Income investors often allocate a sizeable portion of their portfolio to real estate investment trusts, or REITs, as these names typically pay high yields. Since REITs have to distribute at least 90% of their taxable income to shareholders via dividends, these stocks can be a good source of income.
After recently looking at healthcare REITs let's examine a different sector of the REIT universe.
Office REITs have had a rough few years, as the coronavirus pandemic set off the work-from-home trend that still lingers. As a result, valuations across office REITs have come down.
The upside of this is that their dividend yields have broadly risen as well. As a result, office REITs may still have some appeal for income investors.
Go Green
SL Green Realty Corp. (SLG) is Manhattan's largest office landlord, with a market capitalization of $2.2 billion, and currently owns 60 buildings totaling 33 million square feet.
In mid-July, SLG reported financial results for the second quarter of 2023. Its same-store net operating income grew 3.6% over the prior year's quarter but its occupancy rate dipped sequentially from 90.2% to 89.8%.
Given also the negative effect of some assets sales, its funds from operations (FFO) per share decreased 24% over the prior year's quarter, from $1.87 to $1.43, though they exceeded the analysts' consensus by $0.09.
SLG has grown its FFO per share at a 3.0% average annual rate in the last decade. Due to the effect of the pandemic on its business, FFO decreased in 2021 and 2022. The pandemic has subsided this year but the REIT has not begun to recover from the work-from-home trend yet.
Nevertheless, we expect SLG to grow its FFO per share at a 5.0% average annual rate over the next five years off this year's 10-year low expected level.
SLG is under pressure due to the work-from-home trend, which has resulted from the pandemic. Investors should note that SLG recently issued a great amount of debt to buy new properties and its net debt climbed to $5.2 billion, which is about 14 times the annual FFO. Investors should continue monitoring the debt situation closely.
However, SLG has a decent balance sheet, with a healthy BBB credit rating. As a result, it can endure the ongoing crisis and emerge stronger whenever the work-from-home trend subsides. It can also maintain its attractive 9.0% dividend, which is well covered by cash flows, with a healthy payout ratio of 59%.
Work From Home and Get a 13% Yield
Office Properties Income Trust (OPI) currently owns 157 buildings, which are primarily leased to single tenants with high credit quality. The REIT's portfolio currently has a 90.5% occupancy rate and an average building age of 18 years. OPI has a market capitalization of $318 million.
The REIT has enhanced geographic diversification and one of the highest percentages of rent paid by investment-grade rated tenants in the REIT universe. The U.S. government is the largest tenant, as it represents 20% of the annual rental income of the REIT.
On April 11, OPI announced that it agreed to acquire Diversified Healthcare Trust (DHC) in an all-stock deal of nearly $400 million. OPI pursued this acquisition to enhance its diversification and benefit from synergies. OPI has greatly increased its debt load after its latest acquisition. Its net debt is excessive, as it stands at $2.5 billion, which is about 12 times the annual funds from operations.
OPI generates 63% of its annual rental income from investment-grade tenants. This is one of the highest percentages of rent paid by investment-grade tenants in the REIT sector. Moreover, U.S. government tenants generate about 20% of total rental income. This exceptional credit profile constitutes a competitive advantage.
In the 2023 second quarter, revenue of $134 million beat expectations by $2.3 million, while FFO per share of $1.11 beat by $0.04. OPI increased consolidated occupancy to 90.6%, a 120-basis point increase year over year and a 10-basis point increase sequentially.
OPI has a 2023 forecasted dividend payout ratio of 24%, which indicates a relatively secure payout, although the dividend carries elevated risk due to the company's debt levels.
The stock currently yields 13%.
A Different Kind of CIO
City Office REIT (CIO) is an internally-managed real estate investment trust focused on owning, operating, and acquiring high-quality office properties located in "18-hour cities" in the Southern and Western United States. Its target markets possess a number of attractive demographic and employment characteristics, which the trust believes will lead to capital appreciation and growth in rental income at its properties.
At its most recent filing, City Office owned 24 properties comprising of 58 office buildings with a total of approximately 5.7 million square feet of net rentable area that were approximately 85.6% leased. The trust generates around $180 million in annual rental revenues and is headquartered in Dallas, Texas.
On August 3, City Office reported its second-quarter results for the period ending June 30, 2023. For the quarter, rental and other revenues were $44.6 million, down 2.0% year over year. Same-Store Cash NOI (Net Operating Income) rose by 7.1% as compared to Q2 2022. However, due to larger growth in property operating expenses and general and administrative expenses, core FFO fell by 0.9% to $56.6 million.
On a per-share basis, core FFO (which excludes share-based compensation) came in at $1.38 compared to $1.40 last year, aided by share repurchases. The company announced a new share repurchase program amounting to $50 million. Occupancy stood at 85.6% at the end of the quarter, 70 bps lower sequentially.
For 2023, the company raised its outlook, expecting core FFO/share of $1.38 to $1.40. While City Office's dividend was cut last year, this was done for management to capitalize on the possible growth avenues it sees ahead. In that regard, we consider the current payouts to be relatively safe. At an annual rate of $0.40, the trust pays out only 29% of its total FFO.
Amongst its qualities, we note that the REIT's portfolio of properties has an average remaining lease term of 4.9 years, which should provide solid cash flow visibility in the short-medium term. Further, the trust's tenant base is well diversified, with its top 10 tenants accounting for only 22.5% of its total rentable area and no tenant accounting for more than 3.6%.
CIO stock yields 7.5%.
