Office real estate investment trust (REIT) Highwoods Properties (HIW 0.31%) has a lofty 7.8% dividend yield. That should be enticing to dividend investors looking to maximize the income their portfolios generate. The office sector, overall, is facing material headwinds, but here's why Highwoods' dividend is likely to survive.
Not-so-good times for office REITs
The coronavirus pandemic has had a lingering impact on the way people work. At one point, going into the office was the norm. But after being forced to work from home, many employees have found they are happier not commuting to and from the office, and don't see the point in doing it as often, if at all. There's increasing tension between employers and employees on this front, but it is clear that offices are not operating at full capacity. In fact, REIT peer SL Green (SLG -0.53%), which owns offices in the New York City market, recently highlighted that physical occupancy on some work days of around 60% of 2019 levels was a positive update. If that's good news, can you imagine what bad news would look like?
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Here's the thing: Highwoods and SL Green focus on very different markets. While SL Green's New York City portfolio has historically been a great advantage, today, many people are moving south. That's why Highwoods chose to focus on the Sunbelt states, with office properties located in Atlanta, Charlotte, Dallas, Nashville, Orlando, Raleigh, Richmond, and Tampa. In-migration from states like New York is helping to strengthen these markets.
That's good for the REIT's long-term outlook, but it doesn't mean that Highwoods will be immune to the work-from-home trend. For example, funds from operations (FFO) in the first quarter was $0.98 per share, down from $1.03 per share in the prior-year period. But even at $0.98 per share, its FFO payout ratio was roughly 50%. Office REITs tend to have conservative payout ratios, but that ratio still leaves Highwoods a lot of flexibility to handle adversity.
Is the operating environment getting better?
What was, perhaps, more interesting about the first-quarter report was the change management made to the REIT's guidance. The top end of its FFO guidance didn't change, but it inched the bottom end just a little higher. While increasing the low side of the full-year FFO guidance range from $3.66 per share to $3.68 per share might seem modest, it is a sign that management sees the company's worst-case scenario as looking less likely.
Based on the $3.68 per share low side of guidance, the current quarterly dividend, which would annualize to a $2.00 per share full-year dividend, gives it a payout ratio of around 54%. That's not such a terrible outcome, and it suggests that Highwoods can easily keep supporting its lofty yield.
The closer the REIT gets to its high-end target of $3.82 per share, the stronger its FFO payout ratio would be. In the near term, it looks like Highwoods is going to focus on its development projects and not acquisitions. It also intends to sell non-core assets to fund those development efforts. So 2023 is unlikely to be an exciting year on the growth front. But given the headwinds in the office sector, that's to be expected. If you are looking for a high-yield REIT, slow portfolio growth is probably a worthwhile trade-off right now.
For the right investors
Highwoods stock isn't going to be for everyone. It is a pretty small REIT with a market cap of just $2.8 billion, and the idea of investing in offices right now might be off-putting to more conservative investors. That said, if you can stomach a little uncertainty, its big yield might be worth the risk, given that Highwoods appears to be well-positioned to muddle through the headwinds it faces.
