Can This 12% Yield Possibly Be Safe?

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Can this 12% yield possibly be safe?

Mostly, yes.

It depends how you look at it.

Ares Commercial Real Estate (NYSE: ACRE) is a mortgage real estate investment trust (REIT) that specializes in commercial property. One-third of its loans are for office space. The other top holdings in its portfolio are for multifamily housing (20%), hotels and mixed-use space (11% each). The portfolio is spread out around the country, with the highest concentration in the Southeast at 27%.

Ares Commercial Real Estate pays a $0.33 per share quarterly dividend. For the past eight quarters, it has paid an additional $0.02 per share in what it calls a supplemental dividend.

For the purposes of examining the company’s dividend safety, I’m going to exclude the supplemental dividend, since it is not considered part of the regular dividend.

When analyzing mortgage REITs, we key in on a metric known as net interest income (NII). Since mortgage REITs borrow money and then lend it out, NII is the difference between the money they make from the loans that they issue and the cost of borrowing the funds. Expenses are also subtracted. The result is a good indicator of cash flow and whether a company can afford its dividend.

Ares Commercial Real Estate’s NII for 2022 is estimated to be $100 million, rising to $110 million this year. It is forecast to pay out $72 million in dividends each year, again excluding the additional $0.02 per share.

That’s a nice, low 72% payout ratio for 2022 and 65% for 2023. A low payout ratio means a company has plenty of cash to support the dividend. I like to see companies pay out 75% or less of their cash flow or, in this case, NII. That’s a comfortable level where we can be fairly sure the dividend won’t be lowered if a company hits a rough patch.

The mortgage provider has paid a dividend since 2012 and never cut it. The dividend has been raised several times over the past 10 years.

If you include the supplemental dividend, that adds another roughly $4 million in dividends, which pushes 2022’s payout ratio to just above my 75% threshold. For 2023, the payout ratio is 69%, below my 75% cut off.

Ares Commercial Real Estate should have no problem paying its regular dividend this year. As long as the company’s performance doesn’t deteriorate in 2023, I’d expect the supplemental dividend to continue as well.

Dividend Safety Rating: A

Dividend Grade Guide
If you have a stock whose dividend safety you’d like me to analyze, leave the ticker symbol in the comments section. Correction

A few weeks ago, we published an analysis of Icahn Enterprises (Nasdaq: IEP) with incorrect numbers. We apologize for the error.

Using the right numbers, the Dividend Safety Rating is “B.” The one issue is that 2022 net income is expected to be below what the company will pay in dividends. However, I forecast the payout ratio for 2023 to be 69% of net income, so the dividend should be safe.

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