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In today’s low-interest-rate world, dividends of more than 5% are often treated with extreme skepticism.
Most of the time, investors are onto something. But if the market has beaten up a stock to the point where the yield looks pretty enticing, there’s something wrong. Sometimes this problem is fixable and represents a good buying opportunity. Other times, it’s the beginning of something much more dire, which eventually leads to Armageddon for dividend-growth investors. Yes, I’m talking about the dreaded dividend cut.
Among the struggling high yielders, there are often great opportunities. Sure, they’re few and far between, but they’re worth looking for. Finding the right opportunity gives an investor the chance to get a capital gain that beats the market, while collecting an oversized dividend. That’s the kind of combination I can really get behind.
I believe that opportunity is presenting itself today in Dream Office REIT (TSX:D.UN). Let’s take a closer look at this company.
Dream is one of the largest owners of commercial office space in Canada, with more than 24 million square feet in leasable space spread out over 177 buildings. Some of its properties are Canada’s more recognizable office towers, including the Telus Tower in Calgary and Scotia Plaza in Toronto. The company’s list of tenants reads like a who’s who in Canadian business, with companies like Enbridge and Bank of Nova Scotia as top tenants, as well as various levels of government.
Obviously, none of those tenants are going to offer excuses on why the rent won’t get paid on time this month.
Dream’s shares are also relatively cheap. The company has a book value of more than $35 per share, yet shares are languishing at the $28 level. This is even after the company has made some smart moves to please shareholders, including renegotiating some mortgages, buying back shares, and moving its former external management team in house. It has also recently sold more than $100 million in non-core assets.
So, what’s the problem? Why is the stock so cheap?
There are a couple of reasons. First, the trust has exposure to the Alberta market, with approximately 20% of its portfolio located in Calgary and Edmonton. Investors are also worried about Toronto’s office market, which looks poised to add millions of square feet in space over the next few years. The Toronto suburban market is of particular concern.
Plus, there’s the company’s occupancy rate, which currently stands at 91.3%. Even though that’s a better number than many of its competitors, investors would like to see it go up.
As we all know, an undervalued stock can languish for years before the market finally figures it out. Dream’s dividend helps to ease that risk.
The company currently pays a monthly dividend of 0.18666 per share, good enough for an 8.2% yield. But unlike most 8% yields I’ve met, this one is actually sustainable.
In 2014 the company reported funds from operations of $2.87 per share, while paying out a dividend of $2.24. That puts the payout ratio at just 78%, which is comparable to many of its peers who are in more dependable areas of the REIT world, like retail or apartments.
Plus, it’s easy for investors to supercharge their dividends by signing up for Dream’s dividend re-investment plan. By automatically using their dividends to purchase new shares, investors get a 5% bonus. That turns this 8.2% yielder into something closer to 8.6%.
Dream also has quite a few large tenants who will renew their leases over the next 12-24 months. While there’s a risk some of these tenants will bolt to different buildings, most will renew, and most will do so at higher rates than they pay today. This will help make the dividend more secure in the future.
A dividend of 8.2% isn’t going to be risk free. But compared to the other options out there, I think Dream offers a great combination of yield and safety. That, combined with the discount to book value, makes the shares a buy, at least for my portfolio.
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Fool contributor Nelson Smith owns shares of DUNDEE REAL ESTATE INVESTMENT TRUST.