High yield frequently equates to high risk: The yield rises because the share price falls. The share price falls and the yield rises because investors believe the dividend is unsustainable. When investors are right, and the dividend is cut, the yield is no longer high even though the price continues to fall.
I say “frequently,” but frequently is hardly synonymous with always. Sometimes the dividend really is sustainable. And when investors finally believe a dividend that generates a high yield is sustainable, the high yield vanishes because the share price rises.
Two high-yield dividend stocks, both with yields exceeding 8%, have proven their dividends are sustainable. In time, investors will finally believe what has already been proven.
Government Properties Income Trust (NYSE: GOV) continually maintains one of the higher dividend yields among commercial REITs, yet quarter after quarter it continually covers its high-yield dividend with funds from operations (FFO), the key metric for dividend coverage.
For the fourth quarter of 2016, GOV reported FFO of $0.58 per share; the quarterly dividend is $0.43 per share. The dividend consumes 74% of FFO, well within industry norms. As for the entire year, FFO posted at $2.36 per share; the annual dividend was $1.72 per share.
GOV owns 73 properties (95 buildings) with carrying value of $1.6 billion. These 73 properties have approximately 11.4 million rentable square feet. The U.S. government remains GOV’s largest tenant. In aggregate, GOV’s government tenants contributed 87.9% of its annualized rent last year.
Some investors are concerned about GOV’s reliance on the U.S. government. President Trump has said he wants to reduce U.S. government employment, which would appear to reduce demand for GOV’s properties.
To hedge the possibility of fewer government workers, GOV has expanded its leasing to government contractors. GOV’s largest acquisition last year was for a property in Northern Virginia leased to three government contractors. Considering the Trump administration’s goal to reduce government employment and increase defense spending, government contractors will likely need more space to lease.
I’ll also mention that during 2016 GOV completed 61 new and renewal leases for 1.6 million square feet, which resulted in a 6.4% average roll-up in rent. It also renewed 92% of its acquiring square feet during the year, an outstanding tenant retention rate.
A few years ago, GOV issued new shares to buy a 27.9% interest in Select Income REIT (NASDAQ: SIR), a single-tenant commercial REIT. Investors were disappointed in both the dilution and the acquisition. Many investors remain disappointed to this day; hence, GOV’s discount to the market. Select Income appears to dilute GOV’s unique reliance on government tenants, but Select does contribute to cash flow. The cash flow GOV receives received from Select Income increases year over year.
GOV has yet to gain sufficient favor with income investors. That’s good news for income investors seeking additional yield. An 8.4% dividend yield on a quality equity REIT is difficult to find in this market, and GOV is a quality equity REIT, even if it is an under-appreciated one.
High-Yield Dividend Stocks: An Opportunity
Under appreciation extends to another high-yield dividend stock. If interest rates are truly on the rise, then this is good news for Ares Capital Corp. (NASDAQ: ARCC), a business development company. Ares Capital’s business is to borrow at one rate and then lend at a higher right to small- and mid-sized companies.
Ares borrows long term, and most of its debt, 81%, is fixed-rate. Its $8.8-billion investment portfolio, on the other hand, is 80% composed of floating rate loans. Most of these loans are set to LIBOR. Based on recent SEC filings, if LIBOR rises to 2%, net interest income is projected to increase by $90 million, or 19%.
Ares management has anticipated higher lending rates. In 2015 and 2016, it freed capital by initiating fewer loans than those maturing. In short, more capital is available to book new loans at higher interest rates.
Yes, high yield frequently equates to high risk. But for high-yield dividend stocks Government Properties Income Trust and Ares Capital Corp., it equates to high-yield opportunity.