Dividend Cut Spurs
Broader REIT Fears
NEW YORK -- News that Highwoods Properties Inc. slashed its dividend by 27% has prompted some analysts and investors to wonder which real-estate investment trust may be next.
Highwoods announced on April 25 that it would be cutting its annual dividend to $1.70 a share from $2.34. The decision came as the company unveiled another troubling quarter in which it fell short of analysts' expectations by 7 cents a share and lowered its projections for 2003.
Highwoods, like many other REITs, has been facing falling rents and occupancies in its properties.
"The entire office-REIT industry continues to be impacted by deteriorating macroeconomic trends including slow GDP growth, rising unemployment and continuing uncertainty in the corporate sector, which has stymied most firms' expansion plans," Ronald P. Gibson, chief executive of Highwoods, said in a statement.
Highwoods was hit particularly hard as it also held leases with financially troubled WorldCom Inc. and U.S. Airways Group Inc., which have both filed for Chapter 11 bankruptcy protection. Those leases caused Highwoods' rent revenue to drop by $18 million and its occupancy to fall by 2.2%.
Gone are the hopes that a rebound is on the horizon.
"Signs that appeared in the fourth quarter, indicating that a number of our markets had begun to stabilize, evaporated and were replaced with more indications of instability and economic weakness," said Mr. Gibson.
Declining occupancy rates, the weak economy and "the likely prospects of having to fund a shortfall through 2004 and perhaps part of 2005" all prompted Highwoods to trim its dividend, said Mr. Gibson.
But analysts and investors say Highwoods isn't alone.
Already, a couple of apartment REITs -- Post Properties Inc. and Summit Properties Inc. -- have trimmed their dividends. But Highwoods has become the first office REIT, causing many investors to reassess and re-evaluate the safety of the dividends in all of their REIT holdings.
Under REIT rules, REITs must distribute 90% of their taxable income to shareholders as dividends. And currently, there are a number of companies whose property cash flows are falling short of the capital needed to fund their dividends. Some are putting off capital expenditures to hoard cash while others are selling off non-core assets to raise cash.
Jon Fosheim, a principal at buy-side firm Green Street Real Estate Advisors of Newport Beach, Calif., had included Highwoods in his top five list of likely candidates to trim their dividends. Rounding out his top five are Associated Estates Realty Corp., Archstone-Smith Trust, Gables Residential Trust and Chateau Communities Inc.
Deutsche Bank analyst Louis Taylor names Reckson Associates Realty Corp. and First Industrial Realty Trust Inc. as companies that could face dividend cuts sometime in 2003. And if the economy doesn't start to recover until next year as many project, Taylor said Equity Office Properties Trust and Arden Realty Group Inc. could face dividend cuts in 2004.
Some retail and broader-market investors have jumped into REIT stocks over the past couple of years for the healthy, attractive dividend yields the group offers during this volatile economic environment. For those investors, dividend cuts could serve as a wake-up call that the dividends aren't as safe as first thought and that careful assessments are needed.
Roman Ranocha, an equity analyst at AEW Capital Management LP, which holds shares in REITs, said he believes most investors have already priced the risk into the stocks.
Even when Highwoods trimmed its dividend, its yield declined from 10% to about 8%, which is "still more than any other alternative investment out there," he said.
Mr. Ranocha said he chooses REITs based on cash flow, not dividend yield. If cash flows are healthy and stable, then the REIT is able to use that cash to either pay its dividend, acquire new assets or buy back stock -- all of which will help the REIT to grow and deliver stable predictable total returns, he said.
Green Street's Fosheim said he recommends REITs based on valuation, not dividend yield. In some cases, he said, he has buy recommendations on stocks that may be at risk of cutting their dividends -- such as Archstone, Gables and Chateau -- because the valuations are so low.
On the other hand, he said there are some REITs, such as Sun Communities Inc., Public Storage Inc. and Developers Diversified Realty Corp., whose dividends are extremely safe, and yet he rates them at hold because of their high valuations.
Deutsche Bank's Taylor estimates about 15% of REIT investors are retail investors who bought REITs solely for their dividend yield. The remaining 85% are largely institutional investors who look at cash flow, valuations and other factors in addition to yield when investing.
Mr. Taylor doesn't hold shares in Reckson, First Industrial, Equity Office, or Arden. However, his firm has had an investment-banking relationship with Equity Office and First Industrial over the past 12 months.
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