Some companies are aptly named.
Take New York City REIT (NYC). It’s a Big-Apple landlord. Enough said.
Then there are other companies you can make catchy (some might say “hokey”) headlines out of. Like Realty Income (O).
“It’s the Real Deal.”
Or Ladder Capital (LADR).
“This REIT Is Climbing in My Estimation.”
That’s been the case with Gladstone Commercial (GOOD), at least when it comes to its ticker symbol – though not in any positive way.
Instead, I usually come up with titles such as “Gladstone Commercial: Too ‘Good’ to Be True.”
That was the last article I devoted entirely to the company, published on May 23, 2021. But I also included it in my “Naughty List: 2 REITs to Avoid at All Costs” on December 20, 2022, where I noted how “GOOD has seen no earnings or dividend growth” in years.
“Why would you want to invest in any company that’s not growing?”
Yet it just got worse this month.
Sucker Yields on Display
You’ve heard me talk about sucker yields plenty of times before. But I haven’t written about it yet in 2023, so let me do so now.
I’ve mainly focused on positive potential so far this year. And I think I have good reason to. As I wrote in my January 6 article, “I’m Loading Up on REITs Before One of the Most Telegraphed Recessions Ever,” there are some great opportunities out there that I have no intention of being scared away from.
Even after last year’s debacle, I welcome a stock market downturn for the bargains it will provide. In addition, there are some REITs that are very much positioned to take advantage of any continuing economic difficulties.
This year’s expected issues might (or might not) affect them negatively in the short-term, mind you. But solid REITs with smart management know how to save up for such instances when property prices drop and buyable opportunities abound.
That means they get to grow on the cheap and reap greater rewards after the fact. As for their shareholders, they continue to get paid steady dividends all the while.
Unfortunately, as I’ve already mentioned, that’s not the case with Gladstone Commercial. I’ll get to that in a moment.
First though, let me explain what I mean by a sucker yield to those unfamiliar. And for those of you who do know what it is, I wouldn’t advise skipping this part over. It’s easy to get pulled in by these unhealthy offerings.
In some ways, sucker yields are self-explanatory. They’re dividend-paying stocks with high yields that turn investors into suckers. These companies give away too much of their earnings until they’re not sustainable.
Something has to give, and something always eventually does.
GOOD: The Quintessential Sucker Yield
I’ve explained it over and over again, I know. But one of my most clear explanations, I think, was what I published on April Fool’s Day last year:
“It’s articles like these that I love writing because I can help investors avoid painstaking losses. If I can help just one person avoid a sucker yield, I feel as though my work is worthwhile…
“When you buy a sucker yield stock, you are essentially gambling that you will get your principal back in equal installments with no interest earned. If you get it back in 10 years, consider yourself lucky.”
That’s what Gladstone Commercial clearly was, as evidenced by its Tuesday, January 10, announcement:
“In an effort to increase retained capital in anticipation of further economic headwinds, the board of directors has taken what it believes is the prudent path and reduced the run rate on its monthly dividend (from $0.1254 to $0.10).”
That’s a nice way of saying it couldn’t handle its already unadvanced dividend and slashed it 20%.
“In addition, the company’s investment adviser has agreed to amend the current advisory agreement to waive the applicable incentive fee for the quarters ending March 31, 2023, and June 30, 2023. Buzz Cooper, the company’s president, stated, ‘We believe that the dividend cut, along with the temporary incentive fee waiver, will help the company to maintain a strong balance sheet in 2023.’”
My one positive thing to say about everything it said above is that at least its shareholders aren’t the only ones suffering for its mistakes.
Take a look at this 5-year chart below, comparing the price performance of Realty Income and Gladstone Commercial:
Or what about Agree Realty (ADC) vs Gladstone Commercial – also the 5-year price chart below:
One last example, comparing VICI Properties (VICI) and Gladstone Commercial, once again this is the 5-year price chart below:
Fortunately, I’m overweight all three net lease REITs (O, ADC, and VICI) and the reason that I have a large portion of my retirement portfolio invested in these three REITs is because they’re able to create value by investing capital at rates of return that exceed their cost of capital.
Weighted Average Cost of Capital
As mentioned in a recent article, I’m in the process of writing a new book, REITs For Dummies, and I intend to dedicate a chapter or so to the concept of costs of capital, and how there’s empirical evidence supporting the idea that growth and ROIC are the key drivers of value.
I put together this chart below summarizing the WACC (weighted average cost of capital for these net lease REITs:
As you can see above, O, ADC, and VICI have low WACCs that support the ability to spread invest in higher-quality real estate opportunities, whereas GOOD has a higher cost of capital that restricts the company from investing in investment grade rated tenants.
Even in a higher rate environment, O, ADC, and VICI have demonstrated that they can adapt to pricing by purchasing properties such as:
Realty Income agreed to acquire up to 185 single-tenant and industrial properties from CIM Real Estate Finance Trust (OTCPK:CMRF) for ~$894M in cash at a 7.1% cap rate.
VICI said it would acquire four casinos in the province of Alberta from PURE Canadian Gaming for ~C$271.9M (US$200.8M) at a cap rate of 8.0%.
Agree acquired $404.9M in Q4-22 at a weighted-average cap rate of 6.4%.
Digging Deeper Into Earnings
As you can see (above), even though Gladstone Commercial is acquiring lower quality properties (at higher cap rates), the profit margins are laser-thin, suggesting that the externally managed REIT is not generated sufficient profits to sustain its dividend.
Just take a look at the AFFO (adjusted funds from operations) history of O, ADC, and GOOD since 2009 (VICI did not list until 2018):
AFFO per Share:
Here’s the graphic of the same AFFO per share data represented in % growth, year-over-year:
As you can see, it’s impossible to grow the dividend when you’re only growing earnings by an average of 1% per year. Now let’s examine the same data and include VICI:
AFFO per Share:
Once again, here’s the same AFFO per share chart represented as a % of growth year-over-year (since 2018):
So, you can see clearly that we predicted GOOD’s dividend cut from “a mile away”, recognizing the payout ratio was elevated and there was no margin of safety to protect the dividend whatsoever.
More importantly, the amount of value created is the difference between cash inflows and the cost of the investments made, and I have purposely designed my retirement portfolio with overweight allocations to companies that thrive by creating real economic value.
We have found that management’s decisions regarding capital structure can have a profound impact on shareholder returns, and Gladstone Commercial is a textbook example of a REIT that has not been a good steward of capital allocation.
The latest dividend cut was telegraphed (by weak earnings), and any intelligent REIT investor could have avoided the agony of a dividend cut by paying close attention to fundamentals, with a focus on earnings and dividends.
Lesson Learned: Avoid dividends that are vulnerable to be cut, seek dividend that will grow, and pay reasonable or attractive prices when buying.
Stay tuned for my next in the series: Dividends Matter: Don’t Get Duped
Happy SWAN Investing!