Despite the pandemic, the S&P 500 has rallied 25% in the last 12 months, to new all-time highs. As a result, most stocks have become richly valued and hence it has become particularly challenging for investors to identify stocks with decent growth prospects and attractive valuations.

Office Properties Income Trust (OPI) is an exception, as it is offering an exceptional 8.5% dividend yield and it is cheaply valued. As soon as the pandemic begins to subside, Office Properties Income Trust is likely to prove to be a deep-value stock.

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Business overview

Office Properties Income Trust is a REIT that was formed at the end of 2018 with the merger of Government Properties Income Trust with Select Income REIT (SIR). The aggregate transaction value was $2.4 billion, including the assumption of $1.7 billion of debt from SIR. As a result, OPI now has net debt of $2.2 billion, which is approximately 9 times the annual funds from operations and nearly twice as much as the current market capitalization of the REIT.  Due to its high debt load, OPI is in the process of selling assets to reduce its leverage to a more comfortable level.

On the bright side, OPI has one of the highest percentages of rent paid by investment-grade-rated tenants in the REIT universe. The U.S. Government is the largest tenant of OPI, as it represents 39% of the annual rental income of the REIT. OPI owns 184 buildings, which are primarily leased to single tenants. Its portfolio currently has a 91.2% occupancy rate and an average building age of 17 years.

OPI is now facing a headwind due to the coronavirus crisis, which has given rise to a “work from home” model. Due to this headwind, its normalized funds from operations per share decreased 10%, from $6.01 in 2019 to $5.39 in 2020. On the bright side, a 10% decrease in the bottom line amid an unprecedented downturn is not disappointing at all. In addition, the REIT collected 99% of its rent in 2020 and it has collected 79% of its rent deferrals so far. Overall, OPI has proved fairly resilient to the pandemic so far.

Growth prospects

Due to the sales of some of its assets and the continuing effect of the pandemic on its business, OPI is likely to incur a 13% decrease in its funds from operations per share this year. In addition, there are some concerns that the pandemic may impart a permanent hit to the business of the REIT, as the “work from home” model may become permanent to some extent. However, it is too early to draw such a conclusion. In fact, most companies are likely to return to their traditional work model when the pandemic subsides.

Moreover, thanks to the massive vaccination program underway, the pandemic is likely to subside at the second half of this year. Such a development will greatly benefit OPI, as it will help the economy recover from its recession and will lead most employees back to their offices. It is also worth noting that OPI will not face the headwind from its asset sales in the upcoming years, as its asset sale program is likely to be completed this year. Overall, we expect OPI to grow its funds from operations per share at a 3.0% average annual rate over the next five years.

Valuation – Expected Return

OPI is currently trading at a forward price-to-FFO ratio of 5.5, which is much lower than the 10-year average of 8.7 of the stock. The exceptionally cheap valuation has resulted from the high debt load of the REIT and the decrease of its funds from operations in 2020, as investors require a discount to purchase non-growth stocks.

However, it is critical to realize that this year will probably mark an inflection point for OPI. The pandemic is likely to subside later this year while the asset sale program will be completed. As a result, the REIT will begin to recover next year and hence it is reasonable to expect its valuation to revert to its historical level in the upcoming years.

If OPI trades at its historical average price-to-FFO ratio of 8.7 in five years, it will enjoy a 9.6% annualized boost in its returns thanks to the expansion of its valuation level. In other words, when OPI recovers, its stock will enjoy a strong tailwind thanks to the normalization of its valuation level.

Given also the aforementioned 3.0% expected growth in funds from operations and its 8.5% dividend yield, OPI can offer a 17.6% average annual total return over the next five years. Even if its price-to-FFO rises only up to 6.0, it will provide a 1.6% annualized valuation boost and thus the stock will offer a 10.9% average annual total return over the next five years. This expected return is certainly attractive, particularly given the rich valuation of the broad market.

Dividend

Thanks to its exceptionally cheap valuation, OPI is currently offering an 8.5% dividend yield. Such an abnormally high yield usually indicates the risk of an imminent dividend cut but this is not true in the case of OPI. The REIT has a healthy payout ratio of 47% and hence it can maintain its dividend, particularly if the pandemic subsides later this year. The dividend will come under pressure only in the unlikely scenario of a prolonged pandemic.

Final thoughts

Office Properties Income Trust is trading at an exceptionally cheap valuation level and is offering a markedly high dividend yield due to its high debt load and the coronavirus crisis. However, the REIT has proved fairly resilient to the pandemic while it is also in the process of reducing its debt load. Therefore, it is likely to begin to recover next year, and thus its stock is likely to greatly reward patient investors looking for real estate exposure in the upcoming years.