Updated on March 21st, 2019 by Josh Arnold
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 7.2%.
That makes it one of less than 400 stocks with a 5%+ dividend yield. You can see the full list of 5%+ yielding stocks by clicking here.
Gladstone Commercial appears to be an attractive dividend stock, especially considering the available alternatives. The S&P 500 Index, on average, has about a 2% dividend yield.
Plus, Gladstone Commercial is one of only 41 stocks that pays its dividend each month. You can download the complete database of monthly dividend stocks below:
However, Gladstone Commercial’s dividend is far from guaranteed. Indeed, its payout ratio is nearly 100%, leaving little room for error when it comes to maintaining the dividend.
This article will discuss the trust’s business model and financial performance, and why its dividend may be riskier than meets the eye.
Business Overview
Gladstone Commercial invests primarily in single-tenant, and anchored multi-tenant net leased assets. It owns roughly 11.7 million square feet of office and industrial real estate in the U.S.
Gladstone Commercial has a very diversified portfolio. As of the end of 2018, the trust’s portfolio consisted of 101 properties in 24 states, leased to a highly diversified tenant group, as seen below.
Source: Q4 investor presentation, page 14
The trust’s portfolio is typically geared toward long-term agreements. Indeed, Gladstone Commercial’s average remaining lease term is 7 years.
In addition, Gladstone Commercial enjoys high occupancy rates, including a current rate of 99.1%. Impressively, occupancy has never fallen below 96% since the trust’s IPO in 2003.
Approximately 64% of Gladstone Commercial’s tenants are rated investment grade or are the non-rated investment grade equivalent. This contributes to a high-quality portfolio of tenants that should weather minor economic downturns quite well, and preserve Gladstone Commercial’s rent streams.
The trust has generated impressive revenue growth over the past several years, but growth of the bottom line has leveled off lately. As we’ll see, that creates some level of uncertainty with the distribution’s safety.
Growth Prospects
Gladstone Commercial’s Q4 2018 earnings report showed funds from operation, or FFO, of $1.59 per share. This represents a 3.2% increase from 2017.
However, the trust has had a difficult time growing in recent years, owed to an ever-expanding share count and rising operating costs.
Source: Q4 investor presentation, page 17
This isn’t a new problem by any means, as the trust has struggled to produce any sort of meaningful FFO-per-share expansion in the past handful of years. After peaking at $1.80 in 2014, FFO-per-share fell to $1.54 in 2015 and last year, rose only to $1.59.
Declines occurred despite total assets rising by about a third, and revenue that rose similarly. The trust’s higher share count over time, which expanded ~9% in 2018 alone, along with higher operating expenses, have collectively derailed earnings expansion.
Gladstone Commercial continues to invest heavily in new properties, as seen below.
Source: Q4 investor presentation, page 10
The trust has invested an average of nearly $100 million annually in new properties since 2011. Compared to the trust’s current market capitalization of just over $600 million, that is a significant level of investment to do on an annual basis.
Gladstone Commercial divests non-core properties to fund part of these investments, but it also issues shares on a regular basis, as mentioned above. That has crimped FFO-per-share growth, and given that the trust doesn’t appear to be changing its strategy any time soon, we expect that will continue.
In total, while we expect Gladstone Commercial can at least maintain ~$1.60 in FFO-per-share annually, with potential growth rates in the low single digits, we think it will struggle to produce much more than that.
Given where the distribution is today, that could present a problem as the trust’s payout ratio is very close to 100%. However, despite the favorable fundamentals of the trust’s portfolio, its headwinds to earnings growth in recent years – dilution and operating expenses – are still very much present.
Dividend Analysis
Gladstone Commercial 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 7.2% dividend yield.
The distribution has been stagnant at 12.5 cents monthly since January of 2008, reflecting the struggles the trust has had with respect to growth.
To its credit, Gladstone Commercial has paid monthly dividends for more than 14 consecutive years, so there is certainly some staying power, even if the distribution hasn’t grown for more than a decade.
Since Gladstone Commercial’s 2003 initial public offering, the trust has not missed a distribution, nor has it reduced the distribution at any time.
The trust has not increased the dividend since 2008, which means the stock is less attractive for investors interested in dividend growth. At this point, the dividend does not need to be cut.
However, distribution growth is likely years away, and a sizable economic downturn could put the trust’s distribution at risk for a cut. Its FFO-per-share and dividend are nearly identical, leaving very little room for error in the coming years.
Another important consideration when buying dividend stocks is balance sheet strength.
Too much debt can jeopardize a trust’s dividends. On a positive note, Gladstone Commercial has worked to significantly reduce its leverage over the past several years, and now has a balanced maturity schedule.
Source: Q4 investor presentation, page 19
Approximately two-thirds of Gladstone Commercial’s debt is fixed-rate, which could help mitigate the impact of rising interest rates.
In addition, large maturities are a few years away, meaning the trust has time to generate cash to pay them off, or find better ways to refinance them.
Still, there is not much room for error because the trust maintains a high payout ratio. Last year’s FFO-per-share of $1.59 just barely covers the $1.50 annual payout, which has been the case for years.
This means there is very little wiggle room for Gladstone Commerical’s FFO.
If the trust’s fundamentals deteriorate over the next few years, there is a chance it may not be able to sustain its dividend at the current level. We see this as the principal risk of owning Gladstone Commercial today.
Final Thoughts
Gladstone Commercial’s very high dividend yield is attractive and appears to be sustainable, at least in the near term, given the trust’s current FFO generation. The trust enjoys exceedingly high occupancy and strong rental rates as well.
But given the nearly-100% payout ratio, we still have concerns about the dividend’s safety.
As a result, investors will need to monitor the trust’s results closely to make sure FFO does not decline much from present levels. Indeed, even a modest decline could jeopardize the dividend.
Investors should carefully weigh the trust’s risks before investing, as the very high yield is due in part to the risk of a cut. Gladstone’s yield is attractive, but it carries an elevated risk of a cut in the coming years, particularly if there is an economic downturn.