REITs can be managed using either internal managers or external managers. Like their names suggest, internal managers are employees of the REIT, whereas external managers are contracted to manage the REIT’s investment portfolio in exchange for a base management fee as well as a performance-based fee to serve as incentive. Sometimes, REITs use external managers because their resources cannot support a full management team, whereas other times, REITs use external managers because it simplifies their infrastructure. Regardless, externally managed REITs are a fairly controversial practice with a wide range of detractors.
In short, both internal and external managers can be skilled and reliable professionals, but the interests of the latter are not as strongly aligned with the interests of the REIT’s shareholders. This is because both base management and performance-based fees can incentivize decisions that maximize short-term gain for management at long-term loss for shareholders, which is a serious problem for the shareholders but not so much for the external managers. However, it is important to note that in spite of their issues, externally-managed REITs can still make profitable investments and build a good track record.
For example, Gladstone is an example of an externally-managed REIT with a good record when it comes to dividends. After all, while they haven’t raised their dividends in 8 years, they also haven’t missed one of their dividend payments since 2003, which is particularly impressive considering the timing of the Great Recession. Although their AFFO payout ratio is close to 100 percent, its chances of missing a dividend payment are minimal in the short term when considered in combination with their consistently high occupancy rates currently sitting at 97.4 percent as well as a 7 percent expiration rate for its forecast rents through 2019. Finally, it is worth mentioning that the fees for its external managers were recently lowered from a base fee of 2 percent to 1.5 percent and an incentive fee of 20 percent to 15 percent of core FFO. Combined with the insertion of a termination fee when the agreement between the REIT and its external managers is terminated without cause, this should serve to relieve concerns about whether dividends are reliable or not.
With that said, while Gladstone is a profitable investment and has built a good track record, it should be noted that it specializes in providing a stable income rather than spectacular price appreciation, which is something that interested investors should keep in mind when scrutinizing Gladstone shares for their investment portfolios.
Source: Gladstone Commercial Corp.(NasdaqGS:GOOD), Fast Graphs
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Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.