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Is It Safe? Vornado's hidden dividend cut Add to ...

People invest in real estate investment trusts to reap rich cash dividends.

But Vornado Realty Trust shareholders haven't been so lucky lately. In January, Vornado started paying 40 per cent of its dividend in cash and the rest in stock to shore up its balance sheet.

That means investors who previously received 95 cents (U.S.) a share in cash are getting 41.5 cents in cash and 53.5 cents of Vornado stock. The 12 per cent drop in Vornado's stock this year has added to the sting, especially compared with the 2.1 per cent gain of the S&P 500 Index.

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Vornado, whose properties include 50 buildings in New York, has been hit hard by the falling value of commercial real estate. Investors will feel the pinch through a 3 per cent cash dividend yield, which is down from 6.85 per cent in the past year.

A return to all-cash payouts is unlikely until real estate prices and occupancy rates improve. The economic slump has taken its toll on real estate investment trusts, also known as REITs. In addition to falling property values, the industry loaded up with debt in recent years, much of which will need to be paid down or refinanced in the next three years.

U.S. REITs are required to pay 90 per cent of their income to shareholders as dividends. Weak earnings have made it difficult for Vornado to keep up with its hefty payout. On Wednesday, Vornado said first-quarter earnings dropped 67 per cent to 79 cents a share from $2.38 a year ago.

Funds from operations, a key profit gauge for REITs, tumbled to $1.63 from $3.27 in the first quarter. Vornado's funds from operations peaked at $5.89 in 2007 before falling to $5.16 last year. Analysts expect that amount to slide to $4.46 this year and $4.07 in 2010.

That's hardly a solid financial base to support an annual cash payout of $3.80. Investors looking for dividends might be wise to consider Equity Residential or HCP instead.

They offer dividend yields of at least 8.5 per cent, paid entirely in cash. Their shares are down more than 20 per cent this year, creating a potential buying opportunity. To be sure, Vornado has been taking steps to bolster its balance sheet.

In April, the company sold $710 million in stock and offered to buy back more than $500 million in notes that are due over the next two years. That might position the company to acquire smaller REITs that are struggling with debt.

Those moves could benefit long-term investors who can stomach what amounts to a dividend cut this year. Those who can't might be better off looking elsewhere in the market. TheStreet.com Ratings assigns Vornado a grade of C-minus, a "hold" recommendation.

Richard Widows is an analyst for TSC Ratings, which provides exclusive stock, ETF and mutual fund ratings and commentary based on award-winning, proprietary tools. Its "safety first" approach to investing aims to reduce risk while seeking solid outperformance on a total return basis.

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