Beware Of Fool's Gold: 3 REITs To Avoid (2024)

There’s a YouTube channel called AwakenWithJP that I make absolutely no comments on whether you’ll like or not.

It’s run by a very dry comedian who makes fake self-help videos for a whole host of problems. In short, he gives really bad advice that doubles as social commentary.

For instance, his “How to Hide Your Insecurities So No One Will Ever Judge You Again” is standard fare. In it, he asks:

“Do you have insecurities that hold you back from being confident and happy and living your best life? Maybe you’ve tried to make them go away, but you don’t know how? Do you get scared that people would be judging you constantly if they knew about your insecurities?”

If that’s the case, then don’t worry. Because AwakenWithJP has the solution. A wide range of them, in fact.

Whatever the insecurity that plagues “you the most,” he’s got the solution.

At least a solution. Again, I make absolutely no comments about whether it’s the right one. I’ll leave that up to you decide.

Photo Source

Short-Term Solutions

The overarching solution, you see, is to cover everything up: To project a more favorable image or attitude than you’ve actually got to give on your own. Essentially, think short-term gratification instead of long-term rewards.

Which, obviously, is foolish.

As evidenced by that last statement, I clearly misspoke before. I'm making comments about the helpfulness of this self-help advice. It’s hard not to.

Then again, so is JP himself with the entire video, including when he says:

“Solve all your money insecurities by getting new credit cards so you live beyond your means. Responsibly funding a new, luxurious lifestyle with high-interest credit cards will impress other people and therefore bury all your money insecurities under massive debt.”

I’m sure you’ve heard someway say “fake it until you make it.” More than likely, we all know someone who’s tried it out. Perhaps we even used to be that person ourselves. Or we still struggle not to be that person.

In the latter case, don’t give in! It’s not worth it.

Sure, others might truly think you’re “the man” or “the woman” because of the high-priced apparel you always wear… the fancy cars you always drive… the exorbitantly exotic houses you always own… and the fact that you always throw the most awesome parties.

You can afford to be a generous guy or gal when you’re only thinking short term. And so there will be plenty of people who are more than willing to be the recipients of that generosity.

While it lasts.

Just don’t expect them to stick around after your house of credit cards comes crashing down. They’ll disappear faster than the collections agencies take to show up at your door.

Take my word for it. Not JP’s.

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A Flashy Dividend Is a Sign of Corporate Insecurity

Just as individuals are prone to cover up their flaws with outward signs of confidence, companies can make the same mistake too.

That only makes sense when they’re run by individuals. They might be individuals with fancy titles like chief executive officer, chairman of the board, and president, but they’re still individuals.

As such, when you’ve got a great group of such people with great ideas and great execution? You’re going to have a great company.

And when you have a group that’s more interested in covering up its insecurities than providing long-term value. That could mean a dividend cut.

Worse yet, it’s a chain reaction. When the dividend is cut, the price almost always gets cut. That’s why it’s so important to be able to spot such companies.

Honestly, the actual task itself isn’t all that difficult considering the dividend-paying corporate equivalent of always wearing high-priced apparel… always driving fancy cars… always living in exotic houses… and always throwing really awesome parties.

In the world of REITs, that means sporting yields that are suspiciously high.

The late and great REIT industry veteran Ralph Block wrote that “A REIT that yields 10% almost always means that investors perceive very low growth – or even worse – a potential dividend cut.” Companies like that overcompensate by paying out too much.

Even though that strategy never works long term.

Never. Ever. Ever.

That’s why you never ever ever want to tie your fortunes to that kind of stock. Like a credit card-waving neighbor, you’ll want to pass on those pool parties.

They might look like fun in the moment. But that’s long-term drama you just don’t need.

Beware of Fool’s Gold

For instance, take Macerich (MAC), a mall REIT that went public in 1994.

In 2015, it rejected a $16.8 billion takeover from Simon Property Group (SPG). According to Forbes, the initial offer was for $91 per share, which didn’t sit well with Macerich. Yet, even increasing the bid to $95.50 “did not lead to merger negotiations.”

It was a deal that just wasn’t meant to be.

In a press release at the time, Macerich CEO Art Coppola pointed out the company’s transformation over the past three years. As Forbes summarized, it had been hard at work in “exiting underperforming malls and redeveloping it top assets.”

Those changes, Coppola said, meant Macerich would be generating 90% of its expected $1.04 billion in 2016 net operating income from “fortress malls” locations.

Now, keep in mind that Macerich had cut its dividend from $3.20 per share in 2008 to $2.05 in 2011. And while the dividend wasn’t in danger at the time (see the payout ratio below), the company had opted to maintain caution and preserve capital during the latest financial crisis.

That last part may have been wise, but perhaps not so much to turning down the Simon deal. Because 10 years later, Macerich has another crisis on its hands, this one directly correlated to dividend safety.

Over the last three years, all retail landlords have experienced negative earnings growth related to store closures. Naturally, this has put more pressure on dividend growth. But some have handled it better than others.

Currently, Macerich’s dividend is dangerously close to being cut. The company has little margin of safety related to the payout ratio. Although it’s signaled future liquidity regarding its planned JVs, we believe those transactions – if they’re closed on – will be diluted to earnings.

Regardless, we believe that a dividend cut is not priced in. Therefore we maintain a Strong Sell recommendation.

Once the dividend is right sized, we might be interested in buying in. But for now, there’s a high risk to the dividend being cut over the next several months.

Simply put, there’s no reason to be a hero with this pick.

Source: FAST Graphs

Another Problematic Pick

Washington Prime (WPG) is another mall REIT at high risk of a dividend cut. It’s had little dividend growth since it spun off from Simon in 2014, and it’s maintained a flat dividend payout of $1 per share since 2016.

In 2016, Michael Glimcher resigned as CEO and was replaced by Lou Conforti. A Wall Street veteran, Comforti came with experience at places like Colony Capital, Balayasny Asset Management, UBS O’Connor, and a hedge fund.

Since listing, WPG has returned -53% (-13% annualized). Since Conforti took the helm, it has returned -15.6% annualized, generating compounded annualized earnings erosion of -5.75% annually (2016 +5%, 2017 +13%, 2018 -15%, estimated 2019 -26%).

As earnings, or funds from operations (FFO), has declined, the payout ratio has increased to around 78% based on 2019 estimates. But our larger fear is the adjusted funds from operations (AFFO) payout ratio, which provides a more meaningful measure of free cash flow.

As Adam Levine-Weinberg pointed out in a recent article:

“Conforti and his team have published rosy forecasts every year, and Washington Prime has gone on to miss them every year. Of course, it's possible that 2020 will turn out differently. (Indeed, the worse the guidance miss in 2019, the easier the year-over-year comparison for 2020!)

“However, management's forecasting track record doesn't inspire confidence.”

Given the continued pressure forecasted in the department store sector, we’re becoming exceedingly cautious in the mall sector. WPG has been able to prop its dividend up for several years now, sure. But Mr. Market is now telegraphing the likely event of a dividend cut, as evidenced by the stock’s 24.2% yield.

Furthermore, from BB to BB- due to what Seeking Alpha summarizes as “continued deterioration of its operating performance.” This negative outlook reflects S&P's view that WPG's operating metrics "will remain pressured over the next year by ongoing tenant bankruptcies and store closures, which could hurt operating metrics, credit protection measures, and liquidity."

To sum up my thoughts on this one, I’m quoting Jenny from Forrest Gump.” "Run Forest! Run!"

In other words, WPG is a Strong Sell.

Source: FAST Graphs

And Another Shopping-Centered Owner

Whitestone REIT (WSR) is a shopping center REIT that was founded in 1998 and began trading as a public company on Aug. 25, 2010. Its portfolio today consists of 57 community centers, including retail and office/flex properties amounting to 4.9 million square feet of gross leasable area.

Since going public, Whitestone has never increased its dividend once. Its annual distribution is $1.14 per share, which it pays out through monthly dividends.

Whitestone has focused primarily on two states, Texas and Arizona. It especially emphasizes Phoenix (44%), Houston (28%), Dallas (12%), and the Austin/San Antonio area (15%). The company invests in shopping centers that feature a large number of non-credit tenants.

This means it has a diversified portfolio, with only two tenants representing more than 2% of annualized base rent (ABR).

Yet two things concern me with Whitestone:

• The company maintains high leverage of 51% debt to enterprise value.
• The payout ratio is dangerous.

Accordingly, Whitestone has an elevated cost of capital, which means it has to work harder to achieve accretive investment spreads.

And since 2016, it has generated negative earnings growth: -1% in 2016, -7% in 2017, -7% in 2018, and -8% estimated in 2019. This means its payout ratio has become elevated and is currently 106% based on FFO.

Since listing, Whitestone has generated annual returns of 8.2%. And shares have underperformed year-to-date, returning 21%. (Compare that with Kimco (KIM), which has returned 52% YTD).

Although we believe the next recession will be of the “garden style” variety, we’re not convinced Whitestone will be able to maintain its dividend when it hits. The company hasn’t yet experienced a recession as a public company, and we believe there’s a very good chance it won’t handle it well.

Besides, there are better choices for yield and safety out there, something I’ll be focusing on later in the week.

Source: FAST Graphs

In Closing…

In one of my favorite books, The Millionaire Next Door, Thomas Stanley writes:

“I am not impressed with what people own. But I’m impressed with what they achieve. I’m proud to be a physician. Always strive to be the best in your field…. Don’t chase money. If you are the best in your field, money will find you.”

He added:

“Many people who live in expensive homes and drive luxury cars do not actually have much wealth. Then we discovered something even odder: Many people who have a great deal of wealth do not even live in upscale neighborhoods.”

And this one sums it all up nicely:

“Allocating time and money in the pursuit of looking superior often has a predictable outcome: inferior economic achievement. What are three words that profile the affluent? FRUGAL. FRUGAL. FRUGAL.”

On that note, stay tuned for “The Frugal REIT Investor.”

Author's Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.