Office REITs: Buy Now for Huge Discounts and Dividends

Since the end of the Great Recession, commercial real estate, and the real estate investment trusts that own those buildings, have performed marvelously.

Office REITs: Buy Now for Huge Discounts and DividendsResidential, medical and even retail properties have experienced high rent growth and cap-rates as the economy has climbed out of recession. Likewise, investors in REITs have experienced similar gains. The broad iShares U.S. Real Estate ETF (IYR) is up 42% over the last five years.

However, things haven’t been as rosy for office REITs. The real estate subsector has trailed many of its peers since the recession when it comes to returns.

But the purveyors of cube farms, office parks and high-rise towers have given REIT investors a new reason to smile, and things are looking up for office owners. So much so, that the sector looks like a huge buy for investors searching high and low for a value.

Office REITs Have Fully Recovered

For the office REITs, only one thing matters. Jobs. After another recent bullish jobs report, the purveyors of cube farms and other office buildings are now finally hitting their stride. Hiring is up and the July jobs report marked the 65th consecutive month of private sector employment growth. Analysts are now pegging that unemployment should hit 5.2% by the end of the year.

These numbers have been great for office REITs’ bottom lines.

To start with, occupancy and vacancy rates have rebounded like crazy since the recession. Data provided by CBRE Group (CBG) shows that we’ve now had four consecutive years of declining vacancy rates at offices. Absolute vacancies stood at just 13.9% for central business district markets — the lowest level since the financial crisis.

Those lows hold true for the vast number of metropolitan markets, but some have taken them even further. Super-prime CBD markets (like New York, Washington D.C. and San Francisco) have vacancy rates in the single digits. At the same time, suburban markets (albeit, starting at a higher initial point) have followed suit and seen dwindling vacancy rates.

Meanwhile, those dwindling vacancy rates are spurring rising rents across the many office REIT platforms. Over the last year, asking rents were up 3.2%, while effective rents increased 3.3%. This builds on the 2% annual increase in rental rates experienced in 2014. Only seven out of 82 CBD and suburban markets posted flat or declining effective rents in the second quarter.

In spite of the good news, office REITs could still be values.

According to Raymond James & Associates, office REITs offer the best growth prospects relative to their values. RJA’s data shows that the office owners currently can be had for a funds-from-operations-to-price metric of 18.1. That’s right around average for all the property subsectors. However, office REITs currently trade for a substantially less than average 8.7% discount to net asset values. Basically, investors are buying cash flows at fair value and the assets that generate those cash flows at a discount.

And there’s plenty of reasons why that discount to NAV and FFO/P will decrease and make investors money.

Aside from rising rents equating to more cash flows and dividends, many office REITs are seeing rising interest from institutional investors, sovereign wealth funds, pensions and insurance pools in commercial real estate. Prices for buildings are now near pre-recession highs, and many REITs have been purging their portfolios of assets and plowing those dollars into hefty share buybacks. Those buybacks will help decrease the NAV discounts and the share supply, resulting in increases to investors’ bottom lines.

So for investors looking for REIT values, office building owners provide an optimal blend of attributes.

Making an Office REIT Play

Easterly Government Properties (DEA): The Federal government is wonderful tenant to have. They always pay their bills on time and sign long leases. And Easterly strictly owns buildings leased to the government. Of its 31 commercial properties, 28 are leased to U.S. Government agencies, including the FBI and Drug Enforcement Administration. Easterly has also continued to snag-up other properties — including court houses and offices owned by the Department of Energy. That focus on the Feds has furnished Easterly with an occupancy rate of 100% since its initial public offering in February. At the same time, RJA shows that Easterly Government Properties is currently trading at a 9% discount to its net asset value, and sports a juicy 5.3% dividend yield.

Kilroy Realty (KRC): Operating in one of the nation’s office sweet spots — San Francisco — KRC could be a big REIT to buy. The firm is spending big bucks to expand its already expansive portfolio of office buildings in the city. Spurred by technology, biotech and engineering firms, San Fran has seen some of the highest rent growth over the last four years. KRC’s five new projects in the city should get around a 7.5% estimated cash return. That’s pretty darn good for commercial real estate. At the same time, KRC has pruned its portfolio of non-core assets and recently begun to sell a few higher-margined buildings at substantial premiums. That should continue to help investors reap the firm’s steadily rising 2% dividend.

First Potomac Realty Trust (FPO): With only about 8 million square feet of office space, FPO isn’t exactly a giant among REITs. However, the location of those 8 million square feet is what sets FPO apart. First Potomac Realty Trust owns all of its buildings in or near Washington D.C. That high-volume region has allowed First Potomac to maintain high occupancy rates across its entire portfolio. As for that portfolio, FPO has been quite successful at selling buildings and plowing those proceeds into other properties. Now, the REIT has undergone a strategy shift and has begun plowing that back into its shares. The firm plans on acquiring up to 5 million of its shares over the next 12 months. That will help reduce its NAV discount and strengthen its current 5.3% dividend.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/reits-office-reit-krc-cbg-fpo-dea/.

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