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.

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.

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.

U.S. Industrial/Office REITs – Prospecting The Best Performing REIT Stocks

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