Description
We recommend an investment in Equity Commonwealth (EQC). EQC has been written up before on VIC, while much of the past write-ups remain true, we view EQC as particularly actionable in today’s environment.
The story is now rather straightforward. EQC has executed on selling non-core assets since taking over its inherited portfolio, and the resulting cash balance will now be utilized to pursue a value-add transaction(s). EQC has been consistent in its messaging. The team, led by Sam Zell (Chairman) and David Helfand (CEO), has been actively underwriting deals for the last few years. While the deal shot clock has extended beyond initial expectations given market appreciation, the current environment is what Sam Zell has been waiting for. Every article we read discussing tenants not paying their rent raises the probability that Zell and his team can execute a value-add transaction in either the office or an office-adjacent asset class.
We would point to today’s article in the WSJ that highlights the upcoming opportunity: https://www.wsj.com/articles/blumberg-joins-rush-of-property-firms-raising-funds-for-distressed-deals-11609243201
Key advantages EQC has in today’s market:
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Net cash position, rock solid balance sheet. ~$3b+ of cash/dry powder remaining after recent $3.50/share special dividend. EQC is not dependent on the capital markets to transact.
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Ability to be flexible and look outside of office.
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Attractive rates.
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Management team in place. EQC’s relatively high G&A load has been scrutinized by investors but limits disruption in a transaction scenario.
EQC is substantially all cash with four office assets (see company disclosure below). Since 4Q19, EQC has sold three assets at very attractive cap rates.
Rent collections have been great. As of 3Q20, rent collections were 98% and EQC has relatively minimum rent roll (~20%) through 2022.
The downside is limited given the ~$24/share in net cash and recent insider purchase at $28.84 (100k shares or ~$2.9m, $25.34 adjusted for $3.50/share special dividend) by long time EQC board member Gerry Spector. At the ~$26.50 share price, pick your cap rate for the balance of the portfolio, even assuming no lease-up of expiring leases. Given the quality of the remaining assets and current valuation of public office peers, this implies a very limited downside in today’s environment.
Even in our doomsday scenario, we do not see fundamental downside in the current share price. Levered office REITs are trading at ~6% cap rates and the implied market cap rate for EQC is >9.5%, unencumbered! The three assets sold this year were sold at a blended ~5.3% cap rate which speaks to the quality of the remaining assets. We see upside to the shares based on the current portfolio even without a much anticipated transaction.
We believe that EQC’s legacy as a special situation REIT should expire with the announcement of a transaction. A transaction would likely spark a regular dividend and ownership adoption from REIT investors, which has been limited since EQC’s formation.
It is admittedly difficult to underwrite a phantom value-add transaction. However, EQC’s management team has been discussing this scenario for the last five years and finding an attractive transaction given the increasing number of distressed portfolios, both public and private, is clearly easier today. EQC’s management has already done an excellent job of realizing full value of their inherited portfolio by divesting its assets in an appreciating real estate market. Now that they have their cash, we view this environment is more conducive to a value-add transaction.
To summarize, we view EQC as an attractive investment given the asymmetric return profile highlighted by its net cash position and seasoned management team.
Disclaimer:
The views and opinions stated are the personal views of the author. Do not rely on the information set forth in this write-up as the basis upon which you make an investment decision – please do your own work. The author and funds which the author manages hold positions in and trade, from time to time, securities issued by EQC and options on such securities. This write-up does not purport to be complete on the topics addressed, and the author takes no responsibility to update this write-up in the future. This is not a recommendation to buy or sell any securities.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
- Distressed office assets begin to trade