Call it what you will. The Covid-19 pandemic. The Great Lockdown. The Coronavirus Recession. Whatever label you give it, it remains unprecedented. Never in history has more than 60% of the global population come under this kind of lock-and-key restrictions all at once.
The effects of the shutdowns range country to country. But in the U.S. alone, the Congressional Budget Office (CBO) expects second-quarter economic growth to come in at -40%. The New York and St. Louis Feds, meanwhile, have even worse estimates at -47% and -50%, respectively.
Now, for the July-September period, there’s supposed to be a 20%+ surge back upward, which would mark see the strongest economic growth in history. However, let’s face the facts: that this unprecedented situation has largely upended one of REIT investors’ most cherished and basic assumptions.
It will be dangerous moving forward if we don’t.
A REIT Reversal for the Record
So far, more than 180 companies have announced either dividend cuts or full-out suspensions since the start of the shutdowns. And as was expected (as soon as we gathered our wits enough to expect anything), plenty of economically sensitive REITs are among that unfortunate number.
For instance, it’s no surprise that hotel REIT dividends haven’t done well.
Even in typical recessions, they lack the long-term leases and stable cash flow of other equity industries. That’s why I look for AFFO (adjusted funds from operations) payout ratios of 75% or less in this subsector rather than the 90% that’s safe for most REITs. Essentially, you need a safety buffer for the bad times that are bound to happen, sending occupancy down.
The same 75% applies to industrial REITs, which often have economically sensitive cash flow.
We can see similar problems with low-quality mall and shopping center REITs: the kind that have high leverage, like Whitestone Realty(WSR), Macerich(MAC) and Washington Prime Group(WPG). All three have cut or suspended their dividends – something I warned income investors about even before the lockdowns.
What’s much more surprising is the shutdown’s effects on triple-net lease REITs and well-placed, well-run shopping centers, such as Realty Income(O) and Federal Realty(FRT). Both tend to be less sensitive since most of their tenants are recession-resistant… with “tend to be” the apparent keywords to note.
The lockdowns seem to have turned the normal defensive vs. cyclical relationship topsy-turvy. Not completely, mind you, but definitely with industrial REITs. Back in April, they managed to collect virtually all their rent. In this environment, of course, it doesn’t hurt that so many of them lease to the likes of FedEx and Amazon. Cooped up at home, people are ordering online like never before. Which means that industrial REITs are thriving like never before.
That then puts them in stark contrast with triple net leases. The April Nareit rent survey found that, collectively speaking, half of those stalwarts’ expected rent didn’t come in. And shopping center REIT fared even worse. That kind of news was more than enough to knock so-called “bond alternatives” like Realty Income right off their overvalued pedestals.
I and so many other REIT or stock experts have long-since been warning against treating dividend stocks like bonds. Even the best don’t match up; they’re still stocks, no matter how defensive they normally might be. We’re seeing the hard truth of that lesson hit home.
But there’s an even more hard truth at play: a risk-management lesson we’d better take to heart now if we haven’t already.
Their Dividends Remain Solid
A colleague of mine recently stress-tested a wide range of retail REITS, medical REITs, and office REITs with a three-month lockdown scenario compared to Nareit’s April rent data. Factoring in that cash-flow hit along with the AFFO cuts already estimated by analysts, he applied the results to both leverage and interest coverage ratios.
Looked at like this, Realty Income resulted in a 94% stress-test AFFO payout, while Federal Realty came in at 104%. This took both of them down from stellar safety ratings (5/5) to above-average (4/5). Even so, Realty Income and National Retail Properties(NNN) came out ahead in their industry, with very low chances of cutting their dividends anytime soon.