WPC - 1 Risky REIT To Avoid And 1 Stong Buy

2023-06-29 08:05:00 ET

Summary

• I review two REITs. One is a Sell. The other is a Buy.
• One pays a 16% dividend yield. The other pays a 6.5% dividend yield.
• The two REITs in question are Global Net Lease and W.P. Carey.

Lately, I have done a lot of work on a high-yielding real estate investment trust, or REIT ( VNQ ), called Global Net Lease, Inc. ( GNL ).

It pays a 16% dividend yield and it is set to internalize its management and merge with The Necessity Retail REIT, Inc. ( RTL ).

Both of these factors could lead to significant appreciation, and so it has been high on my watchlist for the past weeks.

But ultimately, I decided against investing in it, and in today's article I will explain why and also present a better alternative.

Two Reasons To Not Buy Global Net Lease's 17% Dividend Yield

Reason #1 - The merger benefits the manager, not the shareholders

The manager of GNL is also the manager of RTL, and it allegedly, at least according to what one major shareholder wrote, is not merging both vehicles because it makes sense for shareholders, but rather because it benefits themselves.

Here is what that major shareholder of GNL said about the deal:

“The proposed merger is another deceptive effort by AR Global, in complicity with GNL and RTL, to skirt ongoing proxy fights against them, and the ultimate accountability that will face them," Jason Aintabi, Founder and Chief Investment Officer of Blackwells said in a statement. "Shareholders should be on high alert that the compromised boards of GNL and RTL approved a deal that would arrogate a $375 million ransom payment to AR Global, Michael Weil and Nick Schorsch in return for all the value they’ve destroyed. Blackwells strongly opposes the cockamamie merger, and expects most other shareholders to do the same.”

But shortly after saying this... the same shareholder entered a cooperation pact with GNL, reaching a détente and agreeing to vote in favor of the deal in exchange for 495,000 shares as a "settlement fee."

Does that sound sketchy to you?

The big shareholder was saying that this deal made no sense, but shortly after getting a bunch of free shares, they apparently became in favor of it.

Shortly after, another big shareholder sent a letter to GNL saying the following:

"The proposed internalization terms under the merger are certainly an outrageous enrichment of AR Global at the expense of GNL shareholders," Orange Capital Managing Partner Daniel Lewis wrote in the letter. "Blackwells, having previously called the Merger "cockamamie" and full of "ransom payments" to AR Global, will now receive $23 million in shares if the Merger closes. We believe GNL's apparent willingness to buy shareholder support clearly resembles a greenmail payment and is an indictment of how corrupt this Merger is... We believe the Merger has little industrial logic and is a complete reversal of management's strategy to avoid retail exposure."

I agree that the deal is not favorable to the shareholders of GNL. It will dilute their focus away from industrial properties, and it comes at a huge cost since the management internalization includes an upfront payment of $325M in GNL stock and $50M of cash to the external manager, AR Global LLC.

This means that the management is getting rewarded $375 million for this performance since going public:

Do they deserve it?

The market clearly doesn't think so as the company's share price crashed further after the deal was announced.

Management quality is the most important thing when investing in REITs, and I am not convinced that the management can be trusted here.

Reason #2 - Low-quality assets and high leverage

I suspect that one of the reasons why the management pushed for this merger now is that GNL is heavily invested in single-tenant office buildings that face a very unpredictable future, and they wanted to dilute this exposure by adding RPT's retail portfolio to the mix.

They managed to reduce the office exposure down to 20% with this merger, and that's a good thing.

But this is really an additional piece of evidence that the REIT owns assets that will face significant issues down the line.

If I only had to worry about 20% of the portfolio, I could sleep with this risk, but my fears expand across the entire portfolio. I fear that the management bought a lot of risky assets over the years at high cap rates because its cost of capital was too high to buy the good stuff.

Its rental income has remained fairly steady because it has years left on its leases, but eventually, I expect negative surprises to surface as leases expire, and with a 7.6x Debt-to-EBITDA, it does not take much pain for shareholders to lose a lot.

A Better Alternative: W.P Carey

If you are looking for a high-yielding REIT, then W. P. Carey Inc. ( WPC ) is a much better choice in my opinion. Sure, its yield is not quite as high, but it is still very generous at 6.5%, and importantly, W.P Carey has been growing its dividend, unlike GNL.

It actually has one of the longest dividend growth streaks in the entire REIT sector at 30+ years, and it achieved this by focusing on high-quality net lease properties and maintaining a strong balance sheet .

Today, their portfolio is heavily invested in industrial properties that enjoy strong organic growth prospects, and most of their leases include CPI adjustments, resulting in above-average growth in today's high-inflation world.

In my book, it is much better to earn a 6.5% dividend yield coupled with ~5% long-term annual growth prospects than earn a 16% dividend yield that's going to be cut and suffer 10% annual losses.

Both REITs focus on net lease properties, but their long-term performances show a clear edge for WPC in terms of management quality:

We own a position in W. P. Carey Inc. stock in our Retirement Portfolio at High Yield Landlord, and we are glad to accumulate more of it following the recent dip.

We considered Global Net Lease, Inc. stock for our Core Portfolio, which is targeting higher return opportunities, but we are not convinced that the management issues are over.

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