When net-lease giant Realty Income (O 0.25%) bought peer VEREIT, they both had office assets in their portfolio mix. However, Realty Income decided that, with more office assets, it could spin off these properties as a stand-alone company, and spun off Orion Office (ONL 1.99%) late last year. Orion's stock is down roughly 50% since Realty Income completed the spin off. And that's just the start of the story here.

Born under a bad sign

Looking at Orion Office, it's hard not to think that this real estate investment trust (REIT) was basically stuffed with assets that Realty Income didn't want to own. Given the nature of office buildings, that actually makes a lot of sense. Offices are large, so it can be hard, costly, and time-consuming to replace tenants when they leave. Meanwhile, upgrading a building is expensive, and may be necessary to retain a current tenant or find a new one. Offices are pretty much the exact opposite of the retail properties (small, generic, and easy to sell or lease) that Realty Income favors.

Two people walking through a revolving door.

Image source: Getty Images.

On top of that, the game plan at both VEREIT and Realty Income prior to their merger was to reduce exposure to offices. So the companies were selling assets and not thinking of these properties as long-term investments. That likely resulted in the portfolio Orion inherited being weaker than it might otherwise have been. But you have to play the hand you have, and that's exactly what Orion is doing.

For example, it has continued to sell assets that it doesn't think are attractive over the long term. It is working to keep tenants and sign new leases, even if that requires significant investment in its highest-quality properties. It's why the dividend, at $0.10 per share per quarter (which translates to a miserly 21% funds from operations payout ratio), is much lower than some investors had hoped when the REIT was spun off from Realty Income. Basically, Orion is conserving cash so it can get its portfolio in better shape.

A slow process

Orion is making the right long-term decisions, there's little question about that, even though the choices it is making are hard ones. The real risk here is that there's no easy or quick way to do what needs to be done. It will simply take time, perhaps years, before the portfolio is on stronger ground.

At this point the 91 property portfolio is just 86.7% leased, and it has a 4.1 year average remaining lease term. Meanwhile, leases representing roughly 18% of its base rent are set to expire in 2023, with another 23% in 2024. That's a huge 40% of the company's rent roll that is at a near-term risk of going away. Management is pitching this as an opportunity to raise rents, given that high inflation could allow for generous rent increases versus expiring lease rates. This is true, but only if Orion can actually roll the leases over or find new tenants within a reasonable time frame.

All in all, there are material risks here. And that, along with the smaller-than-hoped-for dividend, helps explain why the stock has performed so poorly since its spin off. Investors don't like uncertainty, and there is a lot of uncertainty here right now.

No easy solutions

You could easily argue that Orion's trouble started the day it was conceived during the Realty Income/VEREIT merger. It is a work in progress at this point, with a lot more to be done before management molds the portfolio into its desired shape. This is not a great fit for conservative investors or those with short attention spans, but management is doing the right things, so there's reason to believe it can right the ship. The next two years or so will be pivotal, and investors will need to monitor the REIT's progress very closely. For most, the risks here probably outweigh the rewards at this point.