4 Ridiculously Cheap Office REITs

This article was coproduced with Cappuccino Finance

There are many words to describe 2022, and definitely one of them is uncertainty.

There were so many different opinions about the state of the economy, and some people have swung from optimism to full-blown pessimism.

What about you?

Energy prices skyrocketed at the beginning of the year, but more recently petrochemical prices have been dropping.

But with all the uncertainty regarding refinery capacity and the ongoing war between Russia and Ukraine, many are worrying about winter energy supplies.

If we have severe winter like some expect, we may have heating oil shortages. The severe U.S. winter weather during the past week caused many unwelcome disruptions around the county.

Also, the forecasts for next year’s economic state are very widespread.

Some expect a severe recession, and others expect (and hope) for a mild and shallow recession. I’m in the camp that the recession will be mild and shallow – aka the “garden style” variety.

Inflation is easing, and I expect the Federal Reserve to ease off mid-way through next year. We shall see.

Regardless of market volatility, it’s always a good idea to invest your hard-earned money in solid real estate investment trusts (“REITs”) with a strong balance sheet and operation. It is a plus if they are trading with a wider margin of safety.

Recently we published our 2023 REIT Roadmap (for iREIT on Alpha members) in which we covered all of the property sectors and subsectors. Some of the office REITs are excellent examples of this combination, in my opinion.

Let’s examine several of our top office REIT picks:

Brandywine Realty Trust (BDN)

Brandywine Realty Trust acquires, develops, owns, and manages a portfolio of office, life science, residential, and mixed-use properties. Their properties are mostly located in Philadelphia Central Business District, Pennsylvania suburbs, Austin, and Washington, D.C.

Brandywine’s management expects to maintain their focus on these current markets to take advantage of economies of scale, human capital allocation, and expertise in the area.

Looking at Brandywine’s current valuation, the company is clearly undervalued. A P/AFFO of 6.40x and P/FFO of 5.01x are simply too low for a company like Brandywine.

These valuations are about 50% lower than their historical 5-year average.

The iREIT equity rating tracker now shows that the margin of safety for Brandywine is 41% at this point.

Thanks to this severe undervaluation, Brandywine’s dividend yield is very favorable, 12.24%. Their dividend is safe at this point, shown by a cash dividend payout ratio of 65.87% and FFO payout ratio of 53.90%.

Highwoods Properties, Inc. (HIW)

Highwoods Properties is an integrated office REIT that owns, develops, acquires, leases, and manages properties in the best business districts of Atlanta, Charlotte, Nashville, Orlando, Pittsburgh, Raleigh, Richmond, and Tampa.

Their footprint and portfolio have been growing substantially in the past several years, and I expect the trend to continue in the future.

One great example of their expansion is the recent acquisition of McKinney & Olive in uptown Dallas. The acquisition will certainly further strengthen the quality of Highwoods portfolio, and the growth from the acquisition will be substantial.

The existing rents are 35% below the market rate, so the expected Dallas NOI growth is substantial.

Highwoods’ balance sheet is strong, and they have favorable capital structure. Their net debt to EBITDAre is at 5.6x, and the weighted average interest rate is at 3.7%. They do not have any significant debt maturities until 2025.

This strong balance sheet and favorable capital structure will allow them to continue to grow and weather any economic uncertainties ahead.

Currently, they are about 35-40% undervalued compared to their historical average. The current P/AFFO (10.94x) and P/FFO (7.18x) are about 37% below their 5-year average.

Also, their dividend payment is safe at this point, shown by a cash dividend payout ratio of 49.65% and FFO payout ratio of 48.43%.

Kilroy Realty Corporation (KRC)

Kilroy Realty Corporation focuses on owning, developing, acquiring, and managing real estate assets. Their portfolio primarily consists of Class A properties in Greater Los Angeles, San Diego, San Francisco, Seattle, and Austin.

Kilroy Realty has been growing at a solid pace in the past several years, and their AFFO has been growing accordingly. The revenue growth rate for the past 5 years was 8.78% (5-year CAGR), and the AFFO growth rate for the same span was 3.39% (5-year CAGR).

Kilroy has a very strong balance sheet and capital structure. Their debt maturity schedule is nicely spread over the next several years, and 100% of their debt is fixed rate. The weighted average of state interest rate is 3.7%, and the weighted average years to maturity is 6.5 years.

The stock price of Kilroy Realty is severely undervalued at this point. The current P/AFFO of 14.88x and P/FFO of 8.33x are more than 50% below their historical average.

The dividend payment of Kilroy Realty is also very safe at this point. The cash dividend payout ratio is at 41.31%, and FAD payout ratio is at 51.34%.

Corporate Office Properties Trust (OFC)

Corporate Office Properties owns, manages, leases, develops, and acquires office and data center properties. Most of their portfolio is in locations that support the U.S. government and their contractors. Their customers are engaged in national security, defense, and information technology in the greater Washington, D.C., and Baltimore area.

Corporate Office Properties has a strong balance sheet with favorable capital structure. The weighted average interest rate is 2.5%, and the weighted average maturity is at 9 years. 92.5% of consolidated debt is fixed rate.

The credit ratings from Fitch, Moody’s, and S&P are BBB-, Baa3, and BBB-, respectively, with stable outlooks.

Also, their net debt to Adjusted EBITDA ratio is 5.9x, and they have significant liquidity available to them. The dividend payment by Corporate Office Properties is safe at this point. The cash dividend payout ratio is at 52.30%, and AFFO payout ratio is at 66.91%.

Risks…

Many experts are expecting a recession to hit next year. Everyone has a different opinion about the severity and length of it, but the consensus is that we will have one.

Also, the layoffs from the technology company have already started, and may speed up going into 2023.

With recession and layoffs, the performance of office REITs could suffer in the short-term future.

Another big uncertainty for the office properties is the remote work environment. Going through the pandemic era, many workers developed a preference toward remote working and a home office environment. More and more people are seeking jobs that offer flexibility.

It’s nearly impossible to predict what will be the norm 5-10 years down the road, in terms of office-work environment. But if remote working environment continues to stay mainstream, the office properties will suffer a loss of their value, and the performance of the office REITs will be negatively impacted.

Conclusion

It is hard to believe that this is already the last week of the year. After going through an unprecedented pandemic between 2020 and 2021, I thought I would find stability and a “normal” in 2022.

I couldn’t have been more wrong about that.

The past year has been just as eventful, if not more eventful than the previous 2 years. Unfortunately, the negative sentiment toward the economy and stock market didn’t really improve. If anything, it got worse going toward the end of the year.

Well, there is no clear solution to the bad economy, high inflation, or geopolitical uncertainty, but the investors should make their best out of the situation. Control the controllable.

Investing in solid REITs with a strong balance sheet and great operation is one of the best ways. Especially during a time of uncertainty, putting money into undervalued REITs is a solid strategy. These four office REITs are providing just that opportunity.