Dwindling Opportunities in Office REITs

  1. The majority of the REIT stock appreciation took place in the months of June and July.
  2. This then affected the office REITs, which saw an appreciation of 16% where 10% took place during those two months.
  3. Many office stocks, such as First Potomac and City Office have been clearly undervalued.
  4. First Potomac and City Office are small caps that have to prove that can deliver good results.

chart01It is fair to say, that the share price appreciation of most REITs is a very recent occurrence. This follows the macroeconomic scenario that was laid out by the Fed in May. Many investors have started to chase REITs, which has created a spurring of rapid stock appreciation across all REIT sectors. What we’ve seen in both June and July is an 11% rally in share prices, while the year to date return is 19%.

Office REITs, which up till now have been neglected by brighter sectors, like date centers, have felt the same effect. These Office REITs rose up to 16% this year, and 10% of that took place between June and July. This has resulted in opportunities in this sector to be harder to find.

There are very few REITs that have been clearly undervalued. First Potomac, which is focused on the Washington DC market, and City Office, which is concentrated on growth cities, have both lagged behind its peers in terms of the returns and have demonstrated lower multiples. While Office REITs trade an average of 25 times AFFO, these REITs are only traded around 15 times.

chart02The warning is that both small cap REITs should have to prove what they came for. First Potomac experienced a recent change in leadership and at the same time, their portfolio has been going through a radical makeover. City Office, on the other hand, has been a public company since 2014 and internalized its management last February.

To summarize, over the last couple months, there has been a dramatic dwindling in every sector. This decrease in number of undervalued stocks has even affected, what has come to be known as ‘neglected’ REIT sectors, such as the office sector.

Source: First Potomac Realty Trust(NYSE:FPO), City Office Reit, Inc.(NYSE:CIO), Fast Graphs

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author is long FCH, XHR, CLDT, PEB.

This Office REIT’s Entry Point

 

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I have had an overwhelming feeling that healthcare and hotels reits are the only good entries left. Over the last few months many companies, with good fundamentals have reached high multiples. This has left fewer options on the table, and one of the last groups left has been net lease retail. Since this list has begun to slowly decline, I have found myself starting to weigh the risks over rewards more often and reviewing less popular picks. For example, just last week I picked Spirit Realty Capital, from the net lease group. I picked Spirit Realty because it showed a chance of potentially having a turnaround in the market.

This week, we’ll feature Whitestone, which is another option to the overcrowded shopping center sector. This company displayed some risks that could have some potential negative impact on their stock performance. But, today, I will look at Government Properties Income, an office REIT that is part of our second tier group. That is, for over five years, this company has been distributing the same or increasing stocks without interruption.

chart02During the last twelve months, the Government share price was down, and more recently up. It has an AFFO multiple that has been around 10 while its dividend yield is at 9% making it one of the highest yields. Despite the recent appreciation, this stock still has a 20% upside just from looking at its past performance.

Government Properties, which has been externally managed by the Portnoy family, is currently faced with two main concerns. The most compelling is that a portion of their portfolio is currently expiring in the short and mid-terms. Meaning that over the next two years 26% of this company’s portfolio will expire. In addition, since this is an election year, there will be a certain degree of uncertainty over the projected federal government expenses.

One of the management’s main goals has been to renew as many of their leases as possible, which they accomplished in the Q1. With their new leasing, the profile has improved, as opposed to the same time frame of last year. The occupancy levels have also been steady over the last year.

At the same, though, we are not sure about their debt profile, since those metrics have deteriorated. The ratios between debt to adjusted EBITDA and the total debt to total gross assets have increased. But the deterioration, so far, has been in small increments and has not yet threatened its public debt covenants. The company hold an investment grade rating.

chart03In regards to the elections, the management has yet been able to tell which direction the market will go. As of right now, they have also decided to not outline possible scenarios. With a potential change of party on the horizon, this will certainly cause a splash in the federal government. As a result of this, it will add more uncertainty to the expiring leases.

In conclusion, with so many declining opportunities that are outside the healthcare and hotel realms, Government Properties, with their high dividend yield and decent record, seems to be a good entry point into the market.

Check our previous post on Government Properties.

Source: Government Properties Income T(NYSE:GOV), Spirit Realty Capital, Inc.(NYSE:SRC), Whitestone REIT(NYSE:WSR)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

What’s to Love and Hate about Government Properties?

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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.chart02

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.

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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.

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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)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

The Exact Opposite of What Investors Expect From a REIT

chart01First Potomac Realty Trust is the exact opposite of what investors expect from a REIT. After all, investors like REITs because of their slightly increasing dividends and growing funds from operations per share. However, First Potomac has been the opposite of this epitome. First Potomac, an office REIT focused on Washington DC, has decreased its dividends and Core FFO per share since the Great Recession of 2008/09.

Slashing dividends is never good news. Even with a dividend payout ratio to AFFO around 80%, First Potomac decreased its annualized dividend from $0.60 to $0.40 this February, alleging this move will save $12 million. This is a representative cut. Although the company is projecting flat FFO per share in 2016, the company appears to be bracing itself for a potential steep dive in funds from operations.

Indeed, management rated almost half of its square footage as either non-core or as market/sold. In February, they released a presentation in which they projected that between the second half of 2016 and the entire year of 2017, net operating income could be cut between 20-25% following the sale of those assets and purchase of new ones.

If you’re a hopeful First Potomac shareholder, I would definitely review my expectations because rough times are ahead for you, while First Potomac shrinks. Last month, when I featured the Bethesda, Maryland based REIT, the company had welcomed a new CEO. At that time, I mentioned the company appeared to be drifting and needed to find a clear direction. While I welcome a strategic plan, they will keep shrinking their portfolio.

Over the past five years, First Potomac decreased in size from 13 to 8 million square feet. Another significant size reduction makes me wonder when things will finally look up for First Potomac. The company will use the proceeds of the sale to reduce debt, strengthen balance sheets, repurchase stocks, and reduce corporate expenses. As a result, they see themselves having a reduced level of NOI and debt in 2019.

The bright side of this asset reduction is that they must have chosen the right assets to sell. While occupancy in DC has decreased, occupancy at First Potomac has increased. This means they have identified what is working, verified if there are similar potential assets in the portfolio that could do as well (repositioning), and set aside those that are not working. Unfortunately, for First Potomac, this exercise has proven to be painful and lasting for shareholders.

Over the past five years, their share price decreased by 42%. Their current share price is 30% below its 52 week high and its AFFO multiple is just under 10x, which indicates their stock in undervalued.

When it comes right down to it, all I see right now is reduction, so I’m not interested in First Potomac for now.

Source: First Potomac Realty Trust (NYSE: FPO)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

U.S. REITs: Longest Dividend-Paying Stocks — Lexington Realty Trust

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Several reasons have led us to believe that Lexington Realty Trust, a net lease REIT mostly in Office/Industrial, has become a good, reliable purchase for dividend lovers. First, it is part of the group of most consistent dividend-paying REIT stocks (not many REITs have distributed dividends for 22 years in a row). Second, it has a dividend yield above the equity REIT average of 8.1%. Finally, it looks undervalued if compared to its closest peers, including office, industrial and net lease REITs.

From its first dividend in January 1994, Lexington never interrupted the distribution of quarterly dividends. Such consistency can be one of the most obvious signs that management has been committed to its shareholders. Since it went public in 1993, the company is the result of several mergers. Regardless, 22 years of consecutive dividends is a very good track record, even though they slashed dividends in 2008 to accelerate the deleveraging of the company and paid dividends mostly in shares in 2009.

chart02A potential risk to its dividend record is an ambitious plan to make over its portfolio. With between $600 – $700 million of dispositions planned for 2016, including a sale of New York City land, the FFO per share in 2016 will reduce to $1.05, as opposed to $1.10 in 2015. However, if everything works as planned, we doubt the company will have any issues in maintaining the current level of dividends. Its current payout ratio is conservative, just around 60%.

chart03The good thing about this plan is that management will mitigate another potential threat to dividends by reducing the leverage level. In Q4, they posted a higher than average debt level of 57% of the capital structure. Although some would argue that an environment of low interest rates is a good time to maximize debt levels, still you don’t want to threaten the company’s liquidity level. Since the dispositions’ proceeds will serve various purposes — to pay down debt, acquire properties that fit their objectives, and repurchase stocks — we believe that the new debt level will not go down beyond 50%.

chart04Lexington management has been skillful in maintaining a resilient portfolio. The company has been moving away from Office and has increased its exposure to Industrial properties. Also, a significant part of the revenues is now sourced from long-term leases, a likely consequence of investing in build-to-suit and sale-leaseback, single-tenant properties. In the end, they enjoy a portfolio that is diversified and well balanced in terms of expirations.

chart05The company valuation metrics indicate they are undervalued. In terms of dividend yield, the company tops any industrial REITs with its 8.1%. Compared with Office REITs, the company would have the third highest yield, after Government Properties and Select Income. Its AFFO multiple is lower than most peers.

It is natural that a non-pure play REIT such as Lexington usually looks undervalued because it is harder to compare. The dual nature of the company, especially during a transitional period, makes some investors step back; but during periods like this is when savvy investors make good purchases.

In summary, I’d buy Lexington for its dividend consistency and few threats to this record. The portfolio transition is long term and represents a potential upside to the stock.

Source: Lexington Realty Trust(NYSE:LXP)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

First Potomac Needs Strong Signal of Growth

chart01Over the past few weeks, First Potomac Realty Trust has been one of the REIT stocks that have experienced a drop greater than 10%, joining a group that includes the lodging sector and ‘anomalies’ such as NorthStar Realty Finance and the Ashford REITs. In fact, Potomac, an office REIT focused on the Washington DC area, has been found to feature great dividend yield, and growing net operating income and FFO per share. The FFO multiple is currently below the sector average therefore the question is, is it worth pursuing it?

From its 52 week high, the stock price has been down 29% and this year, the share price has dropped by approximately 18%, which is more than majority of REITs indices and its office peers. For instance, the Vanguard REIT ETF dropped by 4% this year.

Potomac opportunity lies in the reason that their portfolio has been repositioned over the years. This has resulted in the company becoming leaner therefore decreasing the square footage from 13 million in 2010 to the current 8 million. This has also increased the average lease rate from $9 to $17 per square foot. Also, Potomac’s occupancy has increased while Washington DC region office occupancy has decreased.

chart02Potomac continues its repositioning. Out of their total capitalization of $1.6 billion, they will be disposing of $200 million in assets as part of a plan to get rid of the non-strategic assets. Also, last November, additional changes were made in relation to replacing the management. The founders have retired from executive functions, providing the company with fresh enthusiasm which will take it to great heights.

Therefore, what’s missing?

Currently, the organization is not sending a clear direction to where it’s headed. Is it shrinking or resuming growth? After the sale of the first properties which are associated with the $200 million disposition plan, the company will be using the proceeds to retire its preferred dividends. Recent history of shrinkage and new leadership puts a question mark on growth plans.

Sentiment towards the office sector has been weak, but in some places like Washington DC area, office-occupying jobs have increased. From an investor’s standpoint, weak sentiment is helpful especially when finding good opportunities.

chart03Due to lack of growth, the company has not been able to increase its dividends since 2008. In fact, it’s been normal to find office REIT stocks which have not increased their dividends over the past few years.

In reality, the company has reduced its dividends from $1.36 to $0.60 a share for the period 2008 to 2013. From then, the dividend rate has been flat despite the 60% FFO payout ratio. The company has wanted to keep a cushion for the changes it has promoted.

In conclusion, although it is possible to make a quick buck on Potomac for being undervalued, I have not yet been able to see a strong commitment to promote the company’s growth.

Source: First Potomac Realty Trust(NYSE:FPO), Vanguard REIT ETF(ARCA:VNQ), Fast Graphs.

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

Columbia Property Trust Transition Brings Opportunity to Investors

chart03With Columbia Property Trust’s transition underway, there are numerous positive plans being made and carried out. Some of the more notable including the recent sales of property on the outskirts of Washington D.C. (property situated near Dulles International Airport), the company’s transition into areas like gateway cities’ high barrier office markets, and its share price that’s down almost 20% from March of last year’s peak.

The company has also made great strides in making itself more visible and attractive. One of the more significant noteworthy ambitious moves includes the transition from external management into a self-managed platform and the change in name from Wells Real Estate Investment Trust II to Columbia Property Trust.

chart01Along with the change in brand, the company was also listed as CXP on the New York Stock Exchange in 2013, while also changing the face of their business by transitioning its portfolio to infill markets in central business district (CBD).

With this new quality portfolio, the company has since been upgraded in ratings from BBB- to BBB. Due to all of the changes being made, investors can also see that the company is also clearly capitalizing on the investment concept that the suburban office is on the decline.

Though the trend against suburban office markets can be considered one of those urban myths, there’s a generational behavior change that explains this transitional period. For instance, the younger generation prefers living near places that provide public transportation and they see no need to have a driver’s license.

It is important to note the great recession contributed to these new trends since central business districts have recovered faster than suburban office markets. However, people should also realize that the majority of the jobs are still located in suburban markets and many are performing well.

chart02To that end, Columbia is left in a position to prove that they can handle the acquired assets in central business markets as well as the impending expiring leases that are coming up soon.

With all of this being said, investors should see Columbia as a long term bet, specifically if they believe in CBD portfolios. Also, because of all of their efforts, they are placing themselves in a good entry point for investors to consider.

Source: Columbia Property Trust, Inc.(NYSE:CXP), Fast Graphs, Yahoo!Finance

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.