I’m starting up an office REIT basket, last week City Office REIT (CIO) announced it was being acquired by MCME Carrell (an affiliate of Elliott Management and Morning Calm Management) for $7/share in cash, which is approximately a 10% cap rate on CIO’s net operating income (85% occupancy).
It’s been 5 years since the worst of the pandemic, return to office trends keep moving in the right direction. Anecdotally, my commuter train is generally as crowded as it was pre-pandemic (excluding Fridays) and the Chicago loop seems mostly normal again. New supply is virtually non-existent, likely will be for the foreseeable future, these things take time, but private equity seems willing to take a risk on office at these valuations.
First up, and likely the least risky of the three, is Net Lease Office Properties (NLOP) (~$500MM market cap), a well-known favorite that many other value bloggers have written up since it was spun off from W.P. Carey (WPC) (NLOP’s external manager) in November 2023. It is a vehicle designed to be a liquidation with a limited life, similar to other REIT spins of the past like Retail Value or Spirit MTA — popular among value investors, REIT liquidation, gives me nightmares of the New York REIT (NYRT) pitch. Â
But this situation has mostly de-risked, at the time of the spin, NLOP was saddled with a 14% interest rate mezzanine loan, after several initial rounds of asset sales, the mezzanine loan has now been completed paid off as of April. That news is important because the remaining debt is all non-recourse mortgages attached to specific properties, any further asset sales on the unencumbered properties can be used to make special liquidating distributions to shareholders. Much of the mortgage debt might end up getting extinguished via foreclosure, can almost think of those properties as call options on the office recovery.
As the name suggests, NLOP owns primarily single tenant office properties where the tenant is responsible for most of the operating expenses of the property (net lease or triple net lease). Keeping things simple, below is a quick back of the envelope illustration of what NLOP would be approximately worth at a 10% cap rate, similar to the CIO transaction.
There’s a lot more fun you can have modeling out the liquidation value here, including the cash flow from here until the final distribution, what handing back the keys means on the encumbered properties, etc. The portfolio is 85% leased, there’s one chunky property, KBS’s headquarters in Houston that makes up 23% of the rent roll, but I’m generally more optimistic on Houston than others, it wasn’t as impacted by covid and has a more in-person office culture than some other cities. I think it’s a manageable.
Disclosure: I finally joined the party and now own shares of NLOP