Orion Office REIT (ONLY) has not had good share price performance since being spun off from Realty Income (O) last November, trading at just $ 16.73 and down more than 20% since the time of spin.
While this may be discouraging for some, I believe much of the selling has more to do with Realty Income investors simply having no interest in holding office properties. In this article, I highlight why this presents a good buying opportunity for long-term income, so let’s get started.
ONLY: A Potential High Yield REIT At A Bargain
Orion Office an internally-managed net lease REIT that was formed out of the merger between Realty Income and VEREIT. Its portfolio consists of office properties that are predominately single-tenant, resulting in a more simplistic business model compared to multi-tenancy.
Like peers City Office REIT (CIO) and Highwoods Properties (HIW), ONLY focuses on attractive suburban markets where it can get higher cap rates on new property acquisitions. ONLY has 92 office properties that are 94.4% leased, with a weighted average remaining lease term of 3.4 years. It’s well-diversified by geography, with higher exposure to New York / New Jersey, Illinois (Chicago), and Texas.
As shown below, ONL serves tenants in economically essential industries, and has many recognizable names in its top 10 tenant roster, including the GSA (US Government), Merrill (BAC), Cigna (CI) and Walgreens (WBA).
ONL is led by a seasoned management team that includes CEO Paul McDowell, who served as EVP and COO of VEREIT since 2015. He was also the founder of CapLease, a former publicly-traded net lease REIT. Additionally, Gavin Brandon serves as the CFO, after having served as Chief Accounting Officer of VEREIT since 2014.
What sets ONLY apart from other REITs is its high exposure to investment grade rated tenants, which comprise 72% of its annual base rent. This compares favorably to the 34% net lease average. The high exposure to quality tenants has helped to make ONLY resilient to economic downturns, including COVID. This is reflected by Orion collecting 99% of rents during the pandemic era, from April 2020 through June of 2021.
In addition, ONL’s portfolio consists primarily of mission-critical regional corporate headquarters locations, thereby making them “sticky” in nature, with a strong track record of tenant retention and re-leasing. This is reflected in its recent 7-year extension of a lease agreement with Rockwell Collins, a multinational avionics corporation, and an 11-year renewal with Praxair, a leading North and South American industrial gas supplier now owned by Linde (LIN).
Looking forward, ONL has plenty of growth runway, as the suburban office market remains highly fragmented. Management has outlined a strategy in which it targets those markets with limited new office supply, population growth, a highly educated workforce, and a business-friendly tax environment with access to mass transit. Moreover, ONL maintains plenty of liquidity to execute its strategy, with $ 274M, consisting of $ 10M in cash on hand and $ 264M in available capacity on its revolving credit facility.
Challenges to ONL include increased competition for real estate, which could drive down cap rates. In addition, higher cost of debt could compress investment spreads. Plus, ONL’s weighted average remaining lease term is 3.4 years, which is on the low side, and management is looking to extend that by targeting new investments with long-term leases in the 8-12 year range.
Turning to valuation, ONL appears to be rather cheap at the current price of $ 16.73 with a forward P / FFO of 6.97. This also translates to an 8.6% potential dividend yield, should ONLY target a 60% payout ratio on its forward FFO / share of $ 2.40.
ONL is also priced favorably compared to suburban office REIT peers Highwoods Properties and City Office REIT, which come with forward P / FFO of 11.2 and 13.5, respectively.
While ONLY does not yet have Wall Street ratings, both HIW and CIO have consensus Buy ratings with price targets that are 17% and 23% above their current prices, despite their higher valuations. As such, this bodes well for a potential repricing on ONL’s shares as the market warms up to this stock.
Orion Office REIT has traded rather weakly since being spun off from Realty Income last November. However, it has strong portfolio characteristics, including high exposure to investment grade-rated tenants and its single-tenant, net lease structure.
I see management as having the right strategy in place to grow in suburban markets, where there is less competition. Lastly, ONL trades rather cheaply, especially compared to peers that have a similar investment focus. ONLY appears to be a good bargain for those who seek income and growth potential.