Office Properties Income Trust (OPI -0.79%) is a small real estate investment trust (REIT) that owns offices across the US. Its yield is an extremely high 18% right now. That suggests investors are worried about the safety of the dividend. How realistic is that concern?
The core business
Office Properties owns 160 properties in key markets around the country, including Washington, D.C. (23% of rents); Chicago (11%); and Sacramento/Silicon Valley (10%). Nearly two-thirds of its rents come from investment-grade-rated tenants, including nearly 20% from the U.S. government. It ended 2022 with occupancy of 90.6%.
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But the office sector has been troubled since the start of the coronavirus pandemic in 2020. Many offices sat empty while the government was asking people to socially distance and work from home in an effort to slow the spread of COVID-19. Most tenants continued to pay rent, but employees are still trying to avoid returning to the office even as more and more companies are asking them to do just that. A compromise has been hybrid work, with only three or four days in the office with the rest remote. Some jobs, meanwhile, may never return to the office.
The big takeaway is that many companies see less need for spacious offices. And that could mean more vacancies in the future across the office sector. More empty space will likely lead to increased competition for tenants, putting pressure on rents. Those are not good trends to think about, particularly for a smaller REIT (Office Properties' market cap is a tiny $600 million or so).
A worrying number
REITs do report net income, but that number isn't particularly meaningful because of the high levels of depreciation associated with owning a property. Depreciation is a noncash charge that lowers earnings even though it doesn't change the cash generated from the business. Adding back depreciation is a key part of funds from operations (FFO), an important metric in the REIT sector.
From an FFO perspective, Office Properties' dividend seems perfectly fine. FFO per share was $4.77 in 2022, up from $4.58 in 2021 and well above the $2.20 in dividends the company paid shareholders. However, this isn't the only metric the company provides. It also reports normalized FFO per share, akin to adjusted earnings for an industrial concern, which was $4.76 in 2022, down a touch from $4.87. That's a bit more troubling, but still materially above the dividend.
The real problem comes from the company's cash available for distribution (CAD) per share. The definition of this metric is different for each company, but it boils down to how much management thinks it could actually use to pay dividends. CAD per share in 2022 was $2.62, down from $3.22 the year before and not all that much more than the cost of the dividend. In fact, the CAD payout ratio was roughly 84%. This is at a time when new leases are being signed at lower rates (down 6.7% in the fourth quarter of 2022), highlighting the fact that the office market remains troubled.
There's another not-so-minor wrinkle here. Office Properties is externally managed by RMR Group, which oversees a number of other public REITs. RMR-managed Industrial Logistics Properties Trust was forced to cut its dividend in 2022 because of an aggressive acquisition that didn't play out as positively as RMR thought it would. While this fact doesn't necessarily mean anything for Office Properties, per se, long-term investors should probably keep it in mind just the same, because it suggests that RMR has a history of taking risks that may not be in the best interest of shareholders.
Wait and see
At this point, investors looking for dividend income should probably take a cautious approach with this high-yield stock. Even after three years, the coronavirus pandemic's impact on office REITs lingers. So far Office Properties has managed to muddle through with its dividend intact, but, given the huge yield, Wall Street seems to think that the payout is secure. Note, too, that much larger office REIT peers such as SL Green Realty and Vornado Realty Trust have already cut their dividends. It's probably better to wait until Office Properties shows sustained improvement with regard to rental trends before stepping in here.
