In the examination of CommonWealth REIT (CWH) we must first state the obvious. It is an exceptional value, but plagued by the clear conflict of interest of its management. First, we will take a look at 3 types of strange activity by CWH and then form a concept of where the stock is headed.
1) In August CWH issued $175mm of 30 year 5.75% unsecured notes and used the proceeds to fund the redemption of its 7.125% Series C Preferred shares. In today's low interest rate environment refinancing of this nature is quite standard, so why do I consider this strange activity? Well, it seems odd to buyback 7.125% preferred shares at full liquidation preference when CWH could have instead repurchased common shares costing them over 13% in dividends. With the common trading under 50% of book value, such a maneuver would have been immediately accretive while reducing dividend costs to the company by more than redemption of the preferred.
2) Management of CWH announced intent to reposition its portfolio in favor of properties located in CBDs. With this has come the sale of various suburban offices to free up capital for acquisitions. While offices located in CBDs are in fact performing better in the current environment, the acquisition price is raised accordingly. RMR is functionally selling low and buying high.
3) Many of CommonWealth's best performing properties were spun-off through the IPO of Select Income REIT (SIR). On the 2Q conference call management indicated consideration of another spin-off of its Australian properties which have also been performing very well. The strong occupancy and rental rates of this portion of its portfolio may bring in a nice price if such a deal takes place.
Each of these has in common the generation of large amounts of fees for RMR (CWH's external management team). Since fees are charged for the execution of various transactions, a simple shuffling around of finances, and property portfolios has a very small effect on the company while creating large amounts of fees. Thus, management is incentivized to be very active, even when the marginal benefit of each decision is not worth the cost.
Perceptions that RMR was not aligned with shareholders were furthered through tactless presentation on the 2Q conference call in which Adam Portnoy strongly indicated that CWH would have to reduce its dividend based on a CAD payout ratio of 108% and declining occupancy. He failed to give any guidance as to how much. The only thing that scares shareholders more than knowing a dividend cut is coming, is not knowing how much it will be cut. Consequently, the market price plummeted to as low as $14.60. The bottom line is that investors simply do not trust RMR which is evidenced by the companies they run trading at significant discounts to peers.
Market Price $
Annual yield %
Select Income REIT
Hospitality Properties Trust (HPT)
Government Properties (GOV)
As an investment CWH is very interesting. It is by far the best value in the office sector and gives a great dividend even if it is cut in half. That being said, I imagine its price will remain low until a few events are complete.
- A lower and sustainable dividend being announced would create stability and allow investors to properly gauge the expected income.
- Currently many holders of CWH have the opportunity to sell it, realizing the capital loss for tax benefits. Until the stream of former holders using it for this purpose subsides, it seems the stock price will remain low
- Shareholders need a sign of alignment from management to reignite at least a semblance of trust. In my opinion, a common stock repurchase while it is so far below book would be a phenomenal start.
Once some or all of the above happen, CWH will be unlocked as an excellent value play to gain exposure to the office sector.
Disclosure: This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the author.