August 2, 2007

A High-Dividend REIT With a Kicker

With a low share price, high dividend yield, and some unseen upside from properties in paradise, HRPT Properties Trust (NYSE: HRP) seems to offer compelling opportunities for Foolish investors.

If a REIT yields more than 7%, it's usually because the company has credit exposure that makes investors nervous, such as commercial mezzanine loans and B Notes, or subprime and Alt-A residential mortgages. (We all know there's a lot to be said about credit exposure these days.)

However, HRPT's biggest tenants in 2006 were the U.S. government, GlaxoSmithKline (NYSE: GSK), and Comcast (Nasdaq: CMCSA). Despite its high-grade tenants, the REIT's shares trade at $9.80. That's a roughly 39% tumble from its high, giving the stock an 8% dividend yield. The funds from operations (FFO) yield is even higher, at 11%, meaning that the company's making more than enough to cover its dividend.

I was perplexed by HRPT's valuation, so I recently spoke with its manager of investor relations, Tim Bonang, and his analyst, Katie Johnston, to try to understand what the heck is going on. Here's the breakdown.

Company snapshot
HRPT is a REIT that owns and leases about $5.8 billion and 60 million square feet worth of office and industrial properties, with a focus on government and medical office buildings. The company's property is located in 34 states and Washington, D.C.

Comparables
Although Tim noted that HRPT operates in many different and diverse markets, so do most such companies. Rival office REITs include Brandywine (NYSE: BRT), Mack-Cali (NYSE: CLI), SL Green (NYSE: SLG), and Maguire (NYSE: MPG).

Examining the forward FFO multiples for that peer group, I find that these firms trade anywhere between eight to 16 times 2007 estimated FFO, compared to nine times trailing FFO for HRPT. The company doesn't give forward guidance, so I couldn't do an apples-to-apples comparison. But based on its low historical multiple, we can safely assume that its forward multiple will be even lower. Why is HRPT valued so cheaply, compared to its peers?

An eye toward the long term
Tim noted that HRPT doesn't buy and flip its properties, instead holding onto them to produce income. As a result, the company doesn't report a lot of gains on sale, and its long-term approach probably doesn't excite investors hoping for a quick buyout.

In addition, HRPT's properties aren't marked to market. Instead, REITs take depreciation charges against the carrying value of their properties. HRPT is currently trading at roughly book value, which includes roughly $700 million of accumulated depreciation. Over time, real estate tends to increase, not decrease, in value; in 2006, HRPT sold five buildings for 30% more than historical cost. So it's reasonable to assume that HRPT's book value could be quite understated.

Whereas the aforementioned points are generally true of most REITS, the key difference is that investors give other REITs much more credit for having intrinsic values that exceed their book values.

Company


Share Price


Book Value


Premium/Discount

Mack-Cali


39.04


21.39


82%

SL Green


120.73


54.44


122%

Maguire


26.45


8.86


199%

HRPT


9.48


8.96


6%

Running a tight ship
HRPT actually has no employees, instead contracting out management of the REIT to Reit Management and Research (RMR). RMR also runs other REITs, including Senior Housing Properties (NYSE: SNH) and Hospitality Properties Trust (NYSE: HPT). Although some investors may fear that RMR's attention is spread too thinly, through the end of 2006, HRPT had appreciated 12.2% annually since inception on a total return basis.

The corporate structure also means that expenses can be leveraged quite nicely. HRPT's G&A expenses consume only about 4% of rental income; Tim noted that the company's peers spend 6% to 7% on average. Sarbanes-Oxley costs and other expenses, which might run $750,000 for a company, only cost REITs in general about $250,000, thanks to this ability to leverage G&A costs. Nice.

Island treasure
Lastly, HRPT has a nice catalyst buried in its balance sheet. The company owns 18 million square feet of industrial land in Oahu, Hawaii. Thanks to development and the passage of time, that land in Oahu has appreciated in value over the past couple of years, and Tim mentioned that rent renewal rates have increased between 50%-80%. Although it will take a while for leases to expire and rent increases to roll through the income statement, the Oahu property does seem like a very nice driver for future growth.

The bottom line
HRPT has a very nice collection of high-credit-quality tenants, a very efficient cost structure, at least one hidden asset, and a steady 8% dividend yield. Seems like a decent opportunity to me.

No comments: