The pandemic has had a lasting effect on the real estate industry. On the one hand, it boosted the long-term tailwinds driving demand for some property types like rental housing and logistics properties. However, it has hurt demand for other property types like office and senior housing. Conditions in those sectors continue to deteriorate, especially now that interest rates are much higher. Because of that, many real estate investment trusts (REITs) focused on those property types are struggling.

Office REIT Office Properties Income Trust (OPI -1.05%) and healthcare REIT Diversified Healthcare Trust (DHC -0.21%) are among the many REITs struggling in the current environment. It's leading them to take drastic action by joining forces to create one larger diversified REIT. Here's a closer look at the deal, why they're combining, and what it means for their dividends.

Joining forces

Office Properties Income Trust is acquiring Diversified Healthcare Trust in an all-stock transaction. Diversified Healthcare Trust investors will receive 0.147 shares of Office Properties Income Trust for each share of the healthcare REIT they currently hold. That exchange rate values the company at $1.70 per share, which is a 20% premium to its average price over the last 30 trading days. 

The deal will create a larger-scale, more diversified REIT with $12.4 billion of total gross assets. The combined company, which will become Diversified Properties Trust, will have 539 properties across 40 states. It will have a relatively diversified portfolio, featuring senior living (40%), office (35%), medical office building (12%), life science (9%), and other (4%).

The office-like portfolio (office properties, medical office buildings, and life science facilities) consists of 265 properties with 29.8 million square feet of space that's 88.9% leased with a weighted average lease term of 6.4 years. The combined company will also have 37 senior living and wellness properties secured by triple net leases (NNN). Finally, it will have 237 senior living properties that it operates, which were 76.3% occupied at the end of last year.

Battling a barrage of headwinds

Office Properties Income Trust and Diversified Healthcare Properties are facing several distinct challenges. The REITs believe that by joining forces, they can better address their issues.

The current challenges facing Office Properties Income Trust include:

Meanwhile, Diversified Healthcare Trust is facing its own set of headwinds, including:

  • $700 million of debt maturing by the middle of next year, which will be tough to refinance in the current environment.
  • High leverage and limited liquidity.
  • A slow recovery for its operated senior housing portfolio.

The REITs believe that combining their offsetting strengths will help them overcome their weaknesses. For example, office-like properties generate predictable income that they can use to repay debt. Their larger scale should make refinancing debt easier for the combined company. Meanwhile, the eventual recovery in senior housing should more than offset the expected future decline of office cash flow from lower rental rates and occupancy.

Coinciding with the transaction, the renamed Diversified Properties Trust will have a reset dividend level of $0.25 per share each quarter ($1 per share annually). That represents a significant dividend cut for current Office Properties Income Trust investors. The REIT had been paying $0.55 per share each quarter ($2.20 per share annually), giving it a sky-high dividend yield that was recently in the high teens.

Meanwhile, Diversified Healthcare REIT's dividend is going in the opposite direction. The new rate is a 267% increase from its prior level after the company slashed its dividend to $0.01 per share each quarter during the pandemic to conserve cash. 

The uncertainty remains

Office Properties Income Trust and Diversified Healthcare Properties are combining in hopes that their offsetting strengths will help them overcome their weaknesses. However, the transaction combines two troubled companies, which could make matters worse in the coming years. Because of that, investors should steer clear of the new Diversified Properties Trust while it continues to work through its challenges.