Can REIT Dividends Rebound?
We believe REITs will increase cash payouts in 2010.
By and large, equity real estate investment trusts, or REITs, provided little shelter to dividend investors over the past year and half. Usually less correlated with overall equity markets, REIT stocks nonetheless took the plunge in late 2008 and early 2009, as their operating metrics fell, commercial real estate values tumbled, and liquidity and refinancing concerns came to a head. Faced with divergent outcomes, REITs hoarded cash, and many slashed or nixed their cash dividend payouts. Among our coverage, approximately 70% cut their dividends or eliminated them altogether. On this front, REITs were aided by the IRS, which ruled that REITs could pay up to 90% of their dividends through 2011 in common stock. Among those REITs availing of the IRS ruling for 2009 were stalwarts Simon Property Group (SPG) and Vornado Realty Trust (VNO), both of which plan to revert back to all-cash payouts in 2010.
It remains to be seen whether the trough of this commercial real estate cycle has been reached. Operating fundamentals, which tend to lag the general economy, remain under pressure and commercial real estate transactions remain depressed. Indeed, the bid-ask spread across property types remains quite wide due to limited buyer financing options and "extend and pretend" lender tactics. However, REITs are in much better financial shape today than they were a year ago. The REITs that we follow have improved their debt/gross property asset ratios by roughly 500 basis points since the end of 2008, and capital-raising concerns have largely abated. While the macro environment cannot be characterized as favorable, it has nonetheless stabilized somewhat. The economy is no longer on the brink of systemic distress, and employment declines have arrested. With greater clarity on their financing and operating environments, we believe REITs will increase cash payouts in 2010.
Given the magnitude of dividend cuts over the past 18 months, we expect spectacular dividend growth from some REITs in 2010. For example, mall landlord CBL & Associates (CBL) cut its common dividend three times in the past year and a half to just $0.05 per share per quarter, a level less than 10% of its peak payout of $0.545 per share. Recently, however, CBL announced a $0.20 per share common dividend, which represents a 300% increase to its depressed $0.05 per share payout, but still less than 40% of its peak level. We expect similarly eye-popping dividend increases among those stocks that suffered the most severe cuts. But for this article, we will instead focus on dividends at solid, well-run companies that we believe are sustainable and can increase at a rate greater than inflation over the medium term.
As a caveat, however, we remind investors that our dividend expectations for these firms may not be immediate or even materialize in the next year or two, as REITs may continue to favor retaining cash for added liquidity over increasing dividend payouts. Or they may prefer to hold excess cash in hopes of bagging a few trophies in distressed asset fire sales.
Strong Balance Sheets
Although the following picks vary across property sectors, property quality, and leasing arrangements, we believe all boast a sound balance sheet, which is key to dividend health. Indeed, as evidenced by the following table, they hit the balance sheet trifecta of low financial leverage, few near-term debt maturities, and excellent liquidity resources. With near-term debt issues largely taken care of, we believe these firms can afford to return cash to shareholders.
Solid Strategies Drive Dividends among Retail and Health-Care REITs
Among retail and health-care REITs, we highlight three firms whose dividends have not only held up during the economic downturn, but are poised to continue growing. Realty Income, Tanger Factory Outlet Centers, and Ventas all have solid balance sheets and operations that are holding up well in the face of economic weakness. After posting modest or no dividend increases in 2009, we think each can increase its dividend 4% or more annually over the longer term, for varying reasons.
We believe Realty Income (O) benefits from some of the strongest sale-leaseback underwriting in the retail industry. Realty Income's triple-net leases leave tenants responsible for property operating and maintenance expenditures, resulting in 90%-plus EBITDA margins and strong cash flow for Realty Income. Furthermore, its leases have built-in rent escalators generally tied to inflation, which contribute to a steady, albeit modest, organic rise in revenue over time. And the firm's long average lease terms of greater than 11 years result in relatively few near-term lease expirations that will need to be negotiated in the currently difficult leasing market--just 12% of Realty Income's leases expire in the next three years. Granted, Realty Income's dividend represents a lofty 90% or so of funds from operations (FFO), which is net income plus depreciation expense, less (plus) gains (losses) on sales. However, this relatively high level does not overly concern us, as we believe its leases effectively protect its profitability and cash flows from severe fluctuations and its strong liquidity position should enable it to add value-accretive acquisitions that can improve its payout ratio over time. Consequently, we don't think Realty Income's streak of quarterly dividend increases, now in its 13th year, will be compromised anytime soon.
Tanger Factory Outlet Centers (SKT) owns outlet shopping malls, which are showing their resiliency in the weak macro environment. While mall peers' same-store tenant sales fell in 2009 at rates between 5% and 12%, Tanger's eked out a 1% gain. Furthermore, Tanger's tenants' rent represented just 8.5% of their sales, on average, in 2009, relative to 14% or more for tenants in traditional malls. We believe the former indicates that Tanger's tenants are faring better than peers' tenants in the downturn, while the latter indicates that Tanger's tenants are better able to withstand sales declines before the economic viability of their stores is threatened. Cash-strapped consumers have become increasingly valuecentric, and we don't expect this to change anytime soon. Consequently, we expect Tanger to continue its outperformance relative to retail peers. Tanger marked its 16th consecutive year of dividend increases in 2009. With new developments in the pipeline to fuel cash flow growth and a current dividend that represents just 58% of Tanger's expected 2010 FFO, Tanger is well-positioned to increase its dividend again in 2010 and beyond.
Of course, it's also nice to be nestled in a recession-resistant property type, like Ventas (VTR) is in health care. Tenant coverage levels at Ventas' triple-net leases, which comprise most of its net operating income, haven't wavered much through the downturn, leading to steady 60%-plus EBITDA margins and excellent cash flows. Like Realty Income, Ventas triple-net leases are long-term in nature and tied with rent escalators. With its operating assets posting improving results, and its overall portfolio benefiting from the baby boomer tailwind, we think Ventas can steadily improve its organic revenues at a rate greater than inflation moving forward. In its fourth-quarter release, management raised the quarterly dividend by 4.4% to $0.535. The annualized $2.14 per share payout amounts to just around 80% of our 2010 expectations of FFO, so we believe it's quite safe. Still, we note that management likes to keep payouts at or below that level, so dividend growth will likely come in line with FFO growth.
Checking in with Hotel REIT Dividends, or Lack Thereof
Of all the REIT property types, lodging has probably given investors the most grief through the downturn. Amidst steep declines in occupancy and nightly room rates, all the lodging REITs in our coverage canceled their quarterly payouts. Dividends will be slow to recover in the space for a variety of reasons. There's much uncertainty surrounding when fundamentals will turn the corner, as demand remains deteriorated, and the booking window remains short. Moreover, the best-capitalized REITs are electing to hold cash in anticipation of acquisitions, and the lower-tiered REITs need cash to remain viable.
With that said, we note that Hospitality Properties Trust (HPT), is the only lodging REIT we cover that has reinstated a substantial cash payout of more than pennies per share. Annualizing HPT's first-quarter payout gets us to $1.80 per share for 2010. Our estimate of HPT's 2010 FFO suggests that this will be easily covered. Though there's quite some operational uncertainty due to a couple tenants paying less than their contractual obligations, HPT has security deposits, corporate guarantees, and other protections, which provide us confidence in the ultimate collectability of rents due. Assuming a double-dip isn't in the cards, HPT's dividends should steadily increase from 2010 levels as the economy and travel demand improve.
Jason Ren does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.