to their relatively low payout ratios and cash-rich balance sheets. On the other hand, Brookfield's payout isn't quite a sure thing, given that it's currently paying out more cash than it's producing. Because of that, yield-focused investors might want to avoid the real estate company until its FFO bounces back.