The COVID-19 pandemic continues to have a terrible impact on office landlords, as the work-from-home trend has lingered long after the world has started to reopen for business. There is already a sizable list of office real estate investment trusts (REITs) that have cut their dividends. Boston Properties (BXP -0.71%) isn't on that list, but it seems to be warning investors that it might be some time soon. Here's what you need to know.
A hard time
The big problem for office REITs is a lack of physical occupancy. Basically, people working from home have left offices half-empty even though there may be a lease in place that is getting paid on time. That's not hyperbole. SL Green (SLG -0.53%), a New York City-focused office landlord, noted that physical occupancy only reached about 60% of pre-COVID levels on some days of the week. That's hardly a statement of strength.
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There are multiple issues that come from this situation. If companies continue letting employees work from home, then less overall office space will be needed. Once current leases come up for renewal, that will increase supply and put downward pressure on rental rates. It could also make it harder to justify building new office buildings even though most companies like to be in modern properties. Higher interest rates add to the pressure there as well, as they increase the cost to finance construction efforts.
All in all, office landlords are in a rough spot right now, and there's no clear end in sight or a reason to believe that an industry recovery is imminent. SL Green, for example, has cut its dividend already. Vornado (VNO -0.53%) has, too. These are two of the largest office REITs with properties in important office markets.
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So far, though, Boston Properties, which is also large and focused on key legacy office markets, has managed to avoid a dividend cut. But there's more to this story than meets the eye.
Telegraphing a cut?
When Boston Properties reported first-quarter earnings, management commented on the dividend, which was, not surprisingly, an important issue for its shareholders. The picture isn't great. So far, management has had enough cash available for distribution to cover the dividend and to invest in its development efforts. But asset sales have been an integral part of that story.
That sounds good, but there are only just so many buildings to sell. While the long-term goal is to provide investors with a growing dividend, the driving force behind that today is the company's development pipeline. So the development pipeline really has to take priority over the dividend.
This is where things get interesting. Management highlighted that a slowdown in the sale of assets could create a gap between the cost of the dividend and cash available for distribution. If that were to happen, thanks to an economic slowdown, a continuation of the current sector headwinds, or capital market tightness, the company has the "flexibility" to adjust its dividend policy.
Conservative investors should probably read into that just a little bit. It seems like management is warning that the board may decide to cut the dividend if things don't start to improve because, alone, the rental income it generates won't be enough to pay the dividend.
Listen to management
Boston Properties is not a bad office REIT. Indeed, it has assets in some of the most important office markets in the country. But it is also not immune to the troubles in the sector, even though it has, so far, managed to support its dividend while peers were cutting theirs. So that generous 6.1% dividend yield may not be sustainable. In fact, management seems to be stating that fact pretty clearly so investors aren't caught off guard when what seems like an increasingly inevitable dividend cut comes around.
