In an effort to keep as much cash in their coffers as possible, real-estate investment trusts are now offering dividends comprised partly of company stock.

Vornado Realty Trust (VNO) and Sunstone Hotel Investors Inc. (SHO) both announced revised dividend polices late Wednesday that combine stocks and cash. Analysts say this appears to mark the first time REITs are taking advantage of an IRS rule allowing such a dividend structure. And it's likely to kick start a trend as REITs struggle to preserve cash amid a continuing credit crunch and steep stock declines.

Paul Adornato, an analyst at BMO Capital Markets, noted the Internal Revenue Service recently increased the percentage that a REIT can pay its dividend in stock to 90% from 80%.

"Before this (financial) crisis erupted, I did not recall seeing any REITs that have taken advantage of this."

Since late October, numerous REITs opted to cut or suspend their dividends as a broader market meltdown drained liquidity and hindered debt refinancing. REITs were established in the 1960s to give individuals an easy way to invest in income-producing real estate. The companies, which typically focus on distinct areas of real estate such as offices, retail properties or apartments, pay no corporate income taxes as long as they pay at least 90% of their taxable income to investors as dividends.

"The current liquidity crisis may have caused industry folks to go back and read the fine print on the REIT legislation," Adornato said, adding the dividend structure has more appeal in the current environment.

Vornado Realty said it will retain about $390 million this year by distributing 60% of its dividends in stock and 40% in cash. The company said its next quarterly dividend in the amount of 95 cents a share will be paid March 12.

As of the end of the third quarter, Vornado had $1.5 billion of cash and $2.6 billion of untapped revolving credit facilities. Vornado has $400 million of refinancing needs in 2009 and a further $1.1 billion in 2010.

"The only difference between the new VNO dividend policy and a 'real' dividend cut...is that VNO shareholders will now have more pieces of paper representing ownership of the same economic pie," wrote Green Street Advisors Analyst Michael Knott in a report.

He said the shift in dividend strategy will add 25% to the company's cash balance and further strengthen a large and relatively secure balance sheet.

"The change in common dividend policy is surprising in light of the 5.6% increase announced in October '08," Knott wrote. He noted that investors are concerned about the outlook for Vornado's New York office and retail properties.

Meanwhile, Sunstone Hotel announced its dividend will consist of approximately $7.3 million in cash and about 5 million shares of the company's common stock.

"This is a trend we would expect to hear from other lodging REITs going forward," said C. Patrick Scholes, a lodging analyst at FBR Capital Markets. "If they pay stock, they don't have to pay cash and cash is king."

Scholes said the lodging REITs should still be profitable in 2009 and noted that investors have the option to sell those new shares and convert them into cash.

BMO's Adornato said that any company needing to shore up its balance sheet would have more incentive to pay more of its dividend in the form of stock rather than cash.

Vornado's share price dropped 4% to $48.53 in recent trading and fell roughly 30% last year. Similarly, Sunstone's slipped 4.84% to $4.91 mid-afternoon and lost about 66% in 2008. Such declines occurred amid a rather brutal year for the REIT sector overall which posted a negative total return of 38% last year.

"The Vornado announcement...really forces the industry to do some soul searching to determine what its (appeal) will be," he said, noting that Vornado is the first major REIT to pay part of its regular dividend in the form of common stock. "The notion that REITs are lock solid income vehicles may be challenged."

-By A.D. Pruitt, Dow Jones Newswires, 201-938-2269, angela.pruitt@dowjones.com

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