Equity Commonwealth (NYSE: EQC) has been slowly selling off its properties since real estate titan Sam Zell took control of the office REIT (real estate investment trust) in 2014. At that time, Equity Commonwealth had more than 150 properties with over 40 million square feet of space. However, today the REIT only has four properties remaining, with 1.5 million square feet. As a result of the portfolio purge, normalized funds from operations (FFO)declined from $268.3 million, or $2.14 per share, in 2014 to $15.8 million, or $0.13 per share, in 2020.
That significant decline in its property count and FFO might have investors worried it's in trouble. However, that's not the case. Instead, it positioned the REIT to shift gears and pounce when it found a compelling opportunity.
Repositioning for the right opportunity
Equity Commonwealth cashed in on institutional investors' high demand for office buildings by steadily selling off its portfolio. That strategy enabled it to repay debt, repurchase equity, and build a cash position so it could pounce when the right acquisition opportunity came along. As of the end of this year's first quarter, the REIT had nearly $3 billion of cash on its balance sheet and no debt.
For years, analysts and investors wondered what it would buy. Many thought last year's real estate market downturn would finally provide Equity Commonwealth with a long-awaited opportunity to buy a portfolio of high-quality office buildings.
However, it turns out that the company had other plans. In early May, it agreed to acquire industrial REIT Monmouth Real Estate Investment (NYSE: MNR) in an all-stock deal valued at $3.4 billion. The transaction will give it a portfolio of 120 industrial properties with 24.5 million square feet of space, primarily leased to investment-grade logistics-focused tenants like FedEx. Monmouth also has contracts to purchase six additional properties with 1.8 million square feet of space that should close over the next year.
A new era
The new Equity Commonwealth will operate a large-scale portfolio of high-quality industrial properties benefitting from dual long-term growth drivers. Those catalysts position the existing 120-property portfolio to generate steadily rising cash flow as it captures higher rental rates from the increasing demand for warehouse space. Meanwhile, it has embedded near-term growth from the six properties Monmouth already agreed to acquire. Longer-term, Equity Commonwealth has lots of flexibility to continue expanding via additional acquisitions and development projects.
Because it's using stock to acquire Monmouth, the combined company will have about $2.5 billion of cash post-closing to fund future expansions. In addition, Equity Commonwealth intends on selling its remaining office properties while Monmouth has a portfolio of marketable securities it can monetize over time. That gives the REIT substantial financial flexibility to capture expansion-related opportunities.
Meanwhile, it has significant untapped development potential as many of Monmouth's properties contain ample land to support more logistics and parking capacity. It should be able to secure expansion projects since the U.S. needs an estimated 1 billion square feet of additional logistics space by 2025. As Equity Commonwealth expands its portfolio, it will help reduce its reliance on FedEx, Monmouth's largest tenant, at 55% of its annual rent.
Far from being in trouble
Equity Commonwealth's steadily shrinking portfolio and FFO might have had some investors concerned. However, that was all part of its strategy to cash in on high office property values so that it could pounce when the right opportunity came along.
While it took some time, the company finally found a deal to its liking in Monmouth. That transformation merger gives it a platform to expand in the fast-growing industrial real estate sector. Moreover, with a cash-rich balance sheet, Equity Commonwealth has ample financial flexibility to grow, which should enable it to steadily increase its FFO in the coming years.