2023-11-15 21:07:38 ET
Summary
- W. P. Carey spun off 59 office properties into a new entity called Net Lease Office Properties.
- NLOP has a well-diversified portfolio with high occupancy rates and the potential for significant upside revaluation.
- NLOP shares are trading at a huge AFFO yield of 40%, presenting a huge investment opportunity for investors.
W. P. Carey ( WPC ) strategically exited the office space recently and spun off 59 properties into a new entity called Net Lease Office Properties ( NLOP ) which started to trade on the stock exchange at the beginning of the month. As is often the case with spin-offs, investors quickly sell shares because they are not part of the original investment plan which may lead to a mispricing situation. I believe such a mispricing opportunity exists with shares of Net Lease Office Properties which are trading at an excessive estimated AFFO yield of about 40%. While the office market is out of favor with investors right now, I believe the huge AFFO yield makes NLOP interesting as a turnaround investment!
Spin-off background
W. P. Carey exited the office market due to headwinds in the market that weighed on the REIT’s valuation. The office market has been hit hard by the pandemic and changing work trends, such as remote working, resulting in falling occupancy levels as well as office valuations.
As a result, W. P. Carey decided to spin off 59 of its office properties into a new company, Net Lease Office Properties, which itself has no operating history, no press releases, no investor presentations, no analyst coverage, and no dividend. W. P. Carey's announcement of the spin-off caused shares of the REIT to slump to 1-year lows... which I used as an opportunity to buy into W. P. Carey at the time.
Investors often sell spin-off shares as they are unwanted and not part of the original investment plan... in other words, the conditions are favorable for a mispricing that long-term investors could exploit.
As to Net Lease Office Properties itself: W. P. Carey’s spin-off now owns 59 office properties that include 87M sq. ft. These office properties generate an annual rental income of $145M and the portfolio is well-rented, with a lease rate of 96.8%. A list of the REIT’s top ten tenants is provided below.
About 89.3% of NLOP's commercial real estate is located in the U.S. with smaller percentages represented in Norway (6.4%), the U.K. (3.6%), and Poland (0.7%). The Construction and Engineering sector has the largest industry share with 13.9%, but the REIT is overall well-diversified.
Source: NLOP
AFFO potential and valuation
Like I said, office REITs are currently not favorites for REIT investors, given the headwinds in the sector. These headwinds include falling occupancy rates and higher interest rates that are pressuring office valuations.
However, while the sector may be out of favor, the valuation of Net Lease Office Properties is widely decoupled from the fundamentals that exist at this time.
In the REIT’s 8K disclosure , Net Lease Office Properties stated that its predecessor achieved $88.7M in AFFO for its office portfolio in FY 2022 and $77.5M in FY 2021. The REIT, as of right now, has a market cap of only $223M so the implied AFFO multiplier factor is just 2.5X. The calculation assumes that NLOP can generate about the same level of AFFO from its office properties that W. P. Carey generated... which I believe is a reasonable assumption.
In other words, assuming no growth in AFFO in FY 2023 and considering NLOP's market valuation of $223M following the spin-off, Net Lease Office Properties is selling at a massive 40% estimated AFFO yield which classifies, in my opinion, as a very significant mispricing.
What could drive an upside revaluation?
Spin-offs are not well-covered, not well-understood, and very often unwanted: shareholders that receive spin-off shares from another investment often sell indiscriminately. It also may take time for the real value of a spin-off like Net Lease Office Properties to emerge as spin-offs tend to have poor analyst coverage as well, at least initially.
There are a number of catalysts, however, that could drive an upside revaluation of Net Lease Office Properties’ shares:
- Net Lease Office Properties is a real estate investment trust and must distribute annually at least 90% of its taxable income to shareholders to maintain REIT status. This means that NLOP will soon declare a dividend which could put the shares on the map for dividend investors
- More analysts should eventually start to cover the REIT and issue buy, hold, and sell recommendations, provide insight into AFFO potential and NAV
- With increasing coverage, investors will understand the REIT better (and the degree of its mispricing).
- NLOP's portfolio is well-performing and well-leased, unless the office situation materially worsens, I believe Net Lease Office Properties could actually surprise with its underlying business performance and lease metrics.
Risks with Net Lease Office Properties
There are a number of risks that are obvious: W. P. Carey has exited the office market due to market and valuation headwinds for the office real estate sector. A pure-play office play is therefore expected to trade at a discount to a more diversified, non-office REIT and there is a risk that the share price will languish at least until the market regains its confidence in the office sector as a whole. There is further a reasonable argument to be made for high interest rates and a recession weighing on NLOP's valuation factor. However, given the high AFFO yield, the risk profile overall looks attractive to me nonetheless.
Final thoughts
I believe those W. P. Carey investors that immediately sold shares of Net Lease Office Properties after receiving their spin-off allocations will come to regret this decision. While “office” is an unwanted asset class right now, NLOP sells at an excessive AFFO yield of approximately 40%, based on historical predecessor AFFO.
With an AFFO multiplier factor of only 2.5X, the REIT is a bargain in the truest sense of the word and one of the cheapest REIT investments I have ever seen. Is there a guarantee that Net Lease Office Properties will do well or that the office slump will end soon? No. But at such a steep discount the risk profile is extremely alluring and Net Lease Office Properties has a considerable chance for a major revaluation to the upside over the long haul!
For further details see:
Net Lease Office Properties: The Ultimate Turnaround Spin-Off