Published by Bob Ciura on June 14th, 2017
Real Estate Investment Trusts have a lot to offer investors who desire higher levels of investment income, such as retirees.
For instance, Gladstone Commercial Corporation (GOOD) is a REIT with a current dividend yield of 6.9%.
It is one of 416 stocks with a 5%+ dividend yield.
GOOD appears to be an attractive dividend stock, especially considering the available alternatives. The S&P 500 Index, on average, has a 2% dividend yield.
Plus, GOOD is one of only 29 stocks that pays its dividend each month.
However, GOOD’s dividend is far from guaranteed–its payout ratio is nearly 100%.
This article will discuss GOOD’s business model and financial performance, and why its dividend may be riskier than meets the eye.
GOOD invests primarily in single-tenant, and anchored multi-tenant net leased assets. It owns roughly 11 million square feet of predominantly office and industrial real estate in the U.S.
GOOD has a diversified portfolio. As of March 31st, 2017, GOOD’s portfolio consisted of 95 properties, leased to 88 different tenants across 19 industry groups.
Source: May 2017 REIT Week Presentation, page 13
The company’s portfolio is typically geared toward long-term agreements. GOOD’s average remaining lease term is 7.6 years.
In addition, GOOD enjoys high occupancy of 97.9% currently. Occupancy has never fallen below 96% since the company’s inception.
One thing for investors to keep in mind is whether the company is successful in lease renewals going forward. While only 0.5% of GOOD’s rents are set to expire this year, lease expirations increased to 1.3% in 2018.
Approximately 62% of GOOD’s tenants are rated investment grade or are the non-rated investment grade equivalent.
In all, there are four stocks investors can buy to gain exposure to Gladstone:
- Gladstone Investment Corp. (GAIN), which invests in 75% debt and 25% equity securities.
- Gladstone Capital Corp. (GLAD), which invests in 90% debt and 10% equity securities.
- Gladstone Commercial Corp.
- Gladstone Land Corp. (LAND), a REIT that invests in U.S. farmland.
GOOD has generated impressive revenue growth over the past several years, but growth of the bottom line has leveled off lately.
In order for GOOD to continue growing, it will need to stay on top of its lease expirations. This poses a potential headwind for the company going forward.
In 2016, GOOD reported funds from operation, or FFO, of $37.1 million. FFO-per-share of $1.55 declined 2% from the previous year.
There were a few reasons for the FFO decline last year. Although revenue and net income increased 3.1% and 10%, respectively, several items weighed on FFO-per-share.
These include 9.1% growth in operating expenses, higher preferred stock dividends, and a $2 million asset impairment charge. FFO-per-share was also negatively impacted by rising shares outstanding.
GOOD has exhibited strong growth over a prolonged period.
Source: May 2017 REIT Week Presentation, page 9
From 2012-2016, GOOD grew revenue and total assets by 11% and 9% each year, respectively.
However, as a REIT the company relies heavily on external capital to finance growth initiatives. Greater preferred and common shares outstanding have resulted in FFO dilution.
The good news is, GOOD’s financial performance has firmed to start 2017. First-quarter diluted FFO-per-share was flat year-over-year.
It is a good sign that the decline stopped last quarter. However, the company is now barely covering its dividend payments with cash flow.
FFO-per-share of $0.38 per share last quarter only covered the $0.375 per share dividend by $0.005 per share, as total assets declined 2.2% last quarter.
If GOOD has trouble renewing leases over the back half of 2017, it could put management in an uncomfortable position in 2018.
GOOD has a current monthly dividend payment of $0.125 per share. On an annualized basis, the dividend payment is $1.50 per share, good for a 6.9% dividend yield.
GOOD has paid 147 consecutive monthly cash distributions.
Source: Quarterly Presentation, page 9
Since GOOD’s 2003 initial public offering, the company has not missed a distribution, nor has it reduced the distribution at any time.
The company has not increased the dividend since 2008, which means the stock is less attractive for investors interested in dividend growth.
Another important consideration when buying dividend stocks is balance sheet strength. It is critical to analyze a company’s financial position.
Too much debt can jeopardize a company’s dividends. On a positive note, GOOD has significantly reduced its leverage over the past several years, and now has a balanced maturity schedule.
Source: May 2017 REIT Week Presentation, page 18
Mortgage debt, which is the company’s largest source of debt financing, has a 4.66% weighted average interest rate.
Approximately 70% of GOOD’s debt is fixed-rate, which could help mitigate the impact of rising interest rates.
Still, there is not much room for error, because the company maintains a high payout ratio. 2016 diluted FFO-per-share of $1.55 only barely covers GOOD’s $1.50 per share annual distribution.
This means there is very little wiggle room for GOOD’s FFO.
If the company’s fundamentals deteriorate over the next few years, there is a chance GOOD may not be able to sustain its dividend at the current level.
GOOD’s high dividend yield is attractive, and appears to be sustainable given the company’s current FFO generation. And, only 4% of GOOD’s forecasted rental income expires through 2019.
But even this relatively low amount could have an impact on the company, given its very high payout ratio.
As a result, investors will need to monitor the company’s results closely, to make sure FFO does not decline much from present levels. Even a modest decline could jeopardize the dividend.
Because of its very high payout ratio, one of Gladstone Investment’s other affiliate companies may be a better investment than GOOD, for sustainable dividends. GOOD is 1 of 3 publicly traded Gladstone companies.