Mack Cali (NYSE:CLI) is in the middle of a major transformation. While it's a strategic shift that makes sense, when other real estate investment trusts (REITs) went through similar changes, they wound up cutting their dividends.


Source: Mack Cali.

What we were and what we are
Historically, Mack Cali owned office properties in the Northeast, largely in New York and New Jersey. That's a relatively strong office market because of the proximity to New York City. However, the 2007 to 2009 recession and subsequent slow recovery haven't been kind to the office sector. That's left the REIT looking for new ways to grow.

Continuing to buy more of a relatively weak property type is one avenue the company is going down, using the weakness to pick up solid properties. However, it's also making the shift into a new asset class, buying its way into apartments via its 2012 purchase of Roseland Partners.

Although it had been experimenting on its own prior to that acquisition, Roseland brought with it over 1,700 apartments in Mack Cali's core markets. That quickly gave the REIT notable scale.

In addition to this, Mack Cali is planning on repurposing office properties as apartments where possible and selling non-core assets to help fund the diversification effort. And therein lies the problem. Expanding into a new property type in markets the company knows well makes good sense, it's the transformation that could be a risk.

Transformation and cutting
There's a good reason to be concerned. For example, Washington REIT (NYSE:WRE), one of the oldest REITs, made a similar strategic decision in 2012. Like Mack Cali, Washington REIT has a relatively tight regional focus, in this case on the Washington, D.C. area. The company's operations spanned several property types including a recently constructed medical office portfolio.

Washington REIT believed it had reached a point where further growth of that portfolio would require expanding outside of its core market. So it decided to sell. When you sell properties, however, your rent rolls go down while you try to find good properties to buy with the sale proceeds. That can make it harder to pay dividends.

Washington REIT trimmed its dividend in late 2012 at the same time it announced both its strategic shift and CEO retirement. It basically chose to rip the bandage off. That said, Washington REIT has a long history of recycling capital, so there's every reason to believe investors will be better off down the road once this transformation is in the rear-view mirror.

UDR (NYSE:UDR) went through a similar self assessment, shifting its property-market focus while remaining dedicated to the apartment space. In this instance, UDR, formerly known as United Dominion Realty, had historically bought lower-quality apartments in secondary markets and fixed them up. This allowed the company to raise rents and benefit from the appreciated value of its holdings.

However, in 2008, the company made the choice to shift more toward high barrier-to-entry markets. That included selling off over 25,000 apartments. That's a huge portfolio to unload, and it happened all at once. Although it netted UDR $1.7 billion, its rent roll dropped without any new properties to pick up the slack.

Like Washington REIT, UDR ultimately trimmed its dividend; the cut came in 2009. That said, by 2010 the dividend was back in growth mode and has been increased every year since. This proves transformation can be good over the long term, even if it hurts in the short term.


Mitchell Hersh.

Like the change, but watch the dividend
When asked directly about the dividend during Mack Cali's 2014 guidance call, CEO Mitchell Hersh was non-committal, saying it had to be "scrutinized." While this shift is likely to be positive over the long term, income investors should keep a close eye on the dividend -- Mack Cali might sacrifice it for the greater good like Washington REIT and UDR did.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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