OPINL - Office Properties Income: A 12.5% Yield For 51 Cents On The Dollar With The Notes

2023-09-13 16:39:47 ET

Summary

• Office Properties Income has called off its proposed merger with senior living communities owner Diversified Healthcare Trust.
• The REIT's notes currently offer a 12.5% yield on cost for 51 cents on the dollar.
• An intense wall of debt maturities and lease expirations present strong near-term headwinds.

Office Properties Income Trust ( OPI ) just called off its proposed merger with Diversified Healthcare Trust ( DHC ) after intense shareholder opposition from both sides. The Frankenstein deal would have seen the office property REIT get consolidated with the senior living communities owner to heighten the risk currently faced by shareholders in OPI who have seen their equity value dip 68% over the last year. OPI's common shares are currently seemingly in near-distressed territory, changing hands at a price to forward funds from operations multiple of 1.45x . This is around 88% lower than the 12.2x multiple median of a basket of comparable peer group office REITs. The REIT is also trading for around 21% of its tangible book value as of the end of its fiscal 2023 second quarter.

OPI's common equity chart over most time frames is quite tragic. It's lost 75% of its value over the last three years and it's not extreme to state that the REIT is currently being priced for material financial distress. Critically, the proposed merger created an implied level of operational risk that when aggregated with the erratic management style of external advisor RMR Group ( RMR ) has materially damaged shareholder confidence in the REIT. OPI last declared a quarterly cash dividend of $0.25 per share , in line with its prior payment and for a 17% annualized forward yield. There are safer yields out there and this sits on the opposite end of the spectrum of sleeping well at night stocks. Hence, I think the play here are the 6.375% senior notes due 2050 ( OPINL ).

The Baby Bonds, Liquidity, And Macro Risks

OPINL is currently swapping hands for $12.71 per note, a 49% discount to their $25 par value. They pay out a fixed $1.59375 coupon for what currently works out to be a 12.5% yield on cost. This discount to par mirrors the underlying concerns around solvency faced by the commons. However, to what extent does this ring through? The notes currently trade for roughly 51 cents on the dollar and the play here is that this discount is somewhat detached from the fundamentals of the REIT. The notes were issued back in the summer of 2020 with a $150 million offering and its distributions are paid quarterly.

The REIT's ladder of upcoming debt maturities presents the greatest threat to its stability. Whilst there are no maturities left for the rest of 2023, OPI will face $350 million in debt maturities next year, $650 million in 2025, and $300 million in 2026. To be clear, OPI's current market cap of $288 million is dwarfed by its 2024 maturity alone. The REIT holds a total debt balance of $2.32 billion, with a 4.3% weighted average interest rate and weighted average maturity of 4.7 years. This is against total equity of $1.34 billion as of the end of the second quarter. Debt to equity at 173% is high and drove a quarterly cash interest expense of $26.5 million for the second quarter, flat over its year-ago comp on the back of over 90% of the REIT's debt being issued at a fixed rate and with 96% of the total being unsecured.

The REIT does hold a $510 million credit facility that will likely be tapped to address its debt maturities with total cash and equivalents at $25 million as of the end of the second quarter. OPI has also stated it intends to tap its portfolio to refinance its balance sheet. Hence, with just 4% of its debt being secured against properties, there is capacity for its largely unencumbered balance sheet to help address its wall of maturities. The REIT has closed at least $108 million in interest-only mortgage financings with a weighted average term of 6.8 years and a combined total loan-to-value ratio of over 52%

A Strong Tenant Base

OPI realized second-quarter revenue of $134 million , a 5.2% decline over its year-ago comp and a beat by $2.27 million on consensus estimates. The REIT owned and leased 155 properties spread across roughly 20.8 million square feet as of the end of the second quarter. This has a consolidated occupancy of 90.6%, a 120 basis point increase from its year-ago comp and a 10 basis point increase sequentially from the first quarter. Growth came on the back of 713,000 square feet of new and renewal leasing completed during the quarter with an average lease term of 10.3 years and a roll-up in rent of 3.7%. This was the highest leasing volume in three years and came as investment-grade rated tenants came to represent roughly 63% of annualized rental income.

Upcoming lease expirations, as a cumulative percent of the total, are somewhat frontloaded though with 22% of leases on an annualized rental income basis expiring in 2024 and another 30.8% expiring in 2025. This presents another specter of uncertainty but the REIT has so far ramped up leasing volumes with its occupancy remaining stable even against working-from-home headwinds. Cash from operations during the second quarter at $36.3 million was down from $58.6 million in the year-ago period. This dip was what forced the April dividend cut with the notes being the better option from a safety perspective as OPI works to expand its leases and address its debt.

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