ONL - Sell Alert: 2 REITs That Will Likely Cut Their Dividends

2023-04-25 08:05:00 ET

Summary

• Not all REITs are worth buying.
• OPI recently crashed by 40% after it cut its dividend.
• I present two other REITs that could suffer the same fate.

Most REITs are doing just fine today.

Balance sheets are the strongest they have ever been, rents are still growing at a good pace as they catch up to the inflation, and most management teams are well-aligned with shareholders.

It then isn't surprising that most REITs have maintained and/or hiked their dividend in the recent quarters.

But there are some exceptions that have cut their dividend and you want to avoid those REITs at all cost.

The latest REIT to cut its dividend is Office Properties Income Trust ( OPI ). We predicted back in January that it would likely cut its dividend and just the other week, it announced a 54% cut, which caused its share price to crash:

The weird thing here is that all the signs were there...

We tried to warn investors that the REIT was going to cut because we saw many red flags:

• The REIT owned a lot of single-tenant office buildings that will face significant capex requirements in the coming years as leases expire. Their closest peer, Orion Office REIT ( ONL ), intentionally set its payout ratio very low at 22% for this reason.

• But OPI was still paying out most of its cash flow in the form of dividends, not retaining enough to meet its coming capex requirements.

• And importantly, OPI is externally managed by RMR ( RMR ), which is a notoriously poor asset manager that has a very bad track record in the REIT sector. It has repeatedly cut the dividend of its other REITs and all of them have underperformed in the long run.

Despite that, investors kept buying OPI for its high yield, hoping that it would last...

Today, there is handful of REITs that are in a similar situation as OPI.

I expect them to also cut their dividend and I would stay far away from them because I fear the cut could lead to large losses.

Without further ado, here are two other REITs that are likely going to cut their dividend:

Global Net Lease ( GNL )

GNL has many similarities with OPI.

It also owns a lot of single tenant office buildings that will require significant capex in the coming years to keep them desirable.

It is also externally managed by a team that has made a lot of questionable decisions such as issuing equity at a heavily discounted price. Look at the inverse correlation between its declining share price and its rising share count. It is quite stunning!

Also, just like OPI, its dividend payout ratio is also too high at nearly 100%.

As a result, it is not retaining enough cash flow to reinvest in its properties and so I think that a cut is inevitable.

GNL has already cut its dividend in the past and I think that it is very likely to cut it again.

It also does not help that it has a lot of leverage and interest rates are up very significantly.

Finally, GNL owns a lot of properties in European markets that are facing even greater challenges.

So for these reasons, I think that a dividend cut is just a question of time.

The Necessity Retail REIT ( RTL )

RTL also has clear similarities to OPI and GNL in that:

It owns retail-based assets that will face increased capex requirements in the coming years if we go into a recession:

Its payout ratio is too high at 90%, leaving no room for error.

Moreover, the REIT has a lot of debt to EBITDA ratio is excess of 9x.

Finally, it is also externally managed, just like OPI and GNL.

The external management structure is often a source of conflicts of interest because the management fees are often based on the volume of assets under management. Therefore, cutting the dividend and retaining more cash flow to grow may in many cases lead to higher management fees over time.

Again, I think that a cut is very likely here and as income driven investors sell off the stock, the share price could crash a lot lower from here.

Bottom Line

OPI is a great example of what not to buy in the REIT sector.

It seemed to be discounted and offered a high yield, but this high yield wasn't sustainable and investors end up suffering large losses.

I fear that GNL and RTL shareholders will suffer the same fate.

Today, there is really no need to chase these risky companies. The entire REIT sector ( VNQ ) is heavily discounted and there are plenty of opportunities out there. Even the blue-chip like Realty Income ( O ), Alexandria Real Estate ( ARE ), and Prologis ( PLD ) are undervalued at today's share prices.

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