What’s Keeping You Up At Night?

Summary

Owning under-performing stocks can wreck a good night’s sleep, symptoms including stress, anxiety, and even marriage blues.

Another way that investors can live a stress free life is to avoid higher risk REITs.

This chase for yield in the stock market leads to the same thing that all such chasing leads to – impulsively reacting to dividend quantity over dividend quality.

Before I get started, I want to credit Sandra Block at Kiplinger’s for writing an excellent article by the same name as mine. Here’s how she started this piece,

Americans have rung up a massive sleep debt, and the bill is coming due. More than one-third of adults get less than seven hours of sleep on a regular basis. According to the Centers for Disease Control. Lack of sleep affects job performance, relationships and the ability to perform routine tasks.

There’s little doubt that lack of sleep impacts performance, and that’s also true for stock performance. Owning under-performing stocks can wreck a good night’s sleep, symptoms including stress, anxiety, and even marriage blues. A good friend once explained it like this,

when poverty comes through the front door, love goes out the window.

How to cure the dilemma?

A few years ago I decided that I could solve the mystery, at least in the realm of REIT investing, by designing a system for scoring REITs based on durability.

By ranking the highest quality REITs – based on metrics such as dividend safety, experienced management, earnings performance, leverage, and forecasted growth – I decided to develop a stress free system for REIT investors to sleep well at night.

Currently I have 23 REITs (out of ~125) that are SWANS (an acronym for “sleeping well at night”) in my Intelligent REIT Lab. In fact, yesterday I wrote on one of these SWANs, Federal Realty (NYSE:FRT), and while I’m itching to own a few shares, I’m going to wait for a better margin of safety.

In my upcoming (March) newsletter, I have decided to dedicate all of the content on SWAN investing – I call it the SWAN Edition. Included in the newsletter you will find a list of all SWANs and a scoring system that ranks these blue chips on a variety of metrics, including valuation.

In addition to owning a large percentage of SWANs, another way that investors can live a stress free life is to avoid higher risk REITs.

Let’s face it, SWANs are easy to spot, they are typically battle-tested with a long track record of dividend growth. They have managed risk through multiple economic cycles and they provide shareholders with tremendous comfort and safety.

However, as we move further down the risk curve, outside of the SWAN universe, it becomes more and more difficult to “separate the wheat from the chaff”.

Today I’m going to provide you with a list of my non-starters. Keep in mind, this is not an inclusive list of all of the ugly ducklings, I’m sure I’ve left out quite a few. These are just a few REITs that promise to keep you up at night!

Photo Credit

What’s Keeping You Up At Night?

In case you didn’t know, I’m no fan of Mortgage REITs, especially the traditional residential mortgage REITs. I can tolerate commercial mREITs, and I cover a number of these REITs, such as Ladder Commercial (NYSE:LADR), Blackstone Mortgage (NYSE:BXMT), Starwood Property (NYSE:STWD), and even Apollo Commercial (NYSE:ARI).

The residential mREITs are riskier, due to their complexity. For investors who are opting for the higher risk alternatives, they should follow multiple data series in order to understand what is driving them, and potential for inconsistencies between an investor’s outlook and management’s actions. Back in August 2016 2016 I wrote a detailed article on mREITs – suggesting they should be avoided – and here’s my conclusion:

…it is important to have a macro view in order to create an investment plan (or to adapt your portfolio to meet your outlook), and we believe that mortgage REITs (especially CRE mREITs) can play a role, but if you believe they are a simple beast, you may end up creating losses in your portfolio or your clients’ portfolios.

But mREITs are not the only REITs that keep me up at night, here are a few of the spookier ones:

Senior Housing Properties (NYSE:SNH) is externally-managed and shares are priced at $20.02 with a dividend yield of 7.8%. On the surface, SNH looks tempting, however upon further review you can see that the payout ratio is 94% (yellow flag). Also, the earnings forecast (consensus) is declining ($1.66 to $1.65) and most importantly the dividend is flat and there’s little indication that it will grow any time soon. Recommendation: AVOID

Government Properties Trust (NYSE:GOV) is also externally managed and shares are priced at $19.87 with a dividend yield of 8.7%. Again, GOV looks attractive, but upon closer examination you can see that the dividend has not grown since 2013. In addition, the growth for 2017 is projected to be flat which means that there is little potential for more dividend growth. I prefer Easterly Government (NYSE:DEA) in the “pure play” government sub-sector and remember DEA is internally managed (see DEA article HERE). Recommendation: AVOID

Gladstone Commercial (NASDAQ:GOOD) is also externally managed and shares are trading at $20.61 with a dividend yield of 7.3%. Again, this REIT looks enticing but upon closer examination you will see that the payout ratio (93%) is elevated and the dividend has not been raised in 6 years. Also, earnings are forecasted to decline (AFFO from $1.61 to $1.48) suggesting that GOOD’s dividend is becoming dangerous. Recommendation: AVOID

Bluerock Residential (NYSEMKT:BRG) is also externally managed and shares are trading at $12.80 with a dividend yield of 9.1%. This REIT looks attractive with a dividend yield of 9.1% but be careful, the payout ratio is 146% and even though AFFO is expected to increase to $.87 in 2017, there will still not be enough profit to cover the dividend. Recommendation: AVOID

In conclusion, I recommend owning a healthy mix of “sleep well at night” REITs, and avoid the REITs with dividends that are seemingly “too good to be true”. As I explained on Investopedia,

This chase for yield in the stock market leads to the same thing that all such chasing leads to – impulsively reacting to dividend quantity over dividend quality. A “sucker-yield” is based on quantifiable high yields, seemingly ridiculous, when the underlying security has a flawed or vulnerable business model. Companies that fall under the “sucker-yield” definition typically have unpredictable and unreliable earnings histories with unsafe dividend payouts.

Happy SWAN Investing! (check out my upcoming edition of the Forbes Real Estate Investor)

For further REIT Research (The Intelligent REIT Investor):

Ladder Commercial

Blackstone Mortgage

Starwood Property Trust

Apollo Commercial

Check out The REIT Beat: I plan to publish a weekly Nothing-But-Net REIT Guide that will include WACC metrics and valuation tools. If you’d like to get more of my ideas, including early access to my highest-conviction REIT plays, access to Q&As with management teams, weekend REIT reports and more. We’d love to have you on board, so have a look.

Author Note: Brad Thomas is a Wall Street writer and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).

Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.

Disclosure:I am/we are long APT, ARI, BXMT, CONE, CORR, CCP, CCI, CHCT, CLDT, CUBE, DLR, DOC, EXR, FPI, GPT, HTA, HASI, KIM, LADR, LTC, LXP, O, OHI, QTS, ROIC, STWD, SNR, STAG, SKT, SPG, STOR, TCO, UBA, VTR, WPC, PEI, EQR, DEA, MVEN.

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.