There are really only a couple of ways for real estate investment trusts (REITs) to grow. They can build properties, buy properties, or buy a peer. Industrial Logistics Properties(NASDAQ: ILPT) recently bought a peer, looking to increase its scale and diversification. What dividend investors got, however, was a huge dividend cut. Here's what happened, why, and why you might want to look at other alternatives.
Not exactly a boring investment
REITs are intended to give small investors the opportunity to benefit from the income that institutional-level properties create. The expectation of most dividend investors in the sector is that these stocks will largely be a snooze, providing slow and steady dividend growth. There are some REITs that focus more on growth than yield, but even in such situations the story is generally low-risk in nature. Owning property and collecting rent payments each month just isn't that complicated, and it's better for everyone if these businesses are not all that exciting.
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To be fair, the pandemic did throw a wrench into the REIT sector. However, most companies managed to muddle through in relative stride, with some even increasing their dividends in 2020 despite the health scare. The names that cut their dividends, meanwhile, generally did so to protect their liquidity.
Industrial Logistics Properties actually got through the early days of the pandemic without a dividend cut. But it did end up cutting its dividend in July 2022, dropping the payment to a token penny per share per quarter. That's a level that is generally meant to allow institutional investors with a dividend mandate, like insurance companies, to continue holding a stock. For small investors, the cut to a penny from the previous level of $0.33 is tantamount to the elimination of the payment.
The thing is, this cut had nothing to do with the pandemic. It was totally self-inflicted.
High-risk moves
The story here dates back to November 2021, when the REIT agreed to buy Monmouth REIT for $4 billion. It was an all-cash deal, completed in February, that was announced with very material objectives. Most notably, management said it would be immediately accretive to normalized funds from operations (FFO). A dividend cut was nowhere in the discussion.
However, a key part of the integration plan involved selling assets, which would help Industrial Logistics pay for the deal. The rising interest rate environment and property market weakness, according to the REIT, have delayed that sales process and, thus, led the company to cut the dividend. Although the reduction has been pitched as temporary, the exact wording of the news release is not comforting: "...ILPT currently anticipates that its dividend will return to a rate at, or close to, its historical level sometime in 2023." So investors could end up with a permanently lower dividend after a deal that was supposed to lead to growth.
Additionally the external manager might push the accelerator on growth even if it isn't in the best interests of shareholders. That puts a different light on the Monmouth deal -- and, importantly, this risk won't change even if the dividend gets restored to previous levels.
A poor risk/reward trade-off
Historically, Industrial Logistics' dividend yield has been high relative to other names in the industrial REIT space. That is a clear enticement to dividend investors, but one that, in hindsight, came with material risks. The dividend cut has put those risks on display, with the external management structure front and center. If you own this REIT, you might want to consider alternatives. If you are looking at this REIT, you might want to consider alternatives. It clearly isn't a safe and reliable dividend payer and, as long as it is externally managed, nothing is likely to change that fact any time soon.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
