Shield Your REIT Portfolio From Zombie Yields

With the U.S. unemployment rate soaring to 14.7% in April, the fight to reopen the economy and get cash flowing again has become more urgent than ever.

Businesses that shut down in March have now missed two rent payments. While this month looks a little brighter, June will still be tough for many tenants and their corporate landlords. After all, 29% of all small businesses have closed in the last two weeks, which means more than half the commercial spaces in this country are dark right now.

Whether they want to pay rent or not, many of them are going to default on their leases. And since there aren’t a lot of people lining up to fill those spaces, the immediate future doesn’t look a whole lot brighter. A lot of real estate investment trusts (REITs) are going to struggle in the coming quarter.

Some will need to suspend their dividends to survive. That’s not what shareholders who were counting on that uninterrupted income want to hear.

Truly Too Good to Be True

Anyone who is looking at real estate stocks today would see that half of them currently pay a paper yield of at least 6%, more than four times what you’d get from 30-year Treasury bonds.

It is easy to recognize that some of these payouts only exist on paper. CBL & Associates Properties Inc. (NYSE:CBL), for example, was already struggling before the COVID-19 epidemic hit. The company’s last earnings report revealed $0.37 per share in funds from operations, the crucial metric for REIT survival and success. Unfortunately, that was before the outbreak closed all the malls.

CBL’s tenants aren’t making any money. They won’t be paying any rent. And the company only has $32 million in cash.

It costs a minimum of $160 million a quarter to keep CBL going. Money for shareholders just isn’t in the cards right now. In fact, I don’t see a payment on record in the last year.

But CBL still shows up in the data feeds as paying $0.07 per share. At a dismal $0.35 per year, that’s an annualized yield of well over 100%. If only that historical payout showed any signs of continuing!

The chance to lock in 100% yield in the next year is normally tempting. Nobody is lining up to take it. And that’s true of many of the super yields on my screen.

Start With Realistic Outcomes and Then Stretch

I still love retail. I still love real estate. I believe that great companies will keep rewarding shareholders for generations to come. That’s the ongoing theme for my Millionaire Makers radio show. Have you been listening? (Click here for recorded episodes and local stations.)

However, the transition from the old pre-outbreak world to the new economy will come with its share of pain. Historically strong businesses will hit walls. Cash flow will dry up.

Dividends may need to stop for at least a quarter or two. All income investors need to brace themselves for that. Make sure you have enough cash on hand to weather the storm.

After that, you want to be positioned in the companies that can adapt to the new circumstances and get back to work. I’d start by respecting what the market tells us: companies that are priced for dividend disaster are probably more likely to default on their quarterly requirements.

There’s probably something going wrong when you see an implied yield of 100%, as with CBL. For that matter, there’s an elevated chance that any company with an implied yield above eight to 11% is going to need to reduce its payout soon.

In that scenario, you aren’t locking in guaranteed income at anything like the listed rate. You’re simply trying to capture conditions that applied in the past but are unlikely to carry over to the future. That isn’t investing. It’s nostalgia.

That eight to 11% range is generally my warning signal because it’s what the S&P 500 generally pays in a typical year. If investors thought that they could beat the market on a stock’s dividends, they’d jump at the chance.

When they aren’t jumping, it means that there’s no confidence in the company. Instead, when I’m picking new yield stocks, I start modestly by locking in three to five percent yields and working up the spectrum once my current income needs are met.

Right now, that means doing my best to ignore stocks I would otherwise jump to capture like Omega Healthcare Investors Inc. (NYSE:OHI), which currently yields almost 10% on paper.

Until you have a stock like Crown Castle International Corp. (NYSE:CCI) in your portfolio paying out a reliable income, there’s a lot of risk in reaching for stocks like OHI. I think that this risk will ultimately pay off. But in the immediate future, if you need income and were thinking that a 10% return would feel good, I’d make sure to lock in 3% first.

After all, the cell phone towers that CCI owns are not going away any time soon. The nursing homes that companies like OHI operate, on the other hand, are in for rocky sailing until this outbreak is over.

We don’t invest in yield stocks because we enjoy rough weather. That’s why people love my Value Authority service for sustainable income, year after year.