A Debt-Free Spin-Off in a Traditionally Debt-Heavy Sector
What is one of the main problem with the REIT sector? The high debt level that many of the companies that operate in that sector maintain. One doesn't have to look any farther than the recently well publicized problems that the mall giant General Growth Properties went through and its subsequent filing for bankruptcy to see that a real-estate crash, high debt levels, and REITs don't go well together.
Well, what if I told you that I have found a REIT that not only has practically no debt, but is a recent spin-off, and pays a dividend of over 6%? Sounds pretty good, huh?
The company that I am referring to is Government Properties Income Trust (GOV). This REIT was spun-off from HRPT around a year ago. If only I had known about it then because the stock is up significantly since then. It still offers tremendous value.
As one would suspect, GOV is a REIT that rents buildings to the government. Fortunately most of its contracts are with the Federal government, which keeps growing and can print as much money as it wants, rather than state governments, which are having huge financial problems and many of which are required to have a balanced budget.
For those of you who aren't familiar with how REITs work, they aren't required to pay taxes but they are required to pay 90% of their earnings out to shareholders in the form of dividends. That's why GOV currently yields more than 6%. That's a pretty awesome yield in today's zero interest rate world.
Two of the key metrics to focus on when looking at REITs are companies' funds from operations (FFO) and their renewal rates. Both of these numbers are great for GOV. It currently trades at 10.9 times its estimated FFO and it has a 99%+ lease renewal rate.
As I mentioned previously, most REITs are very levered, but...GOV has practically no debt. As it levels up its balance sheet to more closely resemble other companies in its industry we will likely see a significant increase in its dividend, which in turn will attract more investors to the stock and likely cause its share price to increase. By purchasing GOV today you can ride a long as it raises dividends over the coming years. Without any leverage GOV is significantly safer than most other REITs are today. If you are ultimately uncomfortable with the level of leverage that GOV employs when it ramps things up, you can sell its stock at what will likely be a significant capital gain.
Just a few days ago, GOV announced that it plans to purchase 15 buildings from its former parent company HRPT for $231 million. GOV expects these properties to yield it an 8.9% annual return on investment, which is above its current and the industry average. This transaction alone has the potential to increase GOV's dividend payment by 20%.
Another catalyst that should benefit this stock is that state governments that are having huge financial problems may be forced to sell off assets, including buildings, in the coming years. GOV leases mostly to the Federal government, but one would expect them to become more involved on the state level if attractive opportunities to purchase buildings with the dry powder that being debt-free provides. GOV has openly stated that it intends to be active in purchasing new properties, with the ultimate goal of increasing its asset base from its current $600 million to more than a billion over the next year to two years.
All in all, Government Properties appears to be a relatively safe investment that provides investors with a high current yield and a number of catalysts that could eventually result in significant gains down the road.
To give credit where credit is due, much of the information in this write-up comes from a great presentation on the stock by David Sackler of Moab Capital Partners.