Office real estate investment trusts (REITs) have been under pressure over the past year. The average one produced a total return of -18% in 2020. Weighing on the sector was the pandemic's impact on rental collection rates and concerns that some tenants wouldn't return to their offices in a post-pandemic world, opting instead to operate remotely.
However, the sector is about to get a shot in the arm this year as vaccines roll out, enabling office workers to return in the coming months. That should take some of the pressure off of office REITs like Corporate Office Properties Trust (NYSE: OFC) and Office Properties Income Trust (NYSE: OPI). With that recovery in mind, here's a look at which of these office REITs appears to be the better buy right now.
The case for and against buying Corporate Office Properties Trust
Corporate Office Properties Trust focuses on owning office and data center properties that primarily support the U.S. government and its contractors, most of which are engaged in national security, defense, and information technology (IT). It also owns office properties in the greater Washington, D.C./Baltimore region. About 87% of its annualized rent comes from defense and IT locations, while 13% comes from regional office properties.
That focus on the U.S. government paid dividends last year. The company collected 99.7% of the rent it billed in 2020. It also maintained strong occupancy of 95%, completed several development projects, and grew its rental rate.
As a result, its FFO per share grew by 4.4% last year, which exceeded the high end of its guidance range. Because of that, the REIT performed better than its peers over the past year, generating a total return of less than -6% since the start of 2020. It's also maintained its 4.2%-yielding dividend. That payout seems secure, since the REIT expects its FFO to continue growing this year, driven by its development program and the strength of its operations.
One concern with Corporate Office Properties Trust is its balance sheet. While it has an investment-grade credit rating, it's right on the border of a junk rating. However, the company has significantly improved its credit profile over the years by selling assets. That should continue in 2021 as the REIT aims to raise cash by selling additional properties to joint ventures to finance its development program while maintaining a solid financial profile.
The case for and against buying Office Properties Income Trust
Office Properties Income Trust focuses primarily on operating office buildings leased to a single tenant with high credit quality, like government entities. Like Corporate Office, it has high exposure to the Washington, D.C., metro area (24.1% of its total annualized rental income) and government tenants (39%). However, it has a much more diversified portfolio, as it owns properties in 34 states leased to a wide range of other industries.
The company's focus on leasing to tenants with high credit quality (65% have investment-grade credit ratings) paid dividends last year, as the REIT collected 99% of the rent it billed. Because of that, it delivered solid performance last year, as its normalized FFO and same-property NOI both exceeded expectations. As a result, the REIT had no problem maintaining its monster 8.6%-yielding dividend, which it backs with a low payout ratio of 42% of its normalized FFO.
Like Corporate Office, one concern with Office Properties is its balance sheet. While it has an investment-grade credit rating, it's at the bottom rung. The company has been working to improve its credit profile by strategically recycling capital by selling assets and using the proceeds to buy properties that better align with its strategy. As a result, its leverage is now at the low end of its target range, and it has no significant debt maturities until 2022.
In addition to some balance sheet concerns, the company has several leases expiring in the near term, including 10.3% in 2021, that could weigh on its FFO. That could push its occupancy level even lower, following a decline from 92.4% to 91.2% over the past year. However, it has been selling or redeveloping properties where vacancies are a problem, which should drive better results in the future. Still, these issues weighed on its stock last year, causing it to tumble 21%, which pushed its dividend yield up to its current elevated level.
A bigger yield and greater bounce-back potential
Corporate Office and Office Properties both delivered solid results in 2020 due to their focus on leasing office space to financially sound tenants like the government. However, while government tenants represent the bulk of Corporate Office's portfolio, it's a much smaller portion of Office Properties' business. Because of that, it has more upside potential as the office market recovers. Add in its much higher-yielding dividend, which is on a similarly solid foundation as Corporate Office's payout, and it could produce higher total returns from here, making it look like a better buy right now.