Being humans, investors have a fondness for stories. It makes sense and there's not a whole lot you can do about this other than to make sure that you question the assumptions you make based on these stories. The story surrounding Washington REIT (NYSE: WRE) sucked me in years ago, but left me shortchanged. That story hasn't gotten any better since, given the reality of the situation. Here's what you need to know before buying Washington REIT.
Location, location, location
One of the old lines in real estate is that location is the most important thing to look at. And on that score, real estate investment trust (REIT) Washington REIT operates in a very attractive region. As its name implies, the landlord owns property in and around Washington D.C.
The seat of the U.S. government, Washington, D.C., has a lot going for it. For example, the REIT recently noted that the capital's unemployment rate was below the national average in November of 2020. That's not an uncommon thing, given high government employment and the need for larger companies (and other countries) to deal with the U.S. government on a regular basis. And while the region did lose jobs during the coronavirus pandemic, the hit was nowhere near as bad as other large cities in the United States. To put some perspective on that, D.C. lost half as many jobs as Chicago, New York, and Los Angeles.
Underneath that, Washington REIT has exposure to the office, housing, and retail sectors, providing diversification within the D.C. area. You know that diversification is good for your portfolio, but it can also be good for REIT portfolios. And the REIT sports a fairly generous 5.2% yield, given that the average REIT, using Vanguard Real Estate ETF (NYSEMKT: VNQ) as a proxy, yields 3.9% or so.
So, what's wrong?
The problem is that focusing on a strong region isn't enough to make a REIT a buy. At one point in its history, Washington REIT had amassed an incredible track record of annual dividend increases. But that streak came to an abrupt end in 2012 and the disbursement hasn't been increased since. What happened?
Leading up to the cut, Washington REIT owned an even more diverse portfolio, including office, apartment, retail, industrial, and healthcare assets. Management decided to sell off the industrial portfolio and then the healthcare business to reposition the portfolio shortly before handing off the CEO post to a new leader in 2013. I owned it during this period but sold after the dividend cut.
The question I didn't ask, but should have, is why did the REIT need a makeover if the region in which it operates is so desirable? According to the REIT, the goal was to highlight properties with more growth potential. That sounds great, but it suggests that the earlier approach, which led to decades of annual dividend hikes, was somehow faulty.
And the negatives of this makeover aren't immaterial, either. There was the dividend cut, for starters. But the portfolio also went from five sectors to three, and one of those (retail) is a scant 7% of the mix. This means Washington REIT is really just an apartment and office REIT. And while D.C. is a good region overall, it isn't immune to economic ups and downs. So investors don't avoid downturns, Washington REIT just won't get hit quite as hard as REITs focused on other regions -- a very different proposition. And now there are only two main property types in the mix to help offset such hits.
Meanwhile, if the portfolio rebalancing took place way back in 2012 and 2013, where's the growth that was supposed to come about? After roughly seven years of work, the dividend is still stuck at the same level it was after the original cut. Meanwhile, the third quarter of 2020 saw a funds from operations (FFO) payout ratio of a little more than 80%. That's kind of high given how long the REIT has had to reposition its business. Granted the world is still dealing with the coronavirus, but that just shows that Washington, D.C., isn't immune to the outside world. Makeovers take time, but Washington REIT's business shift just doesn't seem like it's been that great for dividend investors.
On the sidelines
Washington REIT says it has strong internal growth prospects, which may be true. But until the REIT starts to increase its dividend again, the story here just doesn't add up. Even though management has a compelling tale to tell, long-term dividend investors should probably stick to REITs that have better histories, and dividend histories, than Washington REIT.