CLPR - The 7.2% Dividend Of Clipper Realty Comes With High Risk

2023-09-28 09:53:33 ET

Summary

• Clipper Realty is offering a 7.2% dividend yield, but its dividend is far from safe, partly due to a forward FFO payout ratio of 106%.
• The commercial properties of Clipper Realty have been negatively impacted by an accelerated shift to e-commerce.
• The REIT has a high debt load and has underperformed the market, making it a risky investment for income-oriented investors.

The stocks of most REITs have declined this year due to the surge of interest rates to a 15-year-high. Clipper Realty ( CLPR ) has underperformed its sector by a wide margin, as it has shed 21% this year, much more than the 9% decline of the Real Estate Select Sector SPDR Fund ETF (XLRE). After such a steep decline, some investors may be tempted to purchase Clipper Realty, particularly given the exceptionally high dividend yield of 7.2% of the stock. However, these investors should be aware of the high risk of the REIT before initiating a position in it.

The good

Clipper Realty is a self-managed REIT that was formed with the merger of four real estate companies. It owns, operates and redevelops multifamily residential and commercial properties in the New York metropolitan area, with a portfolio in Manhattan and Brooklyn. The founders have a 62% stake in the company and have never sold any of their shares. As the interest of the founders is aligned with that of the unitholders and founders have never sold any shares, they send a positive signal for the prospects of the REIT.

In addition, Clipper Realty currently enjoys positive business momentum. In the second quarter, it posted occupancy levels above 96% in all its residential properties. New lease rental rates grew 15% over the prior year's quarter and renewal rental rates rose 8% thanks to strong demand for these properties. As a result, the REIT grew its revenue 8% over the prior year's quarter, to a new all-time high.

Clipper Realty also grew its funds from operations [FFO] per unit from $0.12 to $0.13 and thus it exceeded the analysts' consensus by $0.03. Thanks to sustained demand for its properties, the REIT is expected by analysts to grow its FFO per unit 6% this year, from $0.34 to $0.36.

The bad

Clipper Realty was severely hurt by the coronavirus crisis, which greatly reduced the value of the commercial properties of the REIT. The pandemic has subsided this year and hence the REIT enjoys strong demand for its residential properties.

However, the work-from-home trend has proved much more persistent than initially expected. In addition, the shift of consumers from brick-and-mortar shopping to e-commerce has greatly accelerated since the onset of the pandemic and is likely to keep strengthening over time. These two trends continue to weigh on the performance of the commercial properties of Clipper Realty. As the commercial properties of the REIT generate 28% of total revenue, it is evident that the above headwinds are hindering the REIT from fully recovering from the pandemic.

Moreover, the book value of Clipper Realty has plunged 86% , from $142 million in 2019 to $19.5 million in the most recent quarter. In addition, its FFO has remained essentially flat over the last six years. In contrast to most REITs, Clipper Realty has not issued any new units over the last six years but still it has failed to grow its FFO per unit due to lackluster demand for its properties and increased interest expense.

The mediocre business performance is probably the key factor behind the freeze of the dividend at $0.38 over the last six years. This dividend corresponds to an above average yield of 7.2% and hence some unitholders may not be worried about the absence of dividend hikes. However, they should be concerned over the safety of the dividend. The forward FFO payout ratio is currently standing at 106% , which is unsustainable in the long run. It is also worth noting that the payout ratio has remained elevated in recent years. To cut a long story short, I believe the elevated payout ratio, which has resulted from mediocre business performance, is the key factor behind the freeze of the dividend for several years in a row.

The ugly

The most concerning factor is the excessive debt pile of Clipper Realty. Its net debt (as per Buffett, net debt = total liabilities - cash - receivables) is currently standing at $1.2 billion . This amount is more than 5 times the market capitalization of the stock ($226 million) and more than 100 times the FFO of the REIT in the last 12 months. Therefore, the debt load is enormous.

On the bright side, Clipper Realty does not have any debt maturities until 2027 . Its debt has an average duration of 6.2 years, with 94% of its debt being fixed at an average rate of 3.8%. The absence of debt maturities for nearly four years may reduce the risk of the REIT in the short run.

However, the high debt load is clearly reflected in the results of Clipper Realty. Its net interest expense has exceeded its operating income every year since 2016 and thus the REIT has been posting losses throughout this period. Of course, due to their material depreciation amounts, REITs are evaluated based on their FFO, not their net income. Nevertheless, the fact that interest expense exceeds operating income should raise a red flag for risk-averse investors.

Moreover, highly indebted companies tend to underperform the broad market by a wide margin over the long run. This is certainly the case for Clipper Realty. The stock has plunged 59% over the last five years, whereas the S&P 500 has rallied 47% and the Real Estate Select Sector SPDR Fund ETF has gained 4% over the same period. I believe the dramatic underperformance of Clipper Realty is a testament to its weak business model and its resultant risk. Due to its nearly 5-year low stock price, the REIT could offer outsized returns if it enjoyed a strong business recovery. However, it is nearly impossible to time such a recovery without luck. In addition, the vast underperformance of Clipper Realty over the long run renders the REIT highly risky.

Final thoughts

Clipper Realty is currently recovering from the pandemic, at least in part, while it is also offering a nearly 7-year high dividend yield of 7.2%. However, the REIT has an exceptionally high payout ratio and carries an excessive amount of debt. As long as the REIT maintains its positive business momentum, it may be able to maintain its generous dividend. On the other hand, whenever Clipper Realty faces an unexpected downturn, such as a recession, it will probably have to cut its dividend in order to preserve funds for its excessive interest expenses. Overall, the stock is not suitable for risk-averse income-oriented investors who seek a reliable income stream.

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