OPINL - Office Properties Income: 18.8% Yield Office Short Unwinding Fed Pivot

2023-11-19 23:25:01 ET

Summary

• Office Properties Income offers a 25 cents per share quarterly distribution for an 18.8% dividend yield.
• The REIT faces challenges with debt maturities in 2024 and 2025, but the dovish moves by the Fed will improve the prospects of the commons recovering.
• OPI's rental income and normalized FFO are decent, but the uncertainty lies in its ability to refinance its debt and the risk of further weakness in FFO.

The decision by legendary Enron short seller Jim Chanos to shutter his short-only hedge funds , which had a bias towards shorting office REITs and Tesla, reflects a conundrum facing shorts entering 2024. CME's 30-Day Fed Funds futures pricing data has placed the probability of a pause at the upcoming December at January FOMC meetings at 100% as the market broadly expects the Fed to have cut rates by roughly 100 basis points a year from now to pull back a Fed funds rate currently sitting at 22-year highs of 5.25% to 5.50%. The impact of this on Office Properties Income Trust ( OPI ) would be multifaceted with a recovery of a dire price to FFO multiple, a reduction in its cost of financing, and the enhanced prospect of the extension of current debt maturities. OPI currently has a 10% short interest and is trading hands for 1.22x its trailing 12-month FFO.

OPI last declared a quarterly cash dividend of $0.25 per share , unchanged from its prior distribution for an 18.8% annualized forward yield. The combination of such a large near-20% yield, one of the highest for an equity REIT, and its near-sub 1x FFO multiple infers the markets is pricing in a near-term Chapter 11 bankruptcy filing. This becomes harder the justify as interest rates get pared back. To be clear, the market does not think the yield is sustainable and a further cut might be on the radar with the distribution already down from $0.55 per share in the first quarter of 2023. I have a substantial position in the 6.375% Senior Notes due 2050 ( OPINL ) and doubled this over the last two months since I last covered the ticker. Whilst I think the baby bonds will continue to move back to par through calendar 2024, the commons now offer a substantial upside profile in light of the dovish moves by the Fed.

Debt Maturities, Liquidity, And Refinancing

OPI held total debt of $2.60 billion at the end of its fiscal 2023 third quarter. This came with a 4.41% interest rate and with 4.5 years to maturity that's 92.3% fixed and around 93.2% unsecured. The REIT has no further debt maturities for 2023 but 2024 presents a challenge with $550 million in debt coming due. The dividend reduction earlier this year was cognizant of this mountain of debt coming due and will save the REIT about $58 million through 2024. Addressing these can't come from existing cash and equivalents with this at $24.4 million at the end of the third quarter.

2025 will see $650 million come due, with around 46% of OPI's total debt balance coming due over the next two calendar years. The REIT has completed around $177 million of property-level mortgage financing year-to-date with just 6.8% of its existing debt being secured against its property. Management stated during the third quarter earnings call that they're in discussions with their lender to enter a new credit facility before the end of 2023 ahead of the January 2024 maturity of its $200 million principal balance. Critically, the Fed's consecutive interest rate pauses and now 0% expectation of further rate hikes will help to inject stability into these discussions. OPI will essentially have to refinance or sell parts of its 147 property portfolio to meet its maturity schedule. The REIT has sold around $24 million worth of property year-to-date at around $62.70 per square foot.

Rental Income, Normalized FFO, And Occupancy

OPI recorded rental revenue of $133.36 million , down 3.1% over its year-ago comp and a beat of $620,000 on consensus estimates. The REIT leased 586,000 square feet with a 7.4-year weighted average lease term during the third quarter and with its occupancy at 93.3% as of the end of the third quarter. This was down 140 basis points from the year-ago quarter. Net operating income at $83.7 million was down by $1.8 million from the year-ago quarter with normalized FFO per share at $1.02 down 9 cents from the year-ago comp. Hence, the underlying operations look decent. The uncertainty is posed by the upcoming debt maturities and the REIT's ability to refinance these.

OPI's selloff has likely been exaggerated by the seasonal end-of-year tax loss harvesting. The REIT faces real risk and FFO is almost certainly set for further weakness as debt is refinanced at higher rates. However, sentiment is set for a material improvement in response to the realization of the bullish macroeconomic base case. This would be for positive GDP growth for the fourth quarter of 2023, a continued fall in inflation, and interest rate pauses through the next two FOMC meetings. This is not a sleep well at night stock. It's risky and the current selloff is pricing the company at 20% of its book value per share of $26.76 at the end of the third quarter. Assuming a 50% haircut to book value in line with recent market sales for office property in San Francisco, the worst office market in the US would still see the REIT trading for 40% of book value.

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