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Earn a 7.9% Yield From “Uncle Sam”

Published April 27th, 2017 by Robert Baillieul

This guest post was written by Robert Baillieul, Editor-in-Chief of Income Investors. He advocates for commonsense, buy-and-hold investing. You can find his daily investment ideas and commentary at IncomeInvestors.com. You can follow him on Twitter @RBaillieul.

You almost never hear this business mentioned on CNBC, but it has quietly made a small group of people rich.

Each year, the General Services and Administration Department dolls out $21.0 billion to keep the federal government humming. The biggest hole in their budget? Rent. While “Uncle Sam” might own a lot of property, he’s also the nation’s biggest tenant.

Some investors have made a fortune leasing office space to the government. The Feds, after all, usually make the rent. One landlord in particular has earned reliable income in this niche and pays investors a 7.9% yield to boot, making it a member of the high dividend stocks list.

I’m talking about Government Properties Income Trust (GOV). This partnership leases out more than 11-million square feet of office space, mostly to the public sector. And while it gets little coverage in the press, I love the business for a couple of reasons.

Earn a 7.9% Yield From the Government’s Landlord

First, you have the world’s best tenant.

The IRS represents GOV’s largest customer by square feet. The U.S. Department of Citizenship and Immigration takes the next spot. Altogether, Federal and State departments account for 90% of the firm’s rental income.

Needless to say, you have a much more dependable tenant than the nice folks answering a Craigslist ad. The U.S. government is rock solid from a financial perspective. These agencies are not going out of “business” anytime soon.

Government departments also tend to stay put. Nowadays, you’d jump for joy if a tenant signs a one year lease (and actually pays on time). Many agencies, in contrast, sign leases for 20 years or longer, with the option to extend for another five to 10 years.

In other words, GOV’s cash flows resemble bond coupons. Profits, you don’t have to worry about; they always roll in. GOV could check the dates on the calendar that will get paid years ahead of time.

Better still, these leases produce eye-popping profits.

Take, for example, GOV’s latest deal. In January, the trust bought one building in Monassas, Virginia that’s 100% leased to Prince William County. The tenant has a lease term of nine years and the “cap rate” number came in at 8.6%.

We use the cap rate as a shorthand for returns in real estate. Essentially, it’s the rent–minus expenses–divided by the building’s cost. Most landlords are happy to earn cap rates between five and six percent, so GOV’s returns are top-notch.

This Monassas purchase looked similar to other deals GOV closed recently. On a conference call last quarter, management announced:

“In December, we acquired an office property in Rancho Cordova, California containing 83,000 square-feet for $13.9 million or $168 per square-foot. The property is 100% leased with the State of California as the majority tenant for a weighted average lease term of 7.2 years and an acquisition yield of 9.1%.”

Not a bad deal. GOV has locked in the State of California for the next seven years. Each month, the trust will pocket about $105,000 in profit.

In short, GOV has done a great job securing eight-percent returns into long-term leases. Since going public in 2009, the trust has bought $2.0 billion of property at a high-single-digit cap rate. The average term on these lease agreements tends to fall around five years.

This has created one of the best dividend stocks around. GOV pays a quarterly distribution of $0.43 each quarter, which comes out to an annual yield of 7.9%. By comparison, a 10-year U.S. Treasury note pays only 2.3% with no inflation protection.

The firm can pay out such a high yield because it’s structured as a real estate investment trust. Thanks to a legal loophole, the firm doesn’t pay any taxes on profits. In exchange for this benefit, however, management must pass on most of their earnings to unitholders.

This three-part formula has resulted in tidy returns for owners. As you can see in the chart below, units have performed well since 2009.

GOV Chart

Source: StockCharts.com

I expect those returns to continue. Management keeps finding ways to increase earnings through acquisitions, rent hikes, and renovations to existing properties. This should translate into a growing stream of distributions for investors.

Of course, you couldn’t call GOV a sure thing. Higher rates could cost all property owners a bundle in interest costs. If bond yields rise, investors would take their money elsewhere.

And while GOV has the best tenant around, they face a lot of the same problems as other landlords. Other costs can eat into margins. More specifically, any spending cuts or a government shut down could crimp profits.

I’m not too worried about these problems, though.

Management has borrowed only $0.50 in debt for every dollar in real estate. Executives have also locked in these liabilities at a low interest rate, with most of these notes not set to mature until 2027 or later. Such a conservative balance sheet would help the trust solider through any Fed rate hikes better than its peers.

Better still, GOV has done a good job at baking inflation and property tax increases into lease agreements. These covenants protect earnings if costs get out of line. Once again, this limits the number of surprises that could impact cash flow.

The Bottom Line On GOV

Most see GOV as a dull business. Over at Income Investors, though, we actually like dull businesses. We shown readers how “selling the basics,” like soda, timber, and railroads, can make the best investments around.

In the case of GOV, this quiet niche can be lucrative. No, the name won’t make you the talk of your next cocktail party, but it will likely crank out distributions for decades to come. If you need extra income, take a second look at this trust.

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