ONL- Orion office REIT
Orion Office REIT Inc. (symbol: ONL) spun out of the combined VEREIT/Realty Income Corp entity in November of 2021. ONL has $156.5mm of committed annualized base rent on 99 leases across 8.514mm square feet of net leased office space (9.512mm of GLA). Orion has 56.664mm shares outstanding and $557.3mm of principal debt outstanding, $175mm of this principal matures on November of this year (five months from now).
ONL faces the headwinds all other office landlords face: corporates downsizing, WFH, general automation of office-level jobs (particularly call centers), and bad balance sheets exacerbated by tighter credit markets. Whether any of these phenomena are actually secular impairments to the business of leasing office space remains to be seen.
ONL was formed with an undepreciated GAAP real estate value of ~$1.8bn in November of 2021. After the VEREIT/Realty Income transaction less than 2 years ago, an auditor signed off that the assets on the ONL books were worth $1.8bn. At current prices, that would imply a stock price of ~$22. That price aligned pretty well with ONL’s initial listing price: the stock traded up to $30ish~ a share before settling around $18, before eventually collapsing to today’s price of $6.50. This is a meaningless bit of information but nonetheless interesting.
ONL’s splits across tenant, geography and industry are unremarkable:
Despite the maturity at the end of 2023, ONL’s real problem is its lease renewals in 2024. The company has current revolving credit capacity to make their 2023 maturity. That revolver would come due in 2024.
Vacancy rates in office have climbed from mid-teens to nearly 20% nationally. Transaction prices per square foot have fallen below $250 per square foot nationally (around $234 in Q1). Rents have remained stubbornly sticky around $28/psf (ONL’s is at around $17/psf), but this figure can be masked with tenant improvements not necessarily reported and passed through in lease terms. ONL has a 12.5% vacancy rate and is priced at around $100/psf.
CEO Paul McDowell called out market pricing for office assets on the recent Q1 earnings call:
Yes. I mean I think we're actually saying the same thing, Mitch. When I say improvement on asset pricing, I mean from a buyer's as compared to a seller's perspective, right? So we seen cap rates for a long time, cap rates seemed persistently stubborn and that sellers were looking for the pricing that was available 6, 8, 12 months ago, while buyers were starting to look forward.
Recently, as we've looked through our pipeline of possible transactions, what we've seen in the marketplace is the cap rates are now starting to widen out relatively significantly for well-leased long-duration, good properties in good markets, and those levels are starting to get to the levels that we've seen over a long period of time. My career is dating back to the mid-1990s that over long periods are attractive. So -- but we've been very careful, as you noted.
We noted we didn't make any acquisitions in the first quarter. In fact, we haven't made any acquisitions from the balance sheet since we spun. So while we see asset pricing getting better, we're still being pretty cautious or quite cautious in deciding whether or not to add to the portfolio.
Depending on how you view office assets over the next two years, ONL has room to lose another 7.5% vacancy to bring it more in-line with industry vacancy levels. If this occurs, ONL will lose another $20mm~ in ABR. With an SG&A base of roughly $20mm, $30mm~ of EBITDA/quarter becomes $25mm of EBITDA/quarter.
At $100mm of EBITDA the company seems properly valued at around $1bn. So the market is pricing that the firm will revert to national averages and lose that $20mm of ABR through 2024 renewables- seems reasonable.
Cash NOI is annualizing at $120mm. With a reasonable 8% cap rate (again, national average pulled from Bloomberg) the firm is fairly valued at around $1bn in total enterprise value.
I have no reason anecdotal reason to think these assets should be any better than national average. Right now, the company is earning significantly below national average per square foot ($18 vs. $28), but occupancy is running much better than average (87.5% vs. 80%). The market is looking past the maturity catalyst here; if you’d like to make a directional bet on office improving during 2024, the leverage here will work pretty well. Maintaining occupancy or getting market-rate rents for these leases would run EBITDA up substantively. You might lose a bunch of tenants in 2024, but those that stick around might get strong renewal pricing. I don’t like office well enough to make a call here, yet.