Shares of Manhattan real estate giant SL Green Realty (SLG -0.48%) have plummeted more than 50% from their peak earlier this year. That has pushed the dividend yield for the real estate investment trust (REIT) up to an eye-popping 9.4%.
A dividend yield approaching double digits is usually a warning sign that the market doesn't believe the company can sustain its current payout much longer. Here's a look at what has investors spooked and whether SL Green can maintain its big-time dividend.
What's weighing on SL Green Realty?
SL Green has faced several headwinds in recent years. As Manhattan's leading office landlord, it has encountered pressures from pandemic-related lockdowns in that city, which have given way to a rise in remote work. The company has battled against this latest headwind by enhancing the quality of its portfolio. It has sold older properties and reinvested the proceeds in improving the amenities of its remaining buildings to attract top tenants.
That strategy is working. Many companies continue to see the value of having their employees come into the office a few days a week. That's leading them to upgrade their office space to incentivize workers to come back into the office.
SL Green is benefiting from this trend. It has signed 1.9 million square feet of office leases this year, which have kept its portfolio well occupied at 92%. Because of that, CEO Marc Holliday said on the third-quarter conference call: "A lot of the focus from the market is on the leasing performance and tenant demand. And on that front, we feel quite good about where we are, given the portfolio is highly improved and our overall asset quality has never been better."
However, another headwind has emerged this year, which has added weight on the company's share price. Holliday noted on the call that "rising interest rates, on the other hand, are more of a concern given the impact it has on our earnings." As a result, he said, hedging interest rates and debt reduction is "our No. 1 priority for the foreseeable future."
Can SL Green successfully navigate its latest headwind?
The office REIT has already made progress on its strategy to mute the impact of rising interest rates. The company entered $1.25 billion of corporate interest rate swaps during the third quarter to hedge against future floating-rate exposure. It also entered cap contracts on another $270 million of variable property debt and swapped another $200 million on a floating-rate mortgage. These moves should help mitigate some of the effects of higher interest rates.
The company had about $2 billion of remaining unhedged debt at the end of the third quarter, approximately 20% of the total. It plans to continue reducing its floating-rate exposure through caps and swaps because the initial cost will save it a lot of money in the long run. In addition, it will look for opportunities to refinance to longer-term fixed-rate debt when the market for commercial mortgage-backed securities reopens. SL Green also plans to pay off debt as it matures via additional asset sales.
What's important to note is that the company's balance sheet is in a solid position overall. Holliday said on the call: "I think we are very fairly leveraged and many of the assets under leverage relative to what I think a proper loan-to-value would be in this market. The debt reduction really is pointedly toward preserving and protecting our earnings from increasing rates and variable-rate debt."
Since its overall debt isn't an issue, and the current strategy aims to preserve earnings, SL Green's dividend seems to be on solid ground, assuming it can achieve its goals. That's because its current earnings more than support its high-yielding dividend. SL Green has generated $5.18 per share of funds from operations (FFO) through the first nine months of the year, including $1.66 per share in the third quarter. That easily supports the company's current monthly dividend payment of $0.3108 per share ($3.73 per share annualized).
The risk could be worth the reward
SL Green's stock price has been under tremendous pressure due to remote work and interest rate concerns. But companies still value having their employees come into the office. That's leading them to upgrade their space. This trend benefits SL Green because it has a high-quality portfolio. Meanwhile, the company is working to reduce its exposure to rising interest rates to mute their impact on its earnings.
Because of that, the REIT should be able to maintain its dividend. While the stock might not be a screaming buy -- some risk is left because it still needs to completely address its floating-rate debt -- the reward could be worth it. SL Green believes its stock remains significantly undervalued by the market, and it pays a highly attractive monthly dividend that seems sustainable.
