Empire State Realty Trust (NYSE: ESRT) suspended its dividend in 2020 in the midst of the coronavirus pandemic. Taking the dividend to zero is never a positive development for a real estate investment trust (REIT) given that REITs are specifically designed to pass cash on to investors. That said, vaccines suggest that the worst of the pandemic is behind us, so it's fair to wonder what the future holds for Empire State Realty. Here are some thoughts on that.
1. Focus, focus, focus
One of the most important things for investors to understand about Empire State Realty Trust is that it has a highly focused portfolio. From a big-picture perspective that means it is keyed in on the New York City region. But it goes deeper than that, with nine of its 14 properties located in Midtown Manhattan. But it doesn't stop there: Just six of its properties accounted for about 75% of its rents in 2020. One property, its namesake Empire State Building, made up roughly a third of the top line.
This is a massive amount of concentration, which increases risk. And it helps explain why this office- focused REIT ended up suspending its dividend in 2020 as the coronavirus pandemic left big-city offices vacant. However, looking forward, the concentrated nature of Empire State's portfolio isn't something that can be easily changed. In other words, concentration risk is something that's likely to stick around for at least the next three years unless there's a major business shift (which seems unlikely).
During Empire State Realty Trust's fourth-quarter 2020 earnings conference call, management noted that it's planning to suspend the dividend through at least the first half of 2021. But there was some interesting nuance in that decision. REITs have to pay out 90% of their taxable earnings to maintain REIT status, which allows them to avoid corporate-level taxation. Empire State noted that it has cash but that it is losing money and, therefore, doesn't have to pay a dividend. So, instead of dividends, it's planning to buy back stock. That's a shareholder-friendly move but perhaps not one dividend-focused investors will appreciate in lieu of a cash dividend.
That said, assuming the REIT's business starts to recover over the next three years, including the results from the observation tower in the Empire State Building, dividends are likely to be reinstated sooner rather than later. That will be an important shift, but right now it's too soon to tell when that change will actually happen. Income investors will probably want to wait until the dividend is back before jumping in here.
3. Portfolio growth
Longer term, Empire State Realty needs to buy properties if it wants to diversify its portfolio and grow its dividend over the long term. On that front, the REIT thinks the New York City market is still trending lower, with the first quarter of 2022 likely to be the bottom. That means there's more potential downside for the company's business but also that growth opportunities might start getting more attractive. And, in fact, that's pretty much what CEO Tony Malkin said is taking shape, noting that the acquisition team has "begun to uncover more interesting situations."
But Malkin also described the current operating environment as a marathon, not a sprint. So Empire State Realty isn't looking to rush into anything and plans to take its time on the investment front. Given that there are still notable uncertainties related to the pandemic, that's probably a good decision. And the stock buybacks highlighted above indicate the REIT is still making use of its capital to build value for shareholders. So it's hard to complain too much about what management is doing here. That said, it is likely that the next three years see some deal activity, which would help get the REIT back on a growth trajectory, help diversify its portfolio, and, perhaps, support long-term dividend growth (once the dividend is reinstated).
Not for the risk averse
When you look at Empire State Realty Trust today, it's pretty clear it isn't a great option for risk-averse dividend investors. Indeed, the dividend is currently suspended and it has a highly focused portfolio. However, for more aggressive investors looking for a turnaround play, Empire State Realty Trust might be an interesting name to look at. The next three years are likely to include a shift back to a more normal operating environment, including acquisitions and, eventually, a resumption of the dividend. When that happens, more investors are likely to be drawn back into the REIT. But, as management made clear, this is a marathon, not a sprint, so it could take a full three years before things look "normal" again.