7.5% Dividend Yields Don’t Come Without Risk: is Medical Properties Trust Too Hairy for You?
If you’re hunting around for an investment that produces gobs of current income, you’re likely to stumble across a company called Medical Properties Trust (MPW). The company’s stock is trading near its 52-week high.
The stock's dividend yield is 7.5%. That’s well down from the 25% yield it touched towards the end of the last recession. But it’s still way above the yield for the 4% yield the average Dow Jones Utility stock produces, the 2.6% average for Dow Jones Industrials or the 2.3% average for the typical S&P 500 component.
So naturally, Medical Properties’ 80-cents-a-share dividend looks tempting. Should you buy in? It comes down to whether you think that dividend is trustworthy.
Medical Properties is a real estate investment trust. Based in Birmingham, Ala., the company owns 79 health care properties in 23 states.
While other health care REITs like to own plain-vanilla doctors offices, Medical Properties prefers to focus on specialized medical buildings. It describes its holdings as “inpatient rehabilitation hospitals, long-term acute care hospitals, regional acute care hospitals, ambulatory surgery centers and other single-discipline healthcare facilities, such as heart hospitals and orthopedic hospitals.” Medical Properties likes to argue that its preference for these specialized medical buildings makes it special.
Alas, Medical Properties doesn’t operate any of its properties. It leaves that task to its tenants, which consist of 21 hospital operating companies that lease the properties from Medical Properties on a “triple-net” basis. The tenants mow the lawns, pay the janitors and the facility managers, pay the insurance bills and property taxes and on and on. For the privilege of being able to not carry the property on their books, these hospital operators pass along rent to Medical Properties.
I view triple-net REITs like this one as off-balance-sheet specialty lenders. Instead of lending money directly to its clients, as a bank might, or offering them non-recourse mortgage loans, also like a bank would, Medical Properties purchases their buildings and charges them rent.
But is passive income a bad thing? Not always. If you’re generally wary of the dividends that big banks pay, there’s less reason to fret here. Were a Medical Properties’ tenant to declare bankruptcy, the judge in that bankruptcy case would regard the leases as “senior” to its loans. Landlords get repaid before lenders do.
Also, unlike banks and specialty lenders, Medical Properties is not terribly overburdened by debt. Its liabilities, which consist mostly of long-term debt, are a reasonable fraction of its enterprise value.
Okay, so enough with the background. What about the 80-cents-a-share dividend Medical Properties is shelling out? Is it sustainable or what?
Medical Properties has a history of backing off on dividend payments when times get rough. During the last recession, it slashed its dividend quite significantly.
Unfortunately, Medical Properties may not have cut the dividend enough. It was still paying out 80 cents a share a year in dividends last year despite only earning 71 cents a share in funds from operations.
That’s a bit of a no-no. FFO, a widely-followed measure of REIT profitability, is essentially earnings before depreciation and gains or losses from property sales. If a REIT pays out a dividend that exceeds its funds from operations, it generally has to raid its cash on hand, sell assets or borrow the funds. A pretty good rule if you’re a disciplined REIT investor is to avoid companies that pad your dividends with gobs money that it didn’t earn from rental income.
(I should mention that’s true despite some tax advantages. Shareholders who get dividends that exceed a company’s taxable net income are not on the hook immediately for income taxes on the excess dividends. Only later, when they sell the shares, will they be hit with a bill. And even then, they’ll only be taxed at the lower, capital-gains rate.)
But analysts estimate Medical Properties will fare better this year, hauling in 86 cents per share. For a company that is planning to pay out 80 cents a share in dividends, that doesn’t leave an overwhelming amount of room for error, obviously, but it would cover the payout.
Throw in the fact that Medical Properties is sitting on 95 cents a share in cash and short-term investments—a decent buffer. And analysts project the company will see funds from operations of $1.03 per share in 2013.
If you’re a fan of income but you gravitate towards the highest-quality managements and hate taking risks, this stock is not for you. But if you’re willing to tolerate some risk and willing to own a second-rate company or two, this 7.5%-yielding stock may be for you.
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