Office real estate investment trust (REIT) Highwoods Properties (HIW 2.19%) has increased its dividend annually for five consecutive years. That may not sound impressive, but it includes dividend hikes in 2020 and 2021, right in the middle of the coronavirus pandemic. So why has the stock fallen 16% so far in 2023, pushing the yield up to a historically high 8.6%?
The good news
Highwoods Properties reported funds from operations (FFO), which is like earnings for a REIT, of $4.03 in 2022, up from $3.86 in 2021. It collected around $829 million in rent during the year, up from $768 million the year before. Occupancy ended the year at 91.1%, down just 0.1 percentage points versus the end of 2021. And the average rent per square foot increased to $30.51 in 2022 from $29.63 in the prior year.
Those aren't exactly hard numbers to read and, in fact, might even be considered pretty good given the upheaval in the office sector during the coronavirus pandemic. Part of the reason for the REIT's solid business performance is its location, which is in the Sun Belt. This region has seen in-migration and, thus, continued strong demand for properties of all types, including offices. Moreover, Highwoods Properties has been buying new assets and developing new properties, thus expanding its business.
All in, it seems like there should be a lot to like about this office REIT. That's particularly true given the dividend cuts at larger office REIT peers like SL Green (SLG 2.42%) and Vornado (VNO 1.92%).
Image source: Getty Images.
Things are about to get harder
However, Highwoods Properties' management team is telegraphing a much harder year in 2023. From a top-level view, the guidance is for FFO to fall to between $3.66 and $3.82 a share. That is down materially from the $4.03 achieved in 2022. There are some very notable drivers here that investors are worried about.
For starters, the company highlighted interest rates as a headwind, stating that, "...interest expense will be significantly higher due to rising rates." So financing costs are going up, which is not a good thing. But that is coupled with the negative impacts from inflation, which will also lead to "...higher same property operating expenses." Given the drop in the company's projected FFO, it seems like costs will rise faster than the REIT can increase rents as an offset.
But there's another follow-on effect from the rising rates, because Highwoods Properties is finding it difficult to acquire new properties at the moment. Simply put, higher debt costs have dramatically impacted the real estate market's sales momentum. In 2023 the plan is "...to sell up to $400 million of non-core assets this year, while we believe acquisitions are unlikely." So the company is going to shrink its business this year, not grow it. And, on top of that, it has a top-20 tenant that is moving out (accounting for 0.84% of rents in 2022) that will reduce occupancy. While a lease is already signed for that space, it won't be filled until 2024.
None of this is good news, and investors have reacted accordingly by selling the stock, which pushes up its dividend yield. That said, Highwoods Properties' FFO payout ratio in 2022 was roughly 50%. That's pretty strong, noting that office REITs tend to have lower payout ratios because offices have higher ongoing costs than other property types. But, even at the low end of 2023 guidance, the FFO payout ratio will only rise to around 55% or so. So it seems as if the dividend is still on solid ground.
For the more aggressive soul
Given the uncertainty in the office sector right now, conservative dividend investors will probably want to tread with caution in this niche of the REIT sphere. That said, if you look at the entire office subsector, Highwoods Properties appears to be holding up relatively well given the headwinds. So, if you are a contrarian looking to find opportunities in the out-of-favor office REIT arena, this Sun Belt landlord might be worth a deep dive. Just go in knowing that 2023 will not be a good year.
