The coronavirus pandemic is having a lasting effect on the world economy, with normal work trends still only starting to come back in many ways. One of the biggest changes has been in the office space, where many people continue to work from home instead of commuting to a central location. This has been terrible news for office landlords like Vornado (VNO +1.65%). Here's why the real estate investment trust (REIT) has such a high yield, and why the dividend is likely to get cut in very short order.
A terrible time
In 2020, the world first faced a very frightening foe, the coronavirus. It was, at the time, a new illness that was spreading quickly and being highly deadly. With no known way to fight it, the world went into lockdown. A big part of that was social distancing, an effort that included sending employees home to work instead of asking them to come into the office.
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A couple of years later, with vaccines and natural immunity allowing the world to get back toward a more normal state, people are heading back to the office. But that's not happening in sizable numbers yet. Many employees are fighting company demands to return to the normal work environment. Simply put, a lot of people like to work from home. This has left properties owned by REITs like Vornado less than full.
Without full offices, some companies are pulling back on the amount of space they occupy. This, in turn, has put downward pressure on occupancy levels. Now add to this the headwinds of inflation (which increases operating costs) and rising interest rates (which are being used to fight inflation), and financial results have not been great.
To put a number on this, Vornado's third-quarter 2022 adjusted funds from operations (FFO) was $0.81 per share, up a dime from the same quarter in 2021 but down from $0.89 per share in the same period of 2019, before the pandemic.
Not holding the line
Given the headwinds of the pandemic, Vornado cut its dividend in mid-2020, from $0.66 per share per quarter to $0.53. While not ideal for dividend investors, given the uncertainty of the time, acting to preserve liquidity was a good business move. The problem is that things have not gotten any easier, as noted above.
In fact, facing the same headwinds, peer SL Green (SLG +1.06%) has already announced that its dividend will be cut by nearly 13%. Investors have been expecting a similar move from Vornado, which is why its yield has been trending in the high single digits since roughly the middle of 2022. At this point, the yield is higher than it was at the worst of the 2020 bear market.
NYSE: VNO
Key Data Points
Not surprisingly, management discussed the need to "right size" the dividend in 2023 as inflation and higher interest rates crimp its results. In other words, another dividend cut is almost certainly coming. Only the company isn't giving any solid guidance on the matter, saying that it will look to pay out all of its taxable income. (A REIT has to pay out at least 90% of taxable income to avoid corporate-level taxation, but most pay much more than that.)
Although analysts attempted to get more guidance on the expected cut, management said it wouldn't provide any more detail until it reported fourth-quarter earnings in early 2023. To be fair, that's because the size of any cut likely depends on the company's 2023 budgeting and financial expectations, which are still in their formative stage.
The only solid takeaway is that Vornado's dividend is almost certainly going to be lower next year than it was in 2022. So the high yield here is not truly indicative of what you can expect if you buy the stock.
Ugly uncertainty
Investors do not like to be left up in the air, particularly when it comes to dividends. So expect Vornado's shares to be under pressure until a new dividend payment level is revealed in 2023. But don't go in hoping that the nearly 10% yield will last, because management is very clearly telling dividend investors that a cut is in the cards very soon. Conservative income investors should probably stay on the sidelines until there's a little more clarity.
