Vornado's Dividend Suspension Reminiscent of 2008-09 Liquidity Crisis

Vornado Realty Trust (VNO), a real estate investment trust (REIT) whose holdings are concentrated in office and street retail space in New York City, announced today that it is suspending its dividend through the end of the year, causing its stock price to plummet.

Two main groups of Vornado investors who may have reacted in the same way--by selling, quickly and decisively--likely did so for very different reasons.

The first group is investors (generally individuals, and especially retirees) who value REITs (and certain other companies, such as MLPs) for the very strong, consistent dividend yields they provide. The average dividend yield across exchange-traded equity REITs is 4.36%, and one of the things that dividend-oriented investors love about REITs is that they don't have a great deal of discretion to adjust their dividend payments: by law they must distribute at least 90 percent of their taxable income to investors in the form of dividends. (Equity REITs are companies like Vornado that own properties, as opposed to mortgage REITs, which own, well, mortgages.)

Vornado just exited the field of dependable dividend payers, so its stock price suffered in part because dividend-focused investors switched to other dividend-payers on which they could still depend.

The second group of investors, though, is quite different from the first: it is composed of investors (often institutional) who value REITs not just for their dividend but for their total return--that is, dividend plus stock price appreciation, which has averaged 10.68% per year over the past 40 years. Those investors concentrate on whether the REIT's management is making good decisions: not simply maintaining a steady stream of dividends, but paying attention to whether there are better uses for a portion of their earnings. Did those total-return-focused investors react in the same way as the dividend-focused investors? Possibly, but not necessarily.

Many REITs reduced their dividend payments during the Great Financial Crisis of 2008-09. At that time I published an academic paper, which I co-authored with Dr. William Hardin, PhD, FRICS (Dean of the Florida International University College of Business) and Zhonghua Wu (Professor, also at FIU College of Business), entitled "REIT Dividend Policies and Dividend Announcement Effects During the 2008–2009 Liquidity Crisis."

What we found was very interesting: "REITs that cut or suspend dividends experience positive cumulative abnormal returns during the post-announcement period," meaning that investors actually reacted favorably to the dividend cut. (That was "after controlling for the potential influence from simultaneous funds from operation announcements," which means this: if two REITs had equally disappointing news regarding their operational earnings, but one preserved its dividend while the other trimmed theirs, then investors preferred the REIT that trimmed its dividend.)

Why would that be? What we believe it came down to was that some REITs fully appreciate how severe the liquidity crisis was, and understood that they had a paramount need to preserve cash because they could not be sure that other sources of capital (banks, equity offerings, etc.) would be available to help them meet debt obligations when they came due. Other REITs didn't fully appreciate the severity of the liquidity crisis, and continued to pay dividends at a rate that had seemed appropriate during non-crisis times.

In effect, the total-return-focused investors saw a dividend cut, in those circumstances, as evidence that the REIT's management was capable of perceiving how market risks had suddenly changed, and responding in a way that would enable them to return to making good investments when the crisis had passed. In contrast, those total-return-focused investors saw a continued payment of the previous dividend as evidence that the REIT's management was either incapable of understanding the changed market situation or unwilling to make a decision that would get the company back to normal quickly following the crisis. As we summarized our findings, "The positive market response over the post-announcement period supports the notion that dividend decisions convey information to investors."

There's a caveat, though: some companies that suspended their dividends, rather than simply cutting them, saw their stock prices hurt badly. A reasonable interpretation is that the total-return-focused investors saw that action as evidence that managers at those REITs saw the situation as even worse than investors had realized. There weren't enough data points during the 2008-09 liquidity crisis to say with confidence whether that story applied, but it's reasonable.

That's where today's Vornado decision comes in. It's possible that the total-return-focused investors actually rewarded Vornado for responding appropriately to the company's own liquidity concerns, even though there isn't an economy-wide liquidity crisis as there was in 2008-09. It seems more likely to me, however, that the total-return-focused investors--like the dividend-focused investors--decided they needed to sell their Vornado holdings because they took the company's action as evidence that its liquidity situation is worse than they realized. Again, as we said in our paper, "dividend decisions convey information to investors"--but it's not always information that instills confidence among investors in management's ability.

I don't have any inside information regarding Vornado's financial situation, so I can't say with any confidence whether suspending their dividend was the right thing to do--in which case I should buy their stock while its price is discounted--or whether suspending their dividend was a sign of worse-than-expected weakness. At times like these, I'm just glad that my own real estate investments are concentrated not in office, not in street retail, not in New York City, but in residential communities in the Virginia-to-Texas arc.

#vornado #vno #realestateinvesting #middleburgcommunities