Real estate investment trusts, or REITs, are known for their dividends. In an ideal world, a REIT would pay one that steadily increases.
Unfortunately, not all REITs can maintain their dividend payments, let alone grow them over time. Several are currently at risk of having to cut their dividends, which they could announce as soon as this month. Here's what puts these dividends at risk as well as a few REITs where near-term cuts seem most likely.
Three factors that put a REIT dividend at risk for a reduction
While most REITs aim to deliver regular dividend growth, not all achieve that goal. Many are lucky if they can even maintain their dividends. That's because they have characteristics that impact dividend safety. Several factors can force a REIT to reduce its dividend, including:
- A high dividend payout ratio. REITs must pay at least 90% of their taxable net income via dividends to comply with IRS regulations. However, many distribute more than that number since it's usually lower than their cash flow, as measured by funds from operations (FFO). Thus, the warning sign is when a dividend payout ratio approaches 100% of a REIT's FFO.
- A weak balance sheet. REITs rely on debt to help finance growth. Because they need access to credit, a REIT will ideally have an investment-grade rating backed by healthy leverage metrics, such as a debt-to-EBITDA ratio of less than 6.0 times. When a REIT's balance sheet starts to weaken, it'll often reduce its dividend so that it can shore up its financial situation.
- High exposure to a challenging tenant base. If a REIT's tenant base can't afford to keep paying rent, it might not be able to maintain its current dividend rate.
These factors don't automatically mean a REIT is about to cut its dividend. However, there are warning signs that a dividend reduction could be forthcoming, which is why a REIT investor needs to keep an eye out for these troubling characteristics.
Three high-risk REIT dividends
Three REIT dividends that may be in trouble are Brookfield Property REIT (NASDAQ: BPYU), Columbia Property Trust (NYSE: CXP), and Office Properties Income Trust (NASDAQ: OPI).
Brookfield Property Partners' liquidity won't last forever at this rate
Brookfield Property Partners (NASDAQ: BPY) and its REIT subsidiary, Brookfield Property REIT, currently yield more than 11%. Several issues are weighing on the global property owner, including weak rental collection rates at its malls, the potential long-term impact of working from home on its office properties, and the effect COVID-19 had on its hospitality investments in the second quarter. Because of that, Brookfield only generated $0.18 per share of FFO during the period, well short of the $0.3325 per share it paid out in dividends.
On one hand, Brookfield believes it can get through the current rough patch thanks to its liquidity, which stood at $6 billion at the end of the second quarter, including $1.5 billion of cash. In addition to that, it's had no problem using its real estate portfolio to borrow money, as it recently completed $2.2 billion in financing transactions. However, the company can't continue paying out more cash than it's producing. Because of that, it could soon follow other REITs in pausing or reducing its payout until market conditions improve.
Columbia Property Trust: The next office REIT dividend to fall?
Major office landlords haven't had as many issues collecting rent this year as some of their counterparts focused on other real estate segments like retail. However, that hasn't stopped some major office REITs from taking a conservative approach, especially as most office workers continue working from home. That caution recently led New York City-focused office REIT Empire State Realty Trust (NYSE: ESRT) to suspend its dividend for the third and fourth quarters, while peer Vornado Realty Trust (NYSE: VNO) cut its payout by 20%.
These moves could cause more office REITs to take similar action. One that could be the next in line to reduce its dividend is Columbia Property Trust. The market already seems to have priced that in, as Columbia's yield has risen from around 3% at the beginning of the year to its current level above 7%.
The REIT's management team said they felt confident in the dividend during the second-quarter conference call. However, Empire State Realty had a strong cash-rich balance sheet and still opted to suspend its payout, suggesting that sometimes caution rules the day in an uncertain market.
Office Properties Income Trust's yield implies a cut could be forthcoming
Office Properties Income Trust (NASDAQ: OPI) is another office REIT with an enormous yield. At more than 9% -- which is more than double that of the average REIT -- the market seems to think a reduction is on the way.
The REIT's management team doesn't believe that will be necessary. CFO Matt Brown stated on the company's second-quarter conference call that it generated $0.95 per share of cash available for distribution, giving it a 57.9% payout ratio. Because of that, he said "our dividend is well covered and we expect it to be below our target of 75% for 2020."
However, just because the REIT can afford to keep paying its dividend doesn't mean it will, which was certainly the case with Empire State Realty Trust. Because of that, and the growing conservatism in the REIT sector, the company might join its peers by reducing or suspending its dividend and using that cash to shore up its balance sheet.
In this market, few dividends feel safe
REITs have been erring on the side of caution this year by slashing or suspending their payouts so they can preserve cash just in case market conditions get worse. As more companies reduce their payouts, those that haven't done so are pressed to consider making similar moves. Because of that, it wouldn't be surprising to see more payouts take a hit this month, with Brookfield, Columbia, and Office Properties being among the more likely candidates for a reduction given their well-above-average yields.