A REIT With a Defensive Edge

 | Jul 03, 2012 | 12:30 PM EDT
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If the onset of summer and the stunning advance of real estate stocks are putting you in the aloha spirit, have we got a stock for you.

Select Income REIT (SIR) is a newly developed commercial and industrial real estate investment trust that owns 251 properties, 228 of which are net leased lands in Hawaii, as well as 14 office and nine industrial properties throughout the rest of the U.S. Together, the land and properties represent a total of over 21 million rentable square feet in 14 states.

The outfit's parent company, CommonWealth REIT (CWH), decided to spin off Select Income to focus on triple-net leases of commercial properties. Triple-net leases are rental agreements that are net of electricity, net of taxes and net of operating expenses. Triple-nets help stabilize revenue, as fluctuations in operating costs are passed on to the tenant. Additionally, after the initial public offering, CommonWealth still retains a 73% ownership position in Select Income.

About 70% of Select Income's portfolio consists of long-term leases of industrial land in Hawaii, where the tenant is responsible for maintaining the building that sits on the land. According to analysts at Morgan Stanley, these rents are 25% below market value, allowing for rental increases in excess of 30% as they come up for periodic rate negotiations.

The rest of the portfolio is split between mainland U.S. office properties (21%) and industrial properties (11%), and this is the segment where the company expects to see most of its future growth. The portfolio currently has 12 years of weighted-average lease term, with just 20% of its total leases expiring within the next five years. This gives Select Income great visibility and gives it a more defensive position over the next several years.

In addition to holding a unique portfolio of assets, Select Income also differs from many of its peers in that it's not internally managed but has turned the reins over to REIT Management and Research, a very experienced manager that has operated since 1986.

The Newton, Mass., firm went public on March 6 at $21.50 per share, and it is up 10% since, largely outperforming its peers during this time frame. Many investors, In addition to seeking stock price appreciation, turn to REITs for their dividend potential, and Select Income is one of the leaders in this category, currently paying out at 6.8%.

To qualify as a REIT, a firm must distribute at least 90% of its taxable income annually to shareholders. As a result, the REIT pays minimal corporate income taxes, because it deducts the dividends it pays out.

The company recently announced quarterly results for the first time, and according to the firm, not all of its historical results under parent CommonWealth are quite compatible with post IPO figures. Nevertheless, the firm got off to an excellent start with its first report as a public entity, reporting funds from operations of $20.4 million, while net income came in at $17.7 million, slightly ahead of results from a year ago.

At the end of second quarter, Select Income reported that 95.2% of its total rentable square feet were leased while it added 96,000 square feet of new leases. Additionally, the firm entered into agreements to acquire $104 million of new property that will add nearly 550,000 square feet to the portfolio.

To which any reasonable income investor just has to say: To SIR, with love.



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