Every year, the 12,000 employees at the U.S. government’s General Services Administration (GSA) are tasked with spending roughly $66 billion dollars on all of the goods and services needed to keep our government running.The biggest expense: real estate. Although Uncle Sam owns nearly 10,000 buildings, he’s also the nation’s largest renter. The government never bounces a rent check, and tends to look for long-term, stable leases; and as it turns out, renting to the government is quite profitable.
I’m talking about Government Properties Income Trust (NYSE: GOV), a real estate investment trust (REIT) that leases more than 10 million square feet spread across 82 buildings, mostly to the public sector.
(Roughly 68% of revenues are derived from the U.S. government, another 20% from state governments, 7% from the private sector, and 5% from the United Nations).
A sample of tenants includes:
– The Centers for Disease Control (CDC) in Atlanta
– Many of the Federal Bureau of Investigation’s (FBI) satellite offices
– A U.S. Army Logistics Center
– The state of Oregon’s capital complex
Apparently, business is good. While the national office building vacancy rate hovers at around 14.8%, according to Reis.com, this landlord has a vacancy rate around 7%. Equally important, this REIT’s vacancy rate tends to be stable in any economic climate compared to commercial office buildings, which saw a spike in the vacancy rate up to the 18% to 20% range when the U.S. economy slowed in 1987, 1991, 2002 and 2009; and GOV’s key tenant is staying put. In the most recent quarter, the average lease renewal was for a term of 20 years.
With government spending under pressure, it’s fair to wonder if GOV might start to see government tenants consolidate into fewer office spaces. “We really are not seeing impact specifically on our properties from sequester,” noted CEO David Blackmon on a recent conference call, adding that “the buildings we have in the D.C. market tend to be relatively strategic to the government tenants. So fortunately for us, it hasn’t had a real effect on occupancy at our portfolio.”
Wondering how can GOV afford to pay out such robust dividends? The answer lies in the company’s judicious use of debt leverage. Thanks to locked-in cash flows, GOV can borrow at low interest rates, and a debt-to-EBITDA ratio of 3.5 means that a little equity goes a long way. Over the past three years, GOV has generated net profit margins in excess of 20%. In contrast, Boston Properties (NYSE: BXP), the country’s largest office REIT, has net profit margins in the 10% to 15% range.
Minimal organic growth
To be sure, the government’s need for office space is likely to remain stable, but isn’t expected to grow in coming years. Yet GOV manages to finds paths to growth anyway, as it acquires more buildings that already house government tenants. That explains why revenues shot up from around $80 million in 2009 to more than $200 million by 2012. Analysts see that figure approaching $250 million by 2014.
That doesn’t mean management is pursing growth for its own sake. GOV has looked at more than 40 potential acquisitions thus far in 2013, with active discussions underway and plenty of deals could be announced in coming months.
Yet even with such acquisitions, don’t expect the dividend to grow at a robust pace. GOV periodically raises fresh capital through secondary share offerings, which means that the share count often rises almost as fast as net income. That can impede EPS growth. For example, analysts expect the REIT to earn around $2.15 a share in 2013 and 2014, right around the levels earned in 2012.
Roughly 10% of those profits are retained to fatten up the balance sheet, while the other 90% supports the dividend. That payout ratio means management can preserve the dividend, even if profits take a modest dip in any given year.
You can find other REITs with more robust growth prospects, but as a good rule of thumb, the greater the prospective growth, the smaller the dividend yield. The typical REIT sports a dividend yield slightly below 4%, according to Morgan Stanley. For the subcategory of office REITs, the average yield falls to 3.5%. That’s just half the yield sported by GOV.
Put simply, lack of organic growth in this case can be a very good thing. Dividends may not grow smartly, but investors can be strongly assured that the current $1.72 a share dividend will be around next year, and well down the road.
Investors can find 7% dividend yields in a wide range of stocks, but you’d be hard-pressed to find another one with such low chances of a dividend cut.
Those looking for high yields and safety should look into Government Properties. There may be a few dips in share price between now and the coming budget discussions, so investors now have a limited-time opportunity to snatch up the stock at a lower price and enjoy even higher returns.