Sounds good, right? Sitting back and collecting a nice rent check every month — without having to be the guy who fixes the roof or calls the plumber or has to deal with tenants who skip town without paying or have loud parties and annoy the neighbors? It’s perfect!
And, of course, it’s been eminently possible for a long time — though without the huge profit of being a physical landlord and renting out a house or a few apartments, because you don’t necessarily benefit from the huge amount of cheap leverage that residential mortgages provide. But Ian Wyatt is hoping you’re not aware of that — the idea of investing in REITs (Real Estate Investment Trusts) is, of course, very much mainstream among individual investors, but if he can convince you that he’s the font of information on that topic, well, maybe you’ll sign up for his newsletter.
So yes, today’s pitch for the Thinkolator’s consideration is from Ian Wyatt, who is promoting his High Yield Wealth newsletter, and he’s got an idea that he thinks can generate “up to” $4,734 a month in “rent check” income for you. So what is it?
Well, I’ve already let you in on part of the “secret” — it’s a Real Estate Investment Trust, that much is pretty obvious… but which one?
If you’re not familiar with REITs, they are companies that effectively have a pass-through tax structure like a BDC or a MLP or a partnership — the work under a special IRS classification that says companies whose business is primarily in real estate (typically either as owner/operator and landlord, or in real estate financing) and who elect to be REITs can avoid paying taxes as long as they pass along 90% or more of their taxable income to their shareholders in the form of dividends. Those dividends are then treated as income for the shareholders, and are taxed at the individual shareholder level (or not taxed, if the shares happen to be held in a tax-free account like a Roth IRA).
This is obviously appealing for many companies, avoiding corporate taxes and paying high dividends, and many nontraditional real estate companies have converted to REIT status or are considering it — including American Tower (AMT), which owns cell phone towers, and several data center or data warehousing stocks like Equinix (EQIX) and Iron Mountain (IRM)… even some telecom networks are joining the REIT party, with Windstream (WIN) in the process of spinning off much of its fixed-line network (what we used to call “telephone wires”) into a separate REIT. But most REITs are still much more understandable and traditional — they own apartment buildings or office buildings or industrial buildings, they rent out space to customers, and they collect rent and pass along the income to shareholders.
So which one is Wyatt excited about now? Let’s look into the clues he provides:
“Become A Partner Today – Collect a Rent Check Next Month
“To break it down for you in the most basic terms: I’m talking about becoming a partner with an already-established landlord.
“But not just any landlord:
“An extremely successful, well-diversified landlord with a Harvard MBA, who has some of the wealthiest and most reliable long-term tenants in the nation.
“A landlord whose 72 rental properties across the country (encompassing nearly 10 million square feet,) are currently 98% occupied.
“And that’s part of the reason this landlord is able to pay out such consistent and oversized ‘rent checks’ to partners.
“In fact, long-time partners have now received 93 consecutive monthly ‘rent checks.'”
He calls this being a “Paper Landlord,” and he notes that this particular landlord you would partner with also has a few good things going for him…
“… this landlord specializes in commercial and industrial properties….
“… major American corporations like Corning, T-Mobile, Penzoil and Sara Lee….
“Not to mention this landlord has struck a pretty amazing deal with them.
“You see, he’s made Corning, T-Mobile, and the other tenants agree to cover 100% of the property tax, insurance, maintenance and repairs on the their rental properties.
“If it sounds like an unusual lease, you’re right.
“But from the landlord-perspective, it’s the perfect arrangement. (And believe it or not, his tenants don’t seem to mind it one bit.)
“And because his properties are so well diversified – he owns commercial, industrial AND medical office spaces spread all across the country – even if one sector, region or property should be hit by hard times, or a long-term tenant should decide to vacate – it only represent a small fraction of portfolio.”
That’s perhaps slightly unusual in the world of REITs, but it’s by no means unique to any one REIT — that’s called a “triple net lease”, where the landlord essentially charges less rent than a full-service real estate operating company would, and takes on no real work — the tenant does all the maintenance and pays the property taxes and essentially acts like the owner… but doesn’t have to have their own capital tied up in owning the building or carrying mortgage debt, which is important for many companies.
So this is some kind of triple-net-lease REIT, of which there are quite a few — which one? Well, we fed all that into the hopper of the Mighty, Mighty Thinkolator and got our answer: Gladstone Commercial (GOOD), a REIT that Ian Wyatt has also touted and teased a few times in the past. And yes, I’m thankful that today he’s teasing it as a way to be a landlord… which is much more accurate and less disingenuous than his past teases that buying this REIT was like getting a “property tax rebate.”
This is indeed a high yielder, the current distribution gives a yield of about 8% — well above average for a REIT. That usually means that there’s some kind of risk involved — maybe the REIT is too levered (has too much debt), or has troubled properties or tenants, or perhaps they simply aren’t growing (a growing dividend is far more valuable than a static one, all else being equal). What’s the story with GOOD?
Well, the quick assessment, just from looking at their financials, is that they aren’t growing the dividend — and they can’t grow it, because the Funds From Operations (FFO) isn’t growing on a per-share basis (FFO is typically used as a “cash earnings” metric by REITs, it removes non-cash stuff like depreciation). Their operating cash flow has failed to cover the dividend for four years now, so they would not have been able to pay the dividend if they didn’t continually sell more stock and borrow more money each year.
Which isn’t to say that the company isn’t growing — it is. It’s just not growing on a per share basis, so all investors are really getting is that dividend, which looks like it’s big enough that it has a little bit of a “wasting” effect… it is — all else being equal — slowly paying out equity to investors (not cash flow or income, but more of a slow liquidation). That’s probably an exaggeration, especially because it’s quite possible that their real estate is worth more than the carrying value on the books and because they seem to have plenty of access to pretty inexpensive financing, but I don’t see any reason to expect anything beyond the dividend… and if anything happens to threaten the dividend (like another financial crisis), they could be in some trouble.
GOOD does have expert management, it’s part of the Gladstone stable of income-producing investments (including Gladstone Land, a farmland REIT, as well as the BDCs Gladstone Investment and Gladstone Capital) and they do generally have strong tenants with mostly long-term leases that provide a decent return.
Wyatt gives us some hope that things are about to pick up with this little tease:
“In a recent conference call, the landlord I’ve been telling you about stated:
‘I think this year might be a good chance for us to raise the [amount of partner rent checks]’.”
Which is, I suppose, true — but you have to have a pretty open definition of “recent” … that quote is from one of Gladstone Commercial’s conference calls in 2012. And no, they haven’t raised the dividend since then (the last dividend increase was in January of 2008). David Gladstone, the Chair and CEO, is the one who said back then that they might be able to raise the dividend, and he continues to say that he wants to, but — as you can read in their most recent conference call — it’s not likely to happen soon. They are focused on deleveraging, a process they’ve been working on for a while as they pay down some debt, which means they’re steadily issuing new shares to pay off debt as well.
So in the end, actually, GOOD is unlike most REITs in that it’s somewhat of a tax-advantaged income vehicle — a little bit similar to a MLP. That’s because they’re not making any profit on the corporate level, so their dividends are generally “return of capital,” which doesn’t create an immediate tax liability for shareholders like “income” does — it just lowers your cost basis in the shares, so it’s effectively like deferring the tax liability until you sell the stock. In 2014 the distribution was all return of capital, they have said they expect it to be about 80% return of capital in 2015.
And to give them some credit, they are very focused on keeping the dividend and not cutting it — they could easily (and maybe should have) cut the dividend in 2008 and 2009 when many of their competitors were under pressure because of financing costs (or lack of financing availability), but they didn’t… so their investors are probably pretty confident that they can keep paying that 8% yield. They are also focused on continuing to grow their asset base so they can appeal to institutional investors (the market cap is well under $500 million now, and volume is pretty light), and that’s also how they earn their management fee (Gladstone Management earns a fee based on the size of the portfolio, and incentive fees if they do well — no incentive fee last year, but they are clearly motivated to make more purchases and increase the size of the property portfolio). Growing should also make them more efficient, at least in theory, and give them more flexibility in refinancing their properties — so perhaps growth in size will eventually lead in growth in per-share metrics like cash flow and FFO and, probably most important to GOOD shareholders, dividends.
Will it work out well for them? I expect they’ll keep paying the current 8% yield as they return capital to shareholders, though they are refinancing some debt by steady issuance of equity so that new equity continues to cost them 8% as they owe dividends on those new shares. This is the kind of situation that can end badly if they get a big hiccup, either from interest rate changes or from internal problems or financing challenges… but probably won’t, given the current market and their ability to buy, sell, borrow and trade over the years to keep the dividend train rolling. If you are excited by GOOD, my personal guess is that we’ll see dips in all the REITs at some point this year as the Fed seems likely to cause some more interest rate panics that tend to drive down the shares of all income investments… but that’s just a guess. I’m keeping some cash on hand because I hope to buy some more quality dividend payers at cheaper prices, including some REITs, but GOOD isn’t currently on my “looking to buy” list.
Have some thoughts on GOOD, high-yield REITs, income stocks, interest rates, or whatever else? Throw them on the pile with a comment below — perhaps you can help make us all just a wee bit wiser.
P.S. Remember that $4,734 number? If you want to get that as a monthly “rent check” from Gladstone Commercial, you’ll have to buy about 37,000 shares — which would cost you a little less than $700,000 (I’m rounding)… so big monthly payouts obviously don’t come without big outlays of capital. By way of illustration, that’s not too far from what you’d earn by buying a couple decent rental houses in my town with cash (no mortgage) and renting them out, you might well be able to buy a house for $350,000 and rent it for $2,300 a month… and it would certainly be easier to own GOOD shares (or some other high-yielding REIT) and not have to do maintenance… but, of course, the returns on those houses could be much more levered if you used mortgages, and if you’re buying rental houses you have something a little more “solid” to pass on to future generations or count on as a buttress against inflation, there’s no dilution or financing or management fee eating away at that real estate value. And, of course, you get something to keep you awake at night if there are ice dams in the roof or termites in the basement, or they decide to widen your road and turn it into a highway.
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