Over the past week, we’ve seen the emergence of externally managed REITS in our weekly best performing stocks. Ashford Prime, CorEnergy Infrastructure, Government Properties, Ashford Trust, and New Senior Investment rounded out our top five companies. With the exception of CorEnergy, which is suffering from energy low prices, they have been impacted by activists’ attacks over the past twelve months.
Although Montgomery Bennett, which is from both Ashfords, has developed a negative sentiment from investors recently, the Portnoy family (who runs four REITs in different sectors – Government Properties, Select Income, Senior Housing Properties and Hospitality Properties) took their turn last year, thanks to several controversial moves in terms of corporate governance. In March 2015, the family disarmed a hostile activist by having Government Properties purchase Select Income shares owned by the activist. In June 2015, the Portnoy family made all of their four managed REITs buy stakes in their external advisor, RMR Group. Obviously, the Portnoy family retained voting control over RMR.
I’m not going to assemble all the arguments against externally managed companies here and ignore some of the good facts. As an investor who is aware of my biases, I acknowledge that I have a bias against externally managed companies. I’ve noticed that some other investors have the same thoughts, too, but unlike them, I’m going to go ahead and go over the positive and negative aspects.
For instance, did you know that of the Portnoy family’s managed companies have maintained or increased dividends since their inception? A couple of weeks ago, I featured Senior Housing Properties and mentioned a few of the things I didn’t like about the company. One thing that I do like is that the company has distributed same or growing dividends for the past 16 years. Government Properties has done the same for the past six years.
In fact, Government Properties has been the third best returning REIT stock this year, following CorEnergy’s whopping performance and Seritage Growth’s spike, even though the REIT has a meager yield of 2%. Since it bottomed in February, Government Properties has rallied and is currently trading at 8x FFO, which is still lower than its historical multiples.
Additionally, the company doesn’t seem to show any signs that it cut its dividends in the short term. The dividend yield is currently at 9.5%, but its FFO payout ratio is at a comfortable 71%. The company also holds an investment grade credit rating from Standard & Poor’s, so it has kept its servicing costs under control.
Finally, Government Properties’ tenants are primarily U.S. federal and state government agencies, which are an unquestionably secure rental income. 93% of their rental income is sourced from the U.S. government, 12 state governments, the United Nations, and two municipal tenants. With 71 properties in 31 states, they are geographically diversified. Although government agencies tend to sign long-term agreements (between 10-20 years), the average remaining term lease is around 5 years. More than 60% of the leases will expire by 2020, but Government is confident they will be able to retain their tenants.
Regardless, this hasn’t changed my mind. Beside management entrenchment, the other caveat is that by investing with Government, you are exposed to Select Income. Select Income Investment represents about half of Government’s market cap. Last year, about a third of their FFO was sourced from Select Income dividends, so its dependency on its sister company is undeniable.
Source: Government Properties Income T(NYSE:GOV)
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Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.