Now Is Not The Time To Be A High-Yield REIT Investor

Summary

• We're living in an all new paradigm in which the world is being shut down by social distancing.
• We've put together a stress test guide designed to steer investors away from high-yielding REITs. We want to focus on the safest names instead.
• I've trained 30 years for this black swan. Now it's time to go to work.
• This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

Have you ever heard of black swans?

Not the bird. Those exist too, of course, and they're apparently not as rare as they once were.

But what I'm talking about is the event - the kind that nobody wants to see and nobody usually does - but that still lurks in the shadows regardless, waiting for as random a moment as possible to jump out and say, "Boo!"

Sound familiar?

I'm sure I don't have to tell you how, in the middle of an amazing economy and stock market, we got jumped. COVID-19, also known as the coronavirus, has spooked us for sure.

I'm also sure I don't need to point out how horribly the markets fell earlier this week. It was painful, to say the least. Painful and very, very real.

There's no getting around that fact.

Yet, if someone had suggested such a possibility back in December of last year - or even this January - they would have been pegged as crazy and scoffed out of the room.

With good reason, when black-swan events are exceptionally rare and even more elusive. You have to be an economic prophet to predict them.

I'm not a prophet, and I don't claim to be one. But I'm a man of conviction and principle, two qualities that existed both before the coronavirus hit and after.

Therefore, I'm going to tell you the same thing I've been telling you for over a decade now…

It's all about quality. Accept nothing less.

Chasing Yield Is the Opposite of Concentrating on Quality

I know you've heard me say this time and time again on Seeking Alpha. But given the context of the current pandemic, let me repeat myself as strongly as I can:

"Now is not the time to be chasing yield."

In late January, I explained that "buying into a high dividend yield involves taking more risk. There's never a free lunch when it comes to chasing yield."

Roger Montgomery, sports agent extraordinaire - and therefore someone who knows a thing or two about long-term investments - also has a thing or two to say on the subject:

"I have yet to uncover a billionaire investor that achieved their success from focusing on high-dividend yield stocks. (It's) a little like the salmon that swims downstream; it just doesn't work over the long run."

Yet many investors become speculators during these fearful times anyway. There's that natural urge to recoup what we lost by any means possible. And so we make decisions that just make things worse in the end.

Let's avoid that by staying steady anyway, no matter how many skies seem to be falling.

The New Paradigm

Lost in the roaring of this week's markets was a dividend cut I predicted six months ago in "The Macerich (MAC) Mousetrap is ready to snap."

But don't for a minute think I'm doing a victory lap on that news. Even if I wanted to, there's no time for it. We need to be fully focused on figuring out this all-new paradigm filled with shutdowns and social distancing.

The cornerstone strategy for defeating the coronavirus is a game changer, to say the least. And we've got to navigate it as strategically as possible.

That means not chasing yields. As always. Last year should have proved that to us once and for all.

By that, I'm of course talking about the mall REIT sector, where dividend cuts became par for the course. Companies like Seritage Growth (SRG), CBL Properties (CBL), and Washington Prime (WPG) - victims of retail store closures and an overabundance of shopping meccas - couldn't handle the changing environment well enough to keep up their dividends.

Source

Balance sheets have become further stretched since then. And the coronavirus may tip us into a full-out recession that results in further dividend cuts for other REITs.

We're just going to have to monitor the situation closely over the next few quarters. That includes providing you with the best REITs to buy, and with those "opportunities" you really want to avoid.

With that goal in mind, we're putting together a stress-test guide designed to steer investors away from high-yielding REITs and focus instead on the safest names. Again - ad nauseam - now is not the time to chase yield.

Take it from us before it's too late.

Battling the Coronavirus, One Investment at a Time

As referenced in a recent article, we now have holds and/or sells on all lodging REITs "based on the 50% decline in leisure bookings and erosion in earnings and occupancy." We "see high risk to the business model as travel becomes highly restrictive."

According to Compass Point, "(The) U.S. hotel market has over $300 billion of debt outstanding" and it "… appears at risk as hotel cash flows will be under pressure in 2020. Hotel dividends in 2020 would appear particularly at risk due to the massive recent retrenchment in travel, as most owners have withdrawn their annual earnings guidance."

We put together a property stress test for all the property sectors as viewed below:

Source: iREIT

As you can see, other naturally high-risk sectors include gaming, billboards, and malls. And with recession risk now elevated, they're in even less optimal positions as consumers become increasingly risk-averse.

That's why the REITs below must address their leverage and cash flows by either selling properties, raising equity, or cutting dividends. While evaluating them, we considered a number of indicators, such as:

• P/FFO multiples
• Dividend yields
• AFFO payout ratios
• Leverage (including preferreds)
• Fixed interest coverage
• S&P ratings (if any).

As you can see, most of the REITs included are highly levered. Only two have a debt and preferred to EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio under 8.0x.

This means they could face troubles faster than other REITs as growth slows and makes capital harder to access.

Moreover, several of the lodging REITs already have announced divided suspensions in 2020, including Park Hotels (PK) and Pebblebrook (PEB). While they're not included in the list above, we do believe the rest of their peers will likely halt dividends altogether until social distancing is over.

Avoid These REITs Like the Coronavirus

Now that you know our mode and means of analysis, here are the subsequent top 10 riskiest REITs:

#10 Preferred Apartment (APTS): 118% payout ratio + high leverage (16.3x)

#9 UMH Properties (UMH): 98% payout ratio + high leverage (12.6x)

#8 Ashford Hospitality (AHT): high leverage (12.4x)

#7 Hersha Hospitality (HT): 85% payout ratio + high leverage (10.8x)

#6 Whitestone REIT (WSR): 144% payout ratio + high leverage (8.6x)

#5 Bluerock Residential (BRG): 93% payout ratio + high leverage (9.9x)

#4 Diversified Healthcare (DHC): high leverage (11.3x)

#3 American Finance (AFIN): 113% payout ratio + retail exposure

#2 Braemar Hotels (BHR): high leverage (9.9x) + limited diversification

#1 PREIT (PEI): 148% payout ratio + high leverage (11.1x)

We'll soon be putting together a stress-test model to assist in designing and implementing the "Dry-Powder REIT Portfolio." Given the current global situation, we consider it an opportune time to tune into REITs.

I promise you, we won't be yield chasing:

Fear Isn't in Our Playbook

As I told someone today on the message board recently:

"Fear is not an investment plan… We are now stress-testing our entire REIT universe to design and construct a dry-power portfolio. While retail closures will hit all retail landlords, we still see value in malls and outlets…

As you know, there is opportunity in the chaos. And we plan to take full advantage of the sell-off to create significant wealth... I have trained 30 years for this black swan event, and it's time to go to work."

Now that you know what I'm NOT buying, get ready for March Madness. The basketball tournament might have been canceled, but - believe it or not - investing is not.

I'll be taking you through the play-by-play for some of the best REIT buying opportunities in my lifetime. I strongly encourage you to stay tuned.

And I even more strongly encourage you to avoid getting fixated on yield. ALWAYS focus on nothing less than quality, quality, quality.

Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

Analyst’s Disclosure: I am/we are long HT. 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.