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A REIT With Notable Risk-Adjusted Yield

|Includes:Government Properties Income Trust (GOV), ICF, IYR, RWR

Government Properties Income Trust (NYSE:GOV) is a REIT that leases office space to government clients. GOV owns 71 properties across 21 states and the District of Columbia comprising a total of 9 million square feet of rentable space. Almost 92% of the company's revenue comes from the U.S. government and the United Nations. The current yield from GOV is almost 7%, which is much higher than that of the largest REIT ETFs such as ICF (iShares Cohen and Steers REIT ETF, yield of 3.3%), RWR (SPDR Dow Jones REIT ETF, yield of 3.2%), or IYR (iShares U.S. Real Estate ETF, yield of 4.1%).

Let's assess the income provided by GOV using the yield-vs.-risk approach. I have summarized the relevant statistics in the table below.



Ticker Correlation to 10-Year Treasury Yield Beta vs. S&P500 Expected Volatility Implied Volatility Trailing 3-Year Volatility 3-Year Average Annual Return Yield  
GOV 25% 102% 21% 21% 18% 5.4% 7.0%  
ICF 11% 103% 20% 22% 17% 11.5% 3.3%  
RWR 12% 104% 20% 23% 17% 12.4% 3.2%  
IYR 12% 100% 19% 21% 16% 11.2% 4.1%  

GOV has substantially under-performed the broader REIT indexes over the past three years. The average annual return shown is the arithmetic average return. GOV's high yield is partly due to lower price appreciation in recent years. When I run GOV through my standard battery, what I find is intriguing. GOV has a higher positive correlation to Treasury bond yields than the REIT index ETFs which suggests that GOV has not tended to be hit as hard when REITs have been sold off as bond yields rise. GOV has a Beta with respect to equities that is essentially identical to the REIT indexes. No flags there.

I have calculated an expected future volatility for GOV and the REIT ETFs using Quantext Portfolio Planner (Expected Volatility in the table above) and these are very close to the implied volatility of at-the-money put options (Implied Volatility above). Implied volatility from options is considered to be the best forward-looking estimate of risk. This agreement between Expected Volatility from Quantext Portfolio Planner and the option implied volatility is an important validation in my approach. If these agree, I have more confidence that risk is being priced consistently across assets.

I have used the longest available options for GOV (expiring in June 2014) and then chosen the options on the ETFs with the closest expiration dates to June 2014. These results suggest that GOV's risk level is very close to that of the broad REIT indexes, which is somewhat surprising. In general, we would expect that a single REIT would be riskier than a broad index. The trailing historical volatility level for GOV is slightly higher than that for the ETFs, but not markedly so.

Given that GOV has a yield of 7%, almost twice the average of the three large REIT ETFs in the table above, and a risk level that is very close to these REIT ETFs, GOV seems under-valued as compared to its asset class. This apparent under-valuation must be considered in light of the fact that REITs generally don't look remarkably attractive as compared to other income generating assets. Consider, for example, that you can get 6.2% in yield from high-yield bonds (NYSEARCA:HYG) and 5.9% from MLPs (NYSEARCA:AMLP) for considerably lower expected risk levels. As compared to the universe of other income assets, GOV appears to be generally on par.

Disclosure: I am long GOV.

Stocks: GOV, ICF, RWR, IYR