Douglas Emmett Cuts Dividend to Prioritize Share Buybacks

Douglas Emmett, an office REIT focused on class-A properties designed for smaller tenants in the Los Angeles (about 90% of rent) and Honolulu (10%) areas, sliced its dividend by over 30%.

The cut came as a surprise, with the REIT boasting a healthy payout ratio under 70%, carrying less than 15% variable-rate debt, and facing no debt maturities until the end of 2024. 

Office utilization was estimated to have improved to over 80% of pre-pandemic levels in recent months, too.

But with the stock's forward price-to-AFFO (adjusted funds from operations) ratio, a metric similar to a P/E ratio for REITs, cut in half this year to a paltry level near 9, management seems to have grown weary of DEI's depressed valuation.

Rather than pay its full dividend, Douglas Emmett has an opportunity to buy back its shares at over a 10% cash flow yield, an opportunity the company has chosen to prioritize with a $300 million share buyback program announced.

Douglas Emmett was already retaining a sizable amount of cash flow after paying all capital expenditures and the dividend, around $60 million in the first nine months of this year, and has about $280 million in cash on hand. For perspective, the annual dividend was just under $200 million before the reduction.

Those numbers highlight how surprising the dividend cut was and that the decision to pivot towards buybacks was more of an offensive move by management to capitalize on the stock's unusually weak valuation. 

The REIT will now retain around $130 million of cash flow annually, assuming profits remain flat. So share buybacks can be self-funded over time and not require further leveraging of the balance sheet. This gives management more flexibility to pursue opportunistic acquisitions as well.

Douglas Emmett's payout ratio is going to drop to a remarkably low rate of around 45% of AFFO following the cut and could push even lower as occupancy trends improve and the share count is reduced.

With such robust dividend coverage following the reduced payout, we wouldn't be surprised to see Douglas Emmett increase the dividend in the next year or two as the share buybacks fade.

Not to mention, REITs are required by law to distribute at least 90% of taxable income to investors, making it hard for the payout to remain at the reduced level, especially if earnings improve.

As such, we are reaffirming Douglas Emmett's Safe Dividend Safety Score for the reduced payout.

While we wish we could have been ahead of the news on this one, an abrupt shift in capital allocation priorities is hard to forecast. Even so, we are using this as a learning experience and remain confident in our scoring system's long-term track record.

Shareholders wondering what to do with their stock may want to continue holding Douglas Emmett given the REIT's depressed valuation. 

While your income took a hit, that may more than be offset by a rising share price which is already up almost 4% today – an unusual price movement following a dividend cut.

Overall, Douglas Emmett looks well-positioned for further share price gains and a growing dividend as long as workers continue to trend back to the office and the long-term economic outlook points upwards.

We will continue to monitor Douglas Emmett and the other office REITs as the industry outlook remains cloudy, providing updates as needed.