REIT Focus: Commonwealth REIT

| About: Equity Commonwealth (EQC)

This REIT Focus is on Commonwealth REIT (NYSE:CWH), a publicly traded third-party managed real estate investment trust that owns industrial and office buildings located throughout the U.S. CWH owns 445 properties with 72.7 million square feet including 8.8 million square feet of industrial and other space and 1.8 mullion square feet of office and industrial properties in Australia. CWH also owns approximately 56% of the common shares of Select Income REIT (NYSE:SIR), a publicly traded REIT, which owns 25.4 million square feet of primarily net leased, single tenant office and industrial properties including 17.8 million square feet which are primarily leaseable to industrial and commercial companies on Oahu, HI. SIR is consolidated into the financial statements of CWH.

As of 3/31/13, the average occupancy of its portfolio was 90%. CWH was founded in 1986, was incorporated as a REIT in the State of Maryland, is traded on the NYSE and is based in Newton, MA.

CWH has no employees and is externally managed by REIT Management & Research LLC (RMR), a private company owned by Barry and Adam Portnoy that manages CWH and its consolidated subsidiary SIV and various other public REITs. RMR receives fees from CWH for providing asset management and property management services pursuant to two agreements, a Business Management Agreement and a Property Management Agreement. During the first quarter of 2013, CWH paid RMR $11.9 million in business management fees. As of 3/31/13, RMR had 830 employees and managed a large portfolio of commercial real estate including 1,700 properties in 46 states and Washington D.C., Puerto Rico, Canada and Australia.real estate. As of March 31, 2013, RMR manages a large

CWH has 118.3 million common shares outstanding, a market capitalization of approximately $2.37 billion and its senior unsecured debt rating is BBB- by Standard & Poor's. In March 2013, CWH issued 34.5 million shares at a price of $19 per share, raising net proceeds of $627 million. The net proceeds were used to repay indebtedness.

In February 2013, Corvex Management LP, Related Fund Management, LLC and other entities made a conditional purported offer to acquire CWH for $24.50 per share. CWH and the investor groups are currently in involved in litigation regarding the offer and a proxy contest for control of the Board of Trustees. The investor group contends that the Board of Trustees, led by the Portnoy family through the RMR management contracts is mismanaging CWH, by growing assets of CWH to maximize fees to RMR.

Select financial data for CWH as of the 3/31/13 10Q and for the period 1/1-3/31/13 are as follows (in millions where applicable):

Real Estate Assets, Gross $8,577
Total Assets $8,083
Mortgages, Unsecured Debt and Line of Credit $3,658
Stockholders' Equity $4,127
Revenue $275
Net Income $14
Net Income Per Share $.15
Cash Flow from Operations $43
Unsecured Revolving Credit Facility ($750 with $135 used) $615
Market Capitalization $2,370
Debt to:
Gross Real Estate Assets 43%
Market Capitalization 154%
Real Estate Assets Per Sq. Ft. $118
Dividend and Yield ($1.00/sh., reduced from $2/sh. in 4Q12) 5%
Valuation Methodology:
First Quarter Revenue Per Above Annualized $1,100
Less: Operating Expenses Annualized (excluding depreciation, amortization & interest expense, plus G&A expenses and other income) 548
Annualized Net Operating Income 2013 $552
Projected Inflation Rate at 3.5% x103.5%
Projected Forward NOI for Next Year $571
Projected Cap Rate 8%
Projected Value of Real Estate Assets $7,137
Add: Net Operating Working Capital 255
Total Projected Asset Value $7,392
Less: Value of Business Management Agreement (proposed buyout of RMR Bus. Mgmt. contract with value at 2.5% of CWH real estate assets) (214)
Less: Total Debt Per Above (3,658)
Less: SIR Minority Interest (44% noncontrolling interest at market price of $28/sh.) (484)
Less: Series E Redeemable Preferred Stock (265)
Projected Net Asset Value $2,771
Shares Outstanding 125.6 M (common stock, 118.3M shares plus series D convertible preferred, 7.3M shares )
Projected NAV Per Share $22
Closing Market Price Per Share on 5/15/13 $20

The gross real estate assets, net income and funds from operations for the years 2011 and 2012 and the 1st. Qtr. of 2013 are shown in the table below:

(millions) 2011 2012 2013 (1st. Qtr)
Gross Real Estate Assets $7,958 $8,614 $8,577
Net Income $63 ($152) $14
Funds from Operations $262 $284 $80

As shown above, our net asset value per share for CWH is $22 versus a market price of $20 per share. Current average cap rates for office/industrial properties per CBRE are in the 4% to 10% range, depending on the type, location and quality of the property. We have used a cap rate of 8% due to CWH's portfolio being primarily Class B office and industrial properties

CWH's strengths include; diversified portfolio, low valuation, low debt to asset leverage, low FFO multiple of only 9 times and attractive dividend yield of 5%. Weaknesses include; low occupancy of 90% and the company is not self managed (however NAV calculation includes acquisition of management company for an internally managed structure). We believe that an internally managed REIT with an experienced executive team adds substantial goodwill market value to a REITs valuation.

We highly recommend the purchase of this stock at the current price of $20/sh. Even though we do not like the third party managed structure, the attractive valuation along with the ongoing buyout offer at $24.50/sh. makes this a compelling investment opportunity.

A five year price chart of CWH is shown below:

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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