Given the current bull market in U.S. equities and general overvaluation, it's slim pickings for value investors nowadays. Commercial real estate appears to be one of the few investable sectors in the U.S. that may still offer some value.
The following chart from Research Affiliates projects a real return of 2.1% per annum (above expected inflation) for this sector over the next 10 years. This is opposed to the negative real returns expected for U.S. stocks and bonds.
Franklin Street Properties Corp. (FSP, Financial) strikes me as a particularly interesting opportunity in the real estate sector. It was highlighted by a screen that I run in GuruFocus on REITs. It has a high 9% modified capitalization rate (operating cash flow divided by market cap) and positive owners' earnings.
Franklin Street Properties is a U.S.-based REIT with a focus on infill developments and central business district office properties in the U.S. Sunbelt and Mountain West, as well as select opportunistic markets.
Its Funds from Operations (FFO), as shown below on a per-share basis, has shrunk since the beginning of the pandemic last year, and the dividend was cut even earlier. However, the stock price has fallen even more. Franklin Street Properties is paying a 9-cent dividend every quarter, which works out to a decent 7.7% yield. FFO covers the dividend quite well, but adjusted FFO (which includes maintenance capex) is below the dividend, so there is a risk the dividend may be cut further.
As per the chart below, Franklin Street Properties' stock is currently selling below its tangible book value per share.
Franklin Street Properties is currently in the process of selling off some assets to strengthen its balance sheet by reducing debt. In its Q1 report, the company has reaffirmed the 2021 property disposition guidance to be in the range of $350 to $450 million in aggregate gross proceeds with disposition proceeds intended to be used primarily for debt reduction. Potential disposition properties include: One and Two River Crossing in Indianapolis, Indiana; Timberlake Corporate Center in Chesterfield, Missouri; Meadow Point in Chantilly, Virginia; Innsbrook Corporate Center in Glen Allen, Virginia; Loudoun Technology Center in Dulles, Virginia; One and Two Ravinia Drive in Atlanta, Georgia; and One Overton Park in Atlanta, Georgia.
The balance sheet is in decent shape with debt maturities fairly spread out and manageable.
The following chart shows Franklin Street Properties' interest expense as well as its cash flow from operations (OCF). OCF is calculated after interest, so there is a wide margin of safety for interest payments. The dividend is well covered by OCF for now.
Looking at the company's median price to sales (PS) and median price to book (PB) ratio justified price, over the last two years, the stock appears to be undervalued by about 30%.
The company is showing positive insider trading with several directors acquiring shares.
About 90% of the company's shares are owned by institutions.
Overall, given the general overvaluation in the market and rising inflation, I think Franklin Street Properties is a good value proposition with 30% to 50% upside potential as the recovery in commercial real estate proceeds. Plus, we are getting a 7.7% dividend while we wait.
