If you’ve been following me for a while, you know that I love real estate and real estate investment trusts (REITs). I think they’re one of the best ways to grow wealth over time that the market has ever created for us.
As we’re looking forward, I know there’s a market perception that we should avoid REITs because interest rates are going up and that’s not good for REITs… Well, that’s not true.
When you apply the basic math and test that out, it’s not true at all. In fact, REITs have tended to do very well in periods where interest rates were rising because real estate tends to do really well when there is inflation.
Rising rates usually means inflation, so do the math. They also have historically done incredibly well in bad market conditions, so if Omicron continues to be a problem and pushes markets down, REITs are a great place to move your cash.
With the exception of 2008, because that was a real estate related financial crisis, REITs have outperformed dramatically in severe market downturns. Back in 2000, when everyone was losing a fortune in internet stocks, REITs actually went up three of the four years between 1999 and 2003.
The problem is that in 2020, REITs went down along with the market as things got dicey for a while. But when it became clear that the government was going to do whatever was necessary, it supported the commercial real estate markets and the banking system, and REITs have rebounded dramatically.
As a result, there aren’t a lot of bargain REITs around, and I’m pretty much a bargain shopper when it comes to real estate and REITs.
Orion Office REIT Inc.
Now, earlier this year, we talked about the merger of Realty Income Corporation (O) and VEREIT, two retail net lease single-tenant property owners. Between them, they own thousands of properties and standalone building with one tenant that are triple-net lease.
That means tenants pay all insurance, maintenance and taxes, and the landlord just collects a check. Well, I noted at the time that both of the two REITs own some single-tenant office properties primarily in the suburbs around the United States.
The decision was made that when the merger was complete, they would combine all of those properties into a new REIT spinoff called Orion Office REIT Inc. (ONL).
Now, we watched this carefully at the start, and it initially moved a bit higher. But what happened is that once the deal was done, you got one share of ONL for every 10 shares of Realty Income Corporation that you owned.
So, it was a really small position, and most retail holders just sold and moved on. But if it was a REIT index fund or an S&P 500 index fund, Realty Income is in those indexes, and Orion is not. They had to sell.
A lot of investors just want the pure play, single-tenant retail properties and have no interest in the office properties, so they also sold. After the initial move up, this stock has been clobbered and is now down about 50% from the highs it reached in the few days following the merger.
This company owns single-tenant office properties all over the US. A 70% of the properties came from VEREIT and 30% came from Realty Income. Most of the people running the REIT all came from VEREIT, so they know most of the portfolio and have been managing it for years.
This is a really exciting market. These are suburban, single-tenant office properties in what I think are some of the hottest markets in the country right now. Deurbanization is continuing, and you’re seeing people and companies leave big cities.
It’s a quality of life decision, as folks are leaving high rents and dense populations and moving somewhere else.
For example, Amazon (AMZN) moved a headquarters building to northern Virginia rather than New York City, while Credit Karma moved its operations from a crowded city to North Carolina where Apple (AAPL) also built a new headquarters facility.
Of course, Oracle (ORCL) went to Austin, Texas to flee everything going on in California. That could be a huge trend that I don’t think is going away.
These suburban office properties are going to be a direct beneficiary of this trend, although they are already doing just fine. They’ve got 92 properties with 10 million square feet and are 94.4% leased. And even with the pandemic, 99.9% of all rents due have been paid on time.
This thing is dramatically undervalued in my opinion. They’ve got creditworthy tenants, with the General Services Administration of the US government being the largest, as well as several other big names.
When I model this and compare the percentage of cash flow that other REITs with similar portfolios are paying out as dividends, I come up with a dividend that’s going to be 7.5%-8% when this company begins paying out later this year.
And I think you can get at least half of that 50% drop back, giving you the potential for a 60% total return over the next year. I think this will continue to be a high-growth market where these guys can make some intelligent acquisitions, add to the portfolio and have this turn into yet another REIT home run.
At current prices, it’s going to be a high-dividend, high-growth situation for Orion Office REIT Inc. I think you can buy it here, hang on to it for a very long time and you’ll be very happy with the dividends and capital gains you earn.
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