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The office real estate sector has endured its fair share of bad news over the last 24 months, but unfortunately, there is more of where that came from. Office REIT Paramount Group Inc. just sent more shock waves through the market by announcing that it will suspend quarterly dividend payments to investors. That means Paramount shareholders will not receive their next scheduled dividend on Oct. 15, 2024.
Ironically, Paramount announced the dividend suspension on Friday, September 13th, making it a most unlucky day for its shareholders. Finding out their REIT is suspending dividends always comes as bad news to investors. However, the short notice they've gotten from Paramount that their expected quarterly dividend isn't coming next month is like adding insult to injury.
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Paramount has paid dividends of $0.1050 per share to investors three times this year, but management now claims paying it next month would consume almost all the REIT’s taxable income. The REIT explained its decision on X (formerly known as Twitter), saying, "The decision by our Board of Directors to suspend our regular quarterly dividend aligns with our commitment to fortify our balance sheet and maintain the utmost financial flexibility."
Paramount's troubles illustrate the strength of the headwinds that have roiled the office sector since the pandemic sparked a shift to work-from-home employment. Once that "temporary" switch became permanent for tens of thousands of office workers nationwide, it left what used to be reliably profitable submarkets of New York, Washington, D.C. and San Francisco suffering from double-digit vacancy rates. Unfortunately for Paramount and its shareholders, most of its assets are in those markets.
The spike in vacancy rates came at almost the same time interest rates began rising, a phenomenon that makes it difficult, bordering on impossible, for office REITs to refinance their debts. Many of the troubled assets in the office market were acquired when interest rates were between 1% and 3%. Those low rates encouraged fund managers to go on a buying spree, but there was always one potential hang-up.
The maximum term on most commercial loans is 15 years, meaning many office REIT assets must be refinanced at least once to pay off the original loan. Unfortunately, refinancing at today's rates (between 6-7%) almost doubles the REIT's debt service when many REITs struggle to find tenants without lowering rents and offering concessions.
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Complicating matters further, the value of a commercial asset is tied to how much money it generates on a dollar-per-square-foot basis. So, lowering the rent to maintain occupancy is like robbing Peter to pay Paul. It depresses asset value at a time when REIT fund managers need it to be as high as possible. According to CBRE's Q2 2024 report, the office vacancy rate in the markets where Paramount's assets are concentrated ranges between 18% and 36%.
Banks holding the paper on these properties are hesitant to refinance. There is still some doubt about whether the sector will recover and banks don't want to throw good money after bad. Even if they refinance, the additional debt service from the higher interest rates would gobble up capital that could have been shareholder dividends. This is the rock and hard place that office REITs like Paramount find themselves stuck between.
When REITs get squeezed for cash, investor dividends can end up on the chopping block. It's always a painful decision for fund managers to suspend dividends, but it's not necessarily the end of the world. Some of the world's largest REITs, including Blackstone, have had to suspend dividends in recent years. Eventually, many of them began paying dividends again. With that said, Paramount shareholders are hurting right now.
However, REIT investing still has several sectors where investors earn dividends and grow wealth. Data centers, telecommunications and health care are just a few examples of sectors with intriguing offerings. In the meantime, consider the situation at Paramount when contemplating risk and conducting due diligence. Dividends are always nice, but unfortunately, they are never guaranteed.
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This article An Unlucky Friday The 13th For Investors After This REIT Suspends Its Quarterly Dividend originally appeared on Benzinga.com