Description
Description
Easterly Government Properties is a REIT that focuses on class A commercial properties that are leased to US government agencies. StuC wrote up DEA in June 2021 and compared it with a defensive 10-year US treasury proxy with an equity while picking up 330 bps of yield. He also warned that max pain would come in the form of a rising interest rate sell-off that causes spread widening. His words were prophetic as 10-year yields rose 250 basis points causing DEA to decline in price over 30%. The effective duration was over 12 years.
Thesis
- Recession resistant single tenant REIT with the highest quality tenants in the world.
- Some inflation protection.
- Low renewal risk.
- Strong balance sheet with low-cost debt.
- Solid Management.
- Cheap valuation with sustainable high dividend yield.
Point 1
DEA focuses on mission critical US government leased real estate for growing agencies. Buildings are at least 40,000 RSF with expansion potential (generally offices). These leases are long-term in nature and are non-cancelable. The weighted average remaining lease term is over 10 years. Department of Veteran Affairs is about 20% of lease income, FBI is 15% and DEA is just under 10%.
Management says the leases are essentially backed by the full faith & credit of the US government. Government leased inventory grew by 23.3% since 1998 and during the same period which has seen government owned properties decline 1.1%.
DEA owns 86 buildings (8.7 million RSF) with a weighted average age of 13.8 years. These are newer buildings. There is mild concentration in CA, TX and VA.
There is no risk of massive lay-offs or work from home concerns.
Point 2
Leases are Gross Modified Leases. They consist of a Shell Rent which remains flat during the lease. There is a Real Estate Tax Base and Operating Expense Base which adjust with CPI offering some inflation protection. In previous years comments management has talked about how well protected they are from inflation. They may have overstated the case but it’s true to an extent.
Renewals also give them some inflation protection, as illustrated in Point 3 below.
Point 3
Three leases are expiring in 2023 representing 5.1% of lease income. 2022 saw five leases expire and all were renewed. Currently the vacancy rate is 1.2%. Renewals are a high probability event but also offer the chance to reset rates.
DEA divides renewals into two basic categories: Bullseye and Plain Vanilla with about 70% falling into the Bullseye category.
Bullseye renewals are based upon replacement cost whereas Plain Vanilla is determined by market rent. The primary difference is that Bullseye meets the category of mission critical with more customized building features (think security, etc.).
GSA leases are paid from the Federal Buildings Fund and are not subject to direct appropriations. The US Government has never experienced a financial default to date.
Their weighted average remaining lease is over 10 years.
Point 4
Total debt is $1.3 billion with debt to EV at 45.9% (as of 12/31/22). No significant debts are due within 3 years. The weighted average maturity of the loans is 5.6 years with a cost of only 3.7%. Almost all of this is fixed (93.5%) with the remaining floating rate debt hedged in February of 2023.
There are few debts maturing in the next couple of years (highlighted below). The balance sheet shows $17.3 million in cash plus there is $384.4 million available under their revolving credit facility.
Their balance sheet gets a little stronger with the settlement of shares issued at $21+ while the current price is under $15. Nice little bonus.
Point 5
Management sold some buildings that closed in December 2022 and had the following comments:
“With the completion of the sale of the Disposition Portfolio, Easterly refined its focus on owning mission critical agencies executing their important jobs from the build-to-suit facilities,” said CEO William Trimble, III. “We believe this is a key differentiator from traditional office-focused peers which gives us confidence in our long-dated, government-backed stable cash flows.”
Management has extensive experience with the governments process and standards for procurement along with longstanding relationships with various government agencies. This includes developing 40 build-to-suit projects.
I believe they have consistently stated DEAs objectives in a clear manner and tried to execute on these objectives.
Point 6
DEA produced $1.27 of fully diluted FFO in 2022. At the current price of $14.49 that’s 11.51 times for a FFO yield of 8.76%. They paid $1.06 in dividends for a TTM yield of 7.32%. The sale of some buildings at the end of the year lowers the forecasted FFOs. Management is targeting $1.12 to $1.15 for 2023 FFO per share.
Source: Seeking Alpha
Margins have been amazingly consistent over the years while SG&A has grown in a manner correlated with revenue. Given the high levels of renewals and recurring lease revenue I believe managements targets are conservative.
Currently the 10-year Treasury yield is the highest in years and the positive dividend yield spread for DEA is 3.41% putting this near the higher spread range in their history. Their weighted average remaining lease makes the yield comparison relevant.
|
Date
|
10 yr.
|
DEA
|
Difference
|
|
12/29/2017
|
2.41
|
4.69
|
2.28
|
|
3/30/2018
|
2.74
|
5.00
|
2.26
|
|
6/29/2018
|
2.87
|
5.21
|
2.35
|
|
9/28/2018
|
3.07
|
5.37
|
2.30
|
|
12/31/2018
|
2.69
|
6.63
|
3.94
|
|
3/29/2019
|
2.41
|
5.77
|
3.36
|
|
6/28/2019
|
2.01
|
5.74
|
3.74
|
|
9/30/2019
|
1.68
|
4.88
|
3.20
|
|
12/31/2019
|
1.92
|
4.38
|
2.46
|
|
3/31/2020
|
0.67
|
4.22
|
3.55
|
|
6/30/2020
|
0.67
|
4.50
|
3.83
|
|
9/30/2020
|
0.69
|
4.64
|
3.95
|
|
12/31/2020
|
0.92
|
4.59
|
3.67
|
|
3/31/2021
|
1.75
|
5.02
|
3.27
|
|
6/30/2021
|
1.47
|
4.93
|
3.46
|
|
9/30/2021
|
1.50
|
5.06
|
3.56
|
|
12/31/2021
|
1.51
|
4.58
|
3.07
|
|
3/31/2022
|
2.38
|
4.99
|
2.61
|
|
6/30/2022
|
3.02
|
5.57
|
2.55
|
|
9/30/2022
|
3.83
|
6.72
|
2.89
|
|
12/30/2022
|
3.88
|
7.41
|
3.53
|
|
3/9/2023
|
3.91
|
7.32
|
3.41
|
Source: Fed; Gurufocus
Frankly, I view this as too cheap. Perhaps investors believe they are facing the same issues as the other office REITs or simply higher rates are offering a competing option for yield investors for the first time in many years. I am not expecting government layoffs or stay at home issues. Management has stated that their goal is slow stable growing FFO (2%+). This goal may not always be achievable, but I am comfortable waiting while I get paid a high yield.
I believe that DEA will fare well in virtually any likely environment over the next few years and is solid risk-adjusted return that will beat treasurys.
Note: All non sourced images are from DEA corporate documents.
Risks
Significantly higher interest rates (10 year Treasury yield goes up 2.5%+).
Rest of the office REITs get crushed lowering comps which could affect 20% of renewals.
Government shutdown or default.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
Falling 10-year Treasury Yield
Collect the dividends