The pandemic has had a lasting impact on the demand for office space. Many employees continue to work remotely, at least part of the time. So office landlords are struggling to fill up their vacant space, which is impacting their rental income.
As a result, several office REITs have recently slashed their dividends. For example, Manhattan's leading office landlord, SL Green Realty, ended more than a decade of consecutive increases by announcing a 13% dividend cut in December. Fellow office-focused REITs Vornado Realty Trust and Douglas Emmett also cut their payouts, with Vornado's falling 29.2% and Douglas Emmett's decreasing by 32%.
More office REIT dividends seem destined to fall. The most likely dividends to get cut next are the ultra-high-yielding payouts by Brandywine Realty Trust (BDN +1.16%) and Office Properties Income Trust (OPI +0.00%). Here's why it looks like those dividends are on the chopping block.
Trying to toe a fine line
Brandywine recently declared its latest dividend payment, of $0.19 per share. At that rate, and its recent stock price, the office REIT yields a tempting 11.8%.
NYSE: BDN
Key Data Points
However, a dividend yield in the double digits is often a warning sign that a cut is coming. A big concern for investors is the gap between Brandywine's cash flow and capital needs. The company expects to produce $175 million of cash flow this year after making interest payments on its debt. While that's enough to cover its $132 million dividend outlay, its total capital requirement for 2023 is $465 million, with most of that balance spent on capital projects.
Brandywine currently expects to bridge the gap by selling $120 million of assets and using a combination of new debt and cash. It has already secured the debt by obtaining a $245 million loan collateralized by seven properties at a 5.875% rate.
However, the company has another gap to bridge next year. It has a $350 million note (with a 3.78% interest rate) maturing that it will need to refinance. That's 16.9% of the company's total debt, so it's a sizable maturity. While Brandywine recently successfully refinanced a 2023 note maturity, it paid a high cost. It issued $350 million in notes due in 2028 with a 7.55% interest rate to redeem $350 million of notes maturing this year with a 3.95% interest rate. If interest rates continue rising, Brandywine might reduce its dividend and use that cash to fund capital projects and strengthen its balance sheet.
Lots of work to do
Office Properties Income Trust declared its latest dividend last month at $0.55 per share. That gives the REIT an eye-popping 12.6% yield at the recent share price.
OTC: OPI
Key Data Points
While Office Properties Income believes it can maintain that payout level, investors remain skeptical. One concern is the significant surge in the company's dividend payout ratio. Its payout ratio based on rolling four-quarter cash available for distribution (CAD) went from a percentage in the mid-60s to 84% at the end of last year, due to its declining cash flow.
In addition, the company has significant upcoming debt maturities and lease expirations. Office Properties Income has 10% of its debt maturing this year and 14.2% in 2024. Meanwhile, leases contributing to 11.2% of its annualized rental income expire this year, while 25.9% expire in 2024.
Therefore, the REIT's main focus this year will be to proactively manage lease expirations and further refine its portfolio to reduce leverage, while also completing its two redevelopment projects. While it has lots of liquidity, the company might need to reduce its dividend as it navigates its current challenges.
Cuts seem inevitable
Office REITs have been slashing their dividends this year as they deal with declining rental income and higher interest rates. Given their sky-high yields, Brandywine and Office Properties Income are likely to join their peers in making cuts. Since their dividends don't seem to be sustainable, yield-seeking investors should steer clear of these office REITs.
