One of the most out-of-favor sectors right now is the office real estate investment trust (REIT) sector. Fears of impending losses in commercial real estate mortgages linked to office properties have added to the worries surrounding the regional banks. One of the companies hardest hit by the office problem is SL Green Realty (SLG -0.53%), whose share prices have fallen enough to create a 14.6% dividend yield.
Why is its dividend yield so high, and is it sustainable?
SL Green is Manhattan's landlord
SL Green is known as "Manhattan's landlord." The company owns and leases office buildings in New York City. It owns 51 buildings with 29.7 million square feet. SL Green's primary tenants are in financial services, technology, advertising, media, information, and professional services. It also leases out some residential and retail spaces. As of the end of 2023, SL Green reported an occupancy percentage of 90.3%. This is much lower than the pre-pandemic level of 94.5% at the end of 2019.
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Office REITs have been out of favor ever since the COVID-19 pandemic demonstrated that many companies can function just fine with a remote workforce. Since many employees prefer remote work, companies find they can operate with less space. Office properties in urban areas were particularly hard-hit, with places like New York City and San Francisco seeing massive decreases in occupancy. Most official occupancy rates are overstated, with some estimates that the actual vacancy rate in New York City is closer to 50%.
SL Green's dividend yield is high compared to its peers
SL Green's dividend yield is much higher than comparable office REITs. The company cut its dividend last year, but the stock struggled since the dividend cut, which has pushed the yield up again.
SLG Dividend Yield data by YCharts
SL Green's heavy Manhattan exposure is an added weight on the stock, given the occupancy rates mentioned above. Its actual occupancy rate is probably higher since it owns primarily Class A and Class B office properties, which are the best quality. The lower-quality spaces are seeing the highest vacancy rates.
SL Green cut its monthly dividend in December 2022 from $0.311 per share to $0.271. This works out to an annual per-share dividend of $3.25. The company has guided for 2023 funds from operations (FFO) per share to come in between $5.30 and $5.60. REITs generally use funds from operations instead of net income as calculated under generally accepted accounting principles (GAAP). This is because real estate companies have a lot of depreciation and amortization (D&A) which must be deducted as an expense under GAAP. D&A is a non-cash charge (you don't write a check for it), so net income tends to understate the cash flows of the company.
The dividend is well covered, but the fundamental business trend is not good
Using the midpoint of SL Green's guidance, the dividend appears to be well covered. That said, funds from operations are decreasing and interest rates keep rising. Rising rates mean that borrowing costs are increasing while SL Green saw declines in same-store rental revenue. This is not a formula for a sustainable dividend.
Ultimately, it all comes down to when workers return to the office. While bosses are advocating for employees to come back, the labor market is tight as a drum and employees have the negotiating leverage these days. Unless the U.S. enters a deep recession and the balance of power tilts back toward employers, the current hybrid model of work-from-home and on-site is probably here to stay. And that means the office sector is dealing with massive overcapacity. This is why the office REITs are so out of favor. SL Green's fat dividend might be sustainable for the near term, but unless we see another seismic event, it won't be sustainable for the long term.
