Kwarkot
Nothing is going well for Franklin Street Properties Corp. (NYSE:FSP), barring a yield in the range of 6 to 8 percent. This real estate investment trust (“REIT”) is focused on infill and central business district (CBD) office properties in the U.S. Sunbelt and Mountain West, as well as select opportunistic markets such as Atlanta, Dallas, Denver, Houston, and Minneapolis. Off late, FSP is pursuing, on a selective basis, a strategy of disposing of its properties in order to take advantage of the value creation, and use such proceeds to reduce debt, buy back shares, pay dividends, and spend for general corporate purposes.
Franklin Street Properties Corp.
Franklin Street Properties was formed in 1997 and is based in Wakefield, Massachusetts. The company’s operations include property acquisitions and dispositions, short-term financing, leasing, development and asset management. It owns and operates 26 properties, including two managed sponsored REITs. Half of the common equity is held by the five large asset management firms, namely BlackRock Inc, Vanguard Group Inc, Fuller & Thaler Asset Management Inc, HighTower Advisors, LLC, State Street Corporation.
This publicly traded hybrid REIT is focused on commercial real estate investments primarily in office markets. Franklin Street Properties seeks value-oriented investments with an eye towards long-term growth and appreciation, as well as current income. FSP’s major sources of revenues are rental income from real estate leasing, interest income from secured loans made on office properties, fee income from property management and development, and sale proceeds from property dispositions.
FSP’s Guidance for 2022, and Performance in Q1
In the wake of a 40 year high inflation, rising interest rates, poor office market conditions, looming recession and geopolitical turbulence, Franklin Street Properties has specified a twofold objective to increase shareholder value. Firstly, it intends to increase the occupancy of the properties it is willing to hold on. Secondly, it intends to sell select properties where the management believes that short to intermediate term valuation potential has been reached. FSP intends to use such sale proceeds to reduce debt, buy back shares, pay dividend, and spend for general corporate purposes.
In its property disposition guidance for the full-year 2022, the management expects to generate gross proceeds of approximately $250 million to $350 million. Potential disposition properties that are in price discovery include 380 and 390 Interlocken in Broomfield, Colorado; Eldridge Green and Park Ten in Houston, Texas; and 909 Davis in Evanston, Illinois. The vulnerability of FSP can be understood from the fact that the company failed to issue net income (NI) and funds from operations (FFO) guidance due to uncertainty surrounding the timing and amount of proceeds received from property dispositions.
Franklin Street Properties undertook a share buyback program, as the management continued to believe that the existing price of its common equity shares did not accurately reflect the value of its underlying real estate assets. During the first quarter of 2022, FSP repurchased approximately 847,000 shares for approximately $4.8 million pursuant to its previously announced stock repurchase plan. According to its previously announced stock repurchase plan, the company had authorized approximately $26.9 million for potential future share buyback.
As of March 31, 2022, weighted average lease term stood at 8.6 years and the weighted average rent per occupied square feet was $30.75. Occupancy decreased during Q1, 2022, due to lease maturities. At present occupancy of the directly owned real estate portfolio is 77 percent. In the next two years, lease agreements of another 10 percent of its properties will get terminated. Due to the “Work from Anywhere” (WFA) culture gaining popularity, there is an increased trend of non-renewal of existing lease contracts. This will impact the revenue and FFO of Franklin Street Properties in the coming years.
Concern over Sustainability of High Yield
Franklin Street Properties has been paying a consistent quarterly dividend since 2005. However, the pay-out has decreased over the years. From a quarterly dividend of $0.31 in 2005, the current pay-out has come down to $0.09. The good thing is the current quarterly pay-out is covered by its FFO. The annual average yield has been in the range of 6 percent to 8 percent for the past 10 years. This denotes that the market price has been falling on a continuous basis. Its price has dropped by 40 percent, 59 percent and 76 percent over the past 3 years, 10 years, and 17 years, respectively.
Besides the quarterly dividends, the company also pays special dividends, the proceeds of which are generated primarily from disposition of existing assets. Last year, Franklin Street Properties paid a special dividend of $0.32, which was almost similar to its regular dividends paid during the entire year. In my opinion, this strategy will have negative consequences. Firstly, it may impact the future revenue and FFO, and thus will pose a serious concern over sustaining the current level of pay-out. Secondly, such special dividends inflate the yield, which may lead to more investors buying this stock under some false assumptions. This in turn will increase the market price, and ultimately will reduce the yield in the coming years.
Investment Thesis
Office REITs face an uncertain future due to the rising popularity of the WFA phenomenon. Franklin Street Properties is already facing declining occupancy, as well as significant lease termination in the coming years. Under such circumstances, disposing of a significant proportion of its existing portfolio of properties will adversely impact the future revenue and FFO, and thus pose a serious question of sustaining the current level of pay-out, and corresponding high level of yield. In absence of a high yield, there will be nothing left for the investors. Thus, despite an extremely low price, I don’t find this company attractive enough to include it in my portfolio of investments.
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