Unfortunately, KBS's success in raising money and buying property has not translated into a sustainable dividend for investors. Through the end of the third quarter, KBS had declared dividends of $56 million, but reported Funds From Operations of only $35 million. This means that KBS REIT II has strongly negative dividend coverage, and this is clearly not sustainable.
Furthermore, in its third quarter 10Q, KBS REIT reported an indicative portfolio capitalization rate of 4.8%, based on annualized third quarter NOI, excluding corporate-level cash of $66 million. This blended indicative 4.8% cap rate obviously does not support a 6.5% dividend, so it's not surprising that KBS has been borrowing to make up the difference between cash flow and distributions:
Through the end of Q3, KBS REIT II had actually borrowed $18.3 million to make up the deficit between cash flow and distributions, but it's not clear that KBS has a plan to bridge the dividend deficit. KBS REIT II had only $66.7 million of cash left to invest at of the end of Q3, and the KBS REIT II offering was scheduled to terminate on December 31st. As KBS points out in its 10Q, "If we are unable to locate investments with attractive yields while we are investing the proceeds of our ongoing initial public offering, our distributions and the long-term returns of our investors may be lower than they otherwise would."We made distributions to our stockholders during the nine months ended September 30, 2010 using a combination of cumulative cash flows from operations and debt financing...We have used and expect to continue to use proceeds from financings to fund a portion of our distributions until the proceeds from our ongoing initial public offering are fully invested.
Source: KBS REIT II 2010 Q3 10Q
With ten year treasuries on the rise, that 4.8% cap rate looks even less appealing than it did before, and if KBS REIT II really wants to fully fund its distributions with cash flow, they'll need to do more than just pay up for assets. Like most other non-traded REITs, KBS has been on a mad dash to capitalize on retail investors' fear of stock market volatility and their desire for income. However, if KBS is unable to make more sensible acquisitions in 2011, it could be almost impossible to cover that 6.5% distribution rate with ordinary FFO.