City Office REIT (NYSE: CIO) offers a fat 5.4% yield today, well above the 1.3% you'll get from an S&P 500 Index fund. But office-focused real estate investment trust (REIT) peer Franklin Street Properties' (NYSE: FSP) yield is an even juicier 7.1%. But before you jump at the higher yield, you need to consider a few facts.
1. Similar businesses
Both of these REITs do roughly the same thing. City Office owns a portfolio of around 60 office properties in Southern and Western states. Franklin Street Properties' office portfolio is focused on the U.S. Sun Belt and the Mountain West. It owns or operates 36 properties.
One of the key takeaways here, however, is that neither of these two REITs is focused on the big coastal cities that would normally fill the portfolio of larger office landlords. They are in secondary markets. There's nothing inherently wrong with that, but the dynamics are different. Right now, as companies explore moving operations toward smaller markets, City Office and Franklin Street could actually be relatively well positioned.
However, historically speaking, rent and occupancy levels have been lower and, at times, more exposed to economic downturns. It's probably too soon to suggest that secondary markets can stand toe to toe with cities like New York or Chicago.
Another important takeaway from the business comparison above is that neither City Office nor Franklin Street are particularly large. Franklin Street has a market cap of around $530 million, with City Office chiming in at $480 million. The former controls roughly 9.7 million square foot of space, while the latter operates 5.5 million square feet of office space. For comparison, office REIT giant Vornado has 26 million square feet in its portfolio.
3. Limited diversification
In addition to having small portfolios, City Office and Franklin Street also operate in very few markets. The bigger of the two is Franklin Street, which has offices in 10 states, but only three (Colorado, Texas, and Georgia) make up around 75% of the portfolio. City Office operates in seven states, with a slightly more diversified footprint. Its three largest markets (Florida, Arizona, and California), however, account for around two-thirds of its business.
In fairness, bigger office REIT players don't necessarily have material diversification, noting that Vornado is basically a New York City landlord, with some assets in Chicago and San Francisco. So what investors need to decide is what markets and regions are most attractive. In the end, neither City Office nor Franklin Street really stands above the other on this front.
4. The dividend seals the deal
The yield difference here has already been noted, but there's another important dividend disparity. City Office cut its dividend in 2020, while Franklin Street did not. That said, Franklin Street's $0.09 per share, per quarter dividend was well above its adjusted funds from operations (FFO), a REIT metric similar to earnings for an industrial company, of $0.04 per share in the first quarter. That suggests it's paying out more than it can afford and helps explain the higher yield. Investors are likely worried about the very real potential for a dividend cut.
City Office, meanwhile, has a quarterly dividend of $0.15 per share and posted adjusted FFO of $0.26 in the first quarter of 2021. Although investors don't like to see dividend cuts, it looks like City Office's reduction in 2020 has left it operating well within its dividend-paying means. On that score, City Office has a material edge.
Also worth noting here is that City Office has provided 2021 FFO guidance, which it actually increased slightly in the first quarter. Franklin Street is not currently providing FFO guidance, only telling investors how much property it hopes to dispose of during the year. City Office's outlook is obviously a bit more clear, and the dividend, assuming it doesn’t change, looks like it will remain well-covered.
If you have to pick
The truth here is that neither City Office nor Franklin Street are great options for risk-averse dividend investors. There are other choices with at least some office exposure (among far more diversified property portfolios) that have equally attractive yields and much more impressive records. A good alternative might be W.P. Carey (NYSE: WPC) and its nearly 5.6% yield backed by 24 years worth of annual dividend increases.
That said, if you insist on an office-only REIT and City Office and Franklin Street are the final pairing, City Office looks like it's in a better place to keep paying dividends right now.