One of Washington REIT's (NYSE: WRE) big talking points is that it's focused on the Washington, D.C. region, the seat of political power in the United States. And it isn't the only landlord hyping its ties to the U.S. government, with names like The GEO Group (NYSE: GEO), Postal Realty Trust (NYSE: PSTL), and Easterly Government Properties (NYSE: DEA) all sporting ties to Uncle Sam. The problem is that such relationships don't always work out as well as hoped. Here's what you need to know before buying into this sales pitch.
A dividend cut -- and then what?
Washington REIT had an impressive history of dividend increases under its belt before a portfolio revamp led to a dividend cut in 2012. The plan was to restructure the business for growth -- only the dividend has been increased in eight years.
There are two questions here that need to be answered. First, if the Washington, D.C. region is so great, why did a real estate investment trust (REIT) with decades of annual dividend increases behind it need to alter its business approach? Second, assuming a change was needed, why has the turnaround taken so long to pan out?
Clearly, there are nuances to every story, and Washington REIT is hardly a bad REIT. But owning apartment and office properties in and around Washington, D.C. clearly hasn't translated into impressive results for dividend-focused investors. This is particularly true for those looking to live off the income they generate, since inflation eats away at the purchasing power of static dividends. The company reports there's built-in growth in its portfolio as it looks to serve the D.C. region, but until that shows up in dividend growth, investors should remain skeptical here.
A fickle master
The GEO Group is another name investors should be leery of, but its tie to the U.S. government is far more direct. This REIT owns and operates prisons, which makes the government its biggest customer. The problem is that if you have just one main customer, that customer may control your destiny. The federal government has started to sour on the idea of hiring for-profit entities to run prisons, leaving GEO's future up in the air.
This change in direction is having a real impact, with The GEO Group losing a federal contract in November 2020 and another one in January. The REIT cut its dividend 29% in the fourth quarter of 2020 and another 26% in the first quarter, for a total dividend cut of more than 50%. When the political winds blow, being reliant on the federal government can hurt.
This brings up Postal Realty Trust, which buys properties leased to the U.S. Postal Service. That sounds like a great business, and the REIT has been growing its portfolio at a rapid clip since its 2019 IPO (it has more than doubled in size). But step back and think about this for a second. The U.S. Postal Service seems to be a perennially money-losing operation, increasingly being hurt by the digitization of things once sent by so-called snail mail. While the U.S. government has been willing to lend a hand to keep the U.S. Postal Service going, would it be so shocking to see cost-cutting efforts lead to the closure of locations?
The U.S. Postal Service did actually vacate one of the REIT's properties in the third quarter. One property is hardly a problem, and maybe Postal Realty can keep growing via acquisition, but you shouldn't simply assume the U.S. Postal Service's future is bright because it's backed by the U.S. government. That's just not the case, given the current trends it's seeing.
These same concerns should be in the back of the minds of shareholders of Easterly Government Properties. Easterly largely owns office buildings (around 70% of the portfolio) occupied by various government entities, with exposure to agencies with acronyms like the FBI, DEA, VA, DHA, HRSA, and others. That's more diversification than you'll get with Postal Realty, which is good.
But government cutbacks could be a big issue here, too, if they were to occur, and should be a part of the thought process for investors. Yes, the list of direct renters is varied, but they all roll up to one main payer: the U.S. government. That's a material concentration risk, even if Uncle Sam is considered a high-grade tenant.
Test the thesis
Owning property leased to the U.S. government or tied to it in some way isn't a bad thing in and of itself. However, investors shouldn't simply believe the storyline from REITs that tout their ties to the government. There are times when it doesn't work out quite as well as planned, which appears to be the case at Washington REIT and its over eight-year turnaround effort, as well as over at The GEO Group, which is seeing the government sour on its business model.
The issues these two REITs have faced should be taken to heart if you own or are looking at Postal Realty and Easterly Government Properties. Things may be going well right now for these REITs, but times change, and having just one main tenant can sometimes turn from a big benefit to a big risk.