2023-05-17 07:53:17 ET
Summary
- 100% occupancy from an investment grade tenant for commercial real estate with “office” in its name.
- Evolving new net leases with 3.5% rent escalators.
- PSTL’s growing, fat, tax-advantaged dividend spends, reinvests, and gifts better than many REIT alternatives.
It’s starting to feel like each and every jobs or CPI report leads to yet another interest rate hike. Every rate hike makes us wonder which and how many regional banks will fall into Fed receivership on the weekend. Will congress raise the debt ceiling tomorrow, or will they just keep politicking? In these times of high anxiety, investors are searching for a little comfort and certainty and that is just what Postal Realty Trust’s ( PSTL ) 1Q earnings report delivers. Let us consider the REIT’s many attributes in our worrisome environment.
What is it?
PSTL owns more than thirteen hundred post office properties spread across 49 states and Puerto Rico.
Though the tenant carries the dreaded descriptor “office” in their name, PSTL’s portfolio more closely resembles that of an industrial/logistics REIT. In fact, the USPS property network is so fully integrated and essential to the still growing E-commerce matrix that Postal Realty enjoys nearly 100% occupancy and retention.
ChatGPT won’t obsolete the USPS’ geographic logistics network; it will enhance Parcel Select’s efficiency and make them an even stronger tenant. We can rest assured that the Postal Service is and will remain recession resistant.
A Nascent Dividend Grower in the Face of Sustaining Inflation
After 14 consecutive dividend hikes since its 2019 IPO, PSTL, in May, paused and maintained its quarterly distribution at $0.2375/share ($0.95 annualized). In prepared remarks on the earnings call , CFO Robert Klein announced –
“Our Board of Directors has decided to maintain a quarterly dividend in the amount of $0.2375 per share. In this environment, the Board believes it is prudent for the company to retain additional cash flow for future growth to reinvest in the business and to continue to fortify our balance sheet. The Board of Directors will review increases to the dividend on an annual basis.”
This is sound and conservative posturing, but rising dividends are addictive, so analysts pestered with questions about what future payouts might be.
Jonathan Michael Petersen
“I actually just wanted to follow up on that dividend question. So maybe to kind of ask it another way. If we think about what you guys might do with it over the next few years, are we holding steady for a while here so you can preserve more cash flow? Or do you expect to grow it in line or kind of below where earnings growth is? Like how do you think about what drives dividend increases in the future?”
Robert B. Klein
“Yes. So I don't think the philosophy has changed. We plan to have this be a covered dividend. We plan to grow it over time. We still have grown it each year since we've been public.
I think the Board would like to stand behind that. They're going to continue to review this on an annual basis. So this is dynamic, it's fluid, and yes, the intent is to grow it over time.”
That might just sound like a proud response, but operationally/contractually, PSTL should be able to sustainably fund future dividend growth. The earnings press release announced impressive strides in Postal’s lease negotiations with USPS.
On April 4, 2023, the Company executed a non-binding letter of intent with the USPS for the renewal of leases that expired in 2022, excluding leases for three properties that were acquired in December 2022 and February 2023. The non-binding letter of intent covers renewals for 86 properties comprising approximately 285,000 net leasable interior square feet. In addition to an increase to the annual rents, the renewals incorporate 3.5% fixed annual rent escalations.
Rent roll ups and fat escalators. PSTL hopes this new lease structure will become the new standard. Those escalators will fund future dividend hikes.
A $0.95 Dividend that Spends Better than $0.95
With PSTL shares currently trading at about $15, the $0.95 dividend produces a yield of about 6.33%. That’s attractive relative to the average equity REIT yield of 4.54%, but a closer look at historical tax characterizations of Postal’s dividends makes it seem functionally larger in taxable investment accounts.
At Portfolio Income Solutions we maintain an archive of historical Tax Treatment of REIT Dividends for more than 130 REITs. A look at Postal Realty’s page describes that ~35% of the dividend has been characterized as a Return of Capital ((ROC)) since its IPO. ROC is not currently taxable as income, so the current year’s tax liability is lower than that of an ordinary dividend. No tax on the ROC is due until the shares are sold. A retiree living on dividend income enjoys a sense of higher current cash flow.
A $0.95 Dividend that Reinvests Better than $0.95
If you are not spending your dividend income and are instead reinvesting it, the ROC treatment grows your investment compounding faster because the tax deferral lets you reinvest more. The $0.32 ROC PSTL paid in 2022 has no current tax due so the full amount can be used to buy more PSTL shares or whatever else has caught your attention.
A $0.95 Dividend that Gifts Better
When a REIT characterizes a portion of a dividend as ROC, your custodian reduces the cost basis of your shares by a like amount. Since its IPO, PSTL has paid $0.93/share in ROC. That ROC reduced your cost basis by $0.93/share which, in turn, increases your potential capital gain on sale of the shares. If you are a long-term holder of shares and have a philanthropical agenda, a recurring, accumulating stream of ROC can make gifting your shares more attractive than selling them and help you avoid paying the accrued tax due on the ROC.
As a hypothetical example: if you hold PSTL for 15 years, collecting the (forecasted) growing dividend and deferring taxes on a 35% ROC every year, your cost basis might be reduced by, let’s say, $7/share. If the markets are kind and the rising dividend helped float the shares for which you paid $15/share up to $25, in selling them, you face a $17/share capital gain (the ROC has reduced your cost basis to $8/share). That $17/share capital gain, taxed at 20% will cost you $3.40/share due the IRS, leaving you with proceeds of $21.60/share. With the proceeds you make a generous donation, your charity gets $21.60/share in cash, and you can take a $21.60/share tax deduction.
However, if you instead choose to gift your shares to your favorite charitable organization, your donation provides the charity with $25/share in cash, you pay no capital gains taxes, and you can take a $25/share tax deduction.
In the latter scenario, the charity gets more working capital, you pay less tax and capture a higher tax deduction, and the IRS has other matters on its mind.
In Summation
The Fed’s hawkish actions in raising interest rates at an unprecedented pace and extent may have broadly destabilized markets and the economy at large. Extensive analysis identifies many economic trend immune opportunities. Further, more granular research reveals net capital superior choices. Mind your Ps and Qs and taxes but keep on investing.
For further details see:
Postal Realty Trust: Logistics Delivering A 6.3% Tax-Advantaged Yield