A Safe 7.2% Preferred Dividend From Global Net Lease

Summary

• Global Net Lease owns a well-diversified portfolio with an average remaining lease term of nine years, and a large base of investment grade tenants.
• While we consider the common shares attractive with its 13% yield, we see elevated risk due to a possible dividend cut which could lead to more downside.
• GNL's Preferred Stock offers a safe 7.2% yield that is very well covered and backed by quality real estate, and is very attractive in today’s marketplace with few opportunities left.
• The margin of safety for the preferred holder is high. Any potential cut will affect common holders, but would lead to an even higher coverage for the preferred stocks.
• The Preferred stock, GNL-A, trades at around its par value of $25/share and provides a safe and generous income for high-yield seekers.

This research report was jointly produced with High Dividend Opportunities co-author Jussi Askola.

Global real estate is an asset class that provides solid diversification benefits and can help improve the risk adjusted returns of a portfolio. Yet, only few investors ever invest in this asset due to the lack of opportunities easily accessible to U.S. individual investors.

In this sense, Global Net Lease (NYSE:GNL) is one of the only U.S. REIT, along with W.P. Carey (WPC) and NorthStar Europe (NRE), to allocate a significant portion of its portfolio into global real estate, or Europe to be more specific.

By investing in these shares, investors are able to gain exposure to foreign real estate in a liquid, diversified and cost-efficient manner. No need to trade shares on a foreign stock exchange and no withholding tax… We find this to be a simple and favorable way to gain a desirable market exposure.

Having looked at the different alternatives including common stock, debt, and preferred, we identify one specific security that we believe will continue to pay generous dividends for many years just like clockwork.

Global Net Lease

Global Net Lease is a U.S. REIT with a market cap of $1.2 billion that is focused on the generation of stable and predictable income through rents from its real estate portfolio.

The current portfolio contains many different property types with a great concentration on single tenant office properties. The 313 properties are located in diverse markets throughout the U.S. (49%) and Europe (51%).

Overall, we think that this particular portfolio has a good mix of positives and negatives. It is far from being perfectly risk-free.

The main positives are the following:

Positive 1: The tenants are strong with 75.8% of implied investment grade tenants. Well-known tenants include FedEx (FDX), Dollar General (DG), Merck (MRK), General Electric (GE), Finnair (OTC:FNNNF) and Quest Diagnostics (DGX) to name a few. It greatly reduces the risk of tenant defaults and other bad surprises to the landlord.

Positive 2: The weighted average remaining lease term is long at nine years with little to no maturities in the near term. This is crucial to the thesis, as it results in highly predictable and stable income for many years to come, especially when considering that the tenants are of high quality and unlikely to default on these leases.

Positive 3: The high European exposure is with the largest single markets including Germany, the U.K., and Finland. All three are certainly part of the strongest economies in Europe and property markets are performing well with growing rents and occupancies to the most part.

Positive 4: Due to its global nature, GNL is less exposed to the risk of rising interest rates in the U.S. This is because risk of rising interest rates in Europe is lower than the U.S.

The majority of its debt is denominated in non-U.S. currency with fixed interest rates. Given that this is the main fear of REIT investors, this is a favorable feature reducing investment risk.

GNL is able to access cheap capital in Europe to potentially undertake new acquisitions and earn higher spreads. The current average interest rate of the firm is surprisingly low at 2.8% and this is really due to its presence in the European market where interest rates are still much lower than in the U.S.

On the other hand, just like any other high yield investment, GNL has its own set of issues which need to be considered carefully:

Negative 1: The great majority of the assets are single tenant office properties. This is a big risk to us. Having worked in the private equity real estate, we have encountered many investors who have had to learn the hard way that single tenant office properties can become very problematic once the tenant vacates. It is very common for investors to buy such properties simply because they are very easy to manage (as long as occupied), and often sell at above-average cap rates. However, what these investors often forget to fully consider is the difficulty to find new tenants at reasonable rent if and when the property ends up empty. In such cases, the needed capex, tenant improvements, and brokerage fees can negatively impact the returns of these properties.

Moreover, for the period the property sits empty, the landlord has to keep on paying all the bills including property taxes, heating, and so on. So, these situations can very quickly turn into nightmares for the property owner if the risk is not managed properly.

Negative 2: The dividend coverage of GNL is very tight at 103%. It leaves absolutely no room for error and given that office properties (especially single tenant) may require high capex in the case of a vacancy, it puts the common shareholder at the risk of a possible future dividend cut. Most office REITs including Boston Properties (BXP), Equity Commonwealth (EQC) and Columbia Property Trust (CXP) follow a more conservative payout approach, and rightfully so. Today, GNL is fine, but we feel that tight liquidity may come sooner rather than later.

Negative 3: GNL is externally managed by AR Global Investments. The management has a poor track record and we suspect it could have conflicted interests with shareholders. By earning management fees based on its assets under management ("AUM"), it has at many times raised equity at dilutive prices (at prices well below NAV), and made poor investments. VEREIT (VER) is another REIT entity that was once managed by the same group. Looking at both GNL and VER charts, they do not look pretty!

It is for these three reasons that we feel uncomfortable with the common stock today, and prefer to play it safe and go with the preferred.

Common vs. Preferred

The common stock sells at less than 8 times FFO (based on the third-quarter annualized FFO of $34.8 million). It pays a hefty yield of 13%, and as such it is the cheapest REIT of its entire peer group.

While not being directly comparable with GNL, other net lease REITs including Realty Income (O), National Retail Properties (NNN), and W.P. Carey are trading at very significant premiums. Yet, as we described earlier, GNL owns a very decent portfolio and income investors may be tempted to consider that the common shares to be opportunistic. That said, a very low share price does not mean that it cannot go lower.

We think that the elevated payout ratio, combined with a high concentration on single tenant office properties, and a conflicted management will remain a drag on the stock. In fact, GNL has almost always traded at cheaper valuations than its peers. Even worse, in case of a dividend cut, the stock could get hammered, similar to what we have seen in the price of Macquarie Infrastructure Corp. (MIC) recently after the dividend cut. MIC stock was down 40% of the dividend cut news, and created a buying opportunity. Should a dividend cut happen with GNL resulting in a higher coverage ratio, this is WHEN we might get interested in the common shares.

Until then, we prefer to take a higher seniority position over the common stock, while still enjoying high yields.

Global Net Lease, 7.25% Series A Cumulative Redeemable Preferred Stock (GNL-A)

Global Net Lease, 7.25% Series A Cumulative Redeemable Preferred Stock (GNL-A) is a preferred stock currently trading around its par value of $25/share and yielding 7.25%. This issue is very well protected given that it has to be fully paid before any common dividend. As such, the preferred stock should not be affected if GNL were to run into some trouble, and in fact would benefit if the dividend cut were to occur on the common stock as the coverage ratio on the preferred would increase, because the company will have more cash flow to pay the preferred shareholders.

The dividend of GNL-A is cumulative: This feature makes cumulative preferred shares more valuable than non-cumulative preferred shares or common shares because in the event that payments are suspended, they accumulate and are owed to the shareholders, and will be repaid in full if and when the payments are restored. Furthermore they must be completely repaid before the common shareholders are allowed to receive any further dividend payments.

We believe that 7.25% is highly generous given the solid cash flows, the predictable nature of the portfolio (high investment grade portion and long lease terms), and the high coverage of the preferred dividend. The yield compares favorably when compared to some of its peers:

Source: High Dividend Opportunities

This is the very first preferred issuance of GNL and it happened only about one year ago. In this sense, the market may have mispriced this issue simply because there is very limited trading history.

The 7.25% yield appears higher than the average in the space suggesting that the risk-to-reward of the preferred is opportunistic for conservative income-seeking investors.

Final Thoughts

Global real estate exposure with a high but durable yield and lower volatility is an attractive proposal to us. While a potential dividend cut may be a big drag for GNL common stockholders, this is not very relevant to the preferred investor who is interested in conservative income generation.

The market seems to misunderstand the true resilience of the cash flow - causing an inefficient market pricing for the preferred issue. We like GNL-A, but will keep a very close eye on the common and will keep you updated should we see an MIC type of selloff, which would open the door for a unique buying opportunity for GNL.

In this sense, the 7.25% preferred of Global Net Lease is a good example of the type of security that we look for at "High Dividend Opportunities". Mispriced, high yield, and yet resilient.

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.