Investors in a number of AR Global-sponsored real estate investment trusts face the potential danger of a cut in distributions, according to industry analysts and consultants.
The culprit is a REIT cash flow metric known as MFFO — or modified funds from operations, or cash flow, — at seven AR Global REITs that in the first quarter of 2016 failed to match or exceed their distributions. by wide margins.
It is typical for nontraded REITs to overpay distributions to investors in their initial stages while the companies buy properties, find tenants and negotiate leases. Over time, however, REITs cash flow and distributions — or dividends — should match up, or investors will see the value of the REIT erode, industry observers noted.
Nontraded REITs also use the lure of 6% to 7% initial annual distribution rate as a marketing tool for advisers to hook clients.
Former nontraded REIT czar Nicholas Schorsch is the majority partner of AR Global. When Mr. Schorsch was ramping up AR Global, at the time known as American Realty Capital, in 2010 and 2011, he routinely railed against the poor practices of nontraded REITs, including paying out more in a dividend than the company was generating in cash flow.
The AR Global nontraded REITs in question are illiquid, high-yield investments, with annual distributions ranging from 6.1% to 8.3%.
“You'd have to be thinking of a dividend adjustment” for the AR Global REITs, said Nathanael Webster, president of Point Loma Investment Management, a consultant. “That's what we've seen these sponsors do.”
“How long is the over distribution sustainable? It's not sustainable forever,” he said. “If you can't figure out a way to get a liquidity event or increase the REIT's cash flow, it's just math. You can't over pay these forever.”
“This is what I call sucker yield,” said Brad Thomas, the editor of Forbes Real Estate Investor, a newsletter. “It's the chase for yield that leads investors to impulsively react to dividend quantity over dividend quality. When a company is paying dividends beyond its earnings power, it is eroding capital.”
Matthew Furbish, head of investor relations at AR Global, said the company had no comment when asked about the dividends at the various REITs.
Meanwhile, the AR Global REITs, which control more than $10 billion in real estate assets, are continuing the process of seeking to merge with each other under the roofs of two AR Global REITs that have unusual 20- year management contracts, according to REIT executives. The two REITs with the long-term management contracts are American Finance Trust Inc. and Global Net Lease Inc.
Five of the AR Global REITs in the quarter that ended in March had dividends that far exceed cash flow, while two REITs, American Realty Capital Global Trust II Inc. and American Realty Capital New York City REIT Inc., had negative cash flow.
|Closed Non-Traded REITs||Offer Price/Share||Net Asset Value/Share||MFFO||Dividend||Payout Ratio|
|American Finance Trust, Inc.||$25||$24.17||0.27||0.41||149.4%|
|American Realty Capital Global Trust II, Inc.||$25||NA||-0.03||0.44||NM*|
|American Realty Capital Healthcare Trust III, Inc.||$25||NA||0.21||0.39||183.5%|
|American Realty Capital Hospitality Trust, Inc.||$25||$21.48||0.15||0.42||280.8|
|American Realty Capital New York City REIT, Inc.||$25||NA||-0.01||0.38||NM*|
|American Realty Capital - Retail Centers of America, Inc.||$10||$9||0.14||0.16||116.1%|
|Healthcare Trust, Inc.||$25||$22.27||0.23||0.42||185.9%|
|Realty Finance Trust, Inc.||$25||$25.27||0.29||0.51||176.5%|
American Finance Trust has $2.2 billion in total assets, and its “payout ratio,” or dividend divided by its MFFO, was 149.4% during the first quarter of the year, according to Robert A. Stanger & Co. Inc., an investment bank that focuses on nontraded REITs.
According to Stanger, other AR Global REITs with high payout ratios are: the $2.4 billion, American Realty Capital Hospitality Trust Inc., at 280.8%; the $2.3 billion Healthcare Trust Inc., at 185.9%; Realty Finance Trust Inc., a mortgage REIT with $1.3 billion in assets, at 176.5%; and American Realty Capital Healthcare Trust III, Inc., with just $144 million in assets, at 183.5%.
One REIT, American Realty Capital – Retail Centers of America Inc., with $1.3 billion in assets, had a payout ratio of 116.1%, or closer to the industry's expectations for a healthy amount of cash flow to sustain the dividend.
The AR Global REITs are “paying out a lot more than they're earning,” said Kevin Gannon, managing director at Stanger. “At the end of day you have to address what those companies are going to do dividend wise, relative to what they're earning. At present, the payout ratios are not sustainable. The REITs have to acquire more assets with decent yields or cut the distributions.”
Another question hanging over the various AR Global REITs is the changes recently proposed at seven REITs that present a danger to investors by eliminating various shareholder protections, Mr. Gannon said. “What's the strategy? There are just a lot of unknowns at AR Global. What's going on behind the scenes there?”