One of the most appealing aspects of owning real estate investment trusts (REITs) is their lucrative dividends. This unique asset class is designed to deliver large cash payments to its shareholders (literally, it's in the federal tax code). If a REIT can't pay its dividend, though, then the value proposition is nowhere near as attractive.
Empire State Realty Trust (NYSE: ESRT) may own one of the most iconic office buildings in America -- the Empire State Building -- but it's still office property that no one's frequenting during coronavirus lockdowns. So should investors be worried that Empire State's dividend -- which currently yields 6.3% at the time of this writing -- is at risk of getting cut? Let's take a look at how the company has been handling the downturn and whether it has the financial fortitude to see it through the coronavirus without cutting its payout.
Rent in the time of coronavirus
There are three questions that any commercial real estate owner or an investor in REITs is asking themselves right now:
- Will tenants remain in business through coronavirus-related shutdowns?
- Will tenants be able to pay rent even if they do remain in business?
- Do I -- or the REIT I'm investing in -- have enough cash on hand to cover any tenant shortfalls in the interim?
Just about every REIT management team has gone out of their way to highlight to investors the scope of the coronavirus's impact and how the trust's portfolio of properties is built to handle it.
In Empire State's case, the impact has certainly been noticeable, but it has been manageable thus far. According to its most recent investor presentation, collections in April and May were 80% and 75% of total rent due, respectively, with a significant dropoff in collections from retail-related tenants versus office tenants.
Management noted, though, that it was able to negotiate with tenants to apply security deposits to cover rent expenses during this time. Under this agreement, tenants will be able to draw on their security deposit to pay rent and pay that back over an 18-month period. It also changed many of its small-business retail clients from fixed rent charges to a percentage of business rent and will pay back the difference in the future. As a result of these two initiatives, total collections for April and May jumped to 93% and 90%, respectively.
Another thing that Empire State's management is quick to point out is its tenant profile. Its tenant portfolio is so diverse that no group of companies in a single industry accounts for more than 20% of total rent collections. Furthermore, many of these clients are multibillion-dollar companies themselves that aren't likely to skip out on rent payments. Management has even focused much of its expansion efforts on working with its high-growth clients.
Cash coverage through a downturn
So the company has a large coterie of clients that aren't likely to relocate in the middle of the night, and so far rent collection has been decent enough to not be too concerned about the short-term future. That still leaves question three above unanswered.
It's hard to say how long its properties will run at limited capacity because it involves knowing the work-from-home protocols of all its tenants. One proxy we can use, though, is management's plan to run the Empire State Building's Observation Tower. Management expects to reopen the observation tower on July 1, 2020, but it will run at 40% capacity until March 2021. Throughout next year, management intends to scale up capacity such that it will be back at 100% capacity by January of 2022.
Using this as a rough guide for the rest of the business, it's pretty safe to say that Empire State Realty will likely need to keep some form of rent relief going for quite some time.
Thankfully, Empire State's management has the financial firepower. With about $1 billion in cash on hand and no long-term debt due until 2024, there's a lot of leeway for the company should rent collection get worse. Keep in mind that Empire State Realty is a $2 billion market-cap company, so $1 billion is a massive cash pile relative to its size.
The bottom line
Based on the company's financials, Empire State appears to have the properties, the tenants, and the cash on hand to pay both bills and its shareholders for the foreseeable future. With curtailed operations continuing for more than a year, though, investors certainly shouldn't expect any big bumps in its dividend payout.
The longer-term safety of its dividend is predicated on two things, though:
- The novel coronavirus remains relatively contained in the New York metropolitan area and the city can continue on a gradual path to reopening.
- Companies with a prolonged work-from-home policy experiment don't permanently lower their office footprint. While many people will want to see a return to normalcy, there is a chance of companies re-examining how much they spend on office space.
Should either of those two things change in the long run, then office rental rates could see some pressure. Investors would then want to re-evaluate Empire State Realty Trust's dividend.