The great news for investors is that Select Income REIT (NASDAQ:SIR) has been a cash cow since its 2012 IPO, has a strong balance sheet, and looks to be undervalued as of June 30, 2014.

On the other hand, you know the familiar adage that sometimes truth is stranger than fiction?

I think that is the kindest way to describe the bare-knuckled boardroom brawl still evolving between the CommonWealth REIT (NYSE:EQC) new management team, and former external manager REIT Management & Research, or RMR.

In a related and convoluted story, RMR is still the external manager of Select Income and CommonWealth is the largest Select Income shareholder by far -- owning a little over 37% of the company shares. More good news for Select Income shareholders is that the battle for control of the boardroom should be over on or before the next shareholder meeting.

The battle over RMR's fees, and related payments for termination of duties as external manager, will likely take longer to resolve.

The Lakewood Capital Management, LP letter
A June 11, 2014 letter to the Select Income REIT Board of Trustees, from a fund holding a 5.8% interest, lays out a detailed chronology of recent events. It also contains a net asset value, or NAV, estimate which indicates Select Income REIT to be trading significantly below its NAV.

I feel far beyond its utility for evaluating Select Income REIT as a potential investment, this version of events is important for all Motley Fool readers because:

1. It serves as a textbook example of how important it is for REIT investors to understand the track-record and background of the sponsors and management of any REIT.

2. It underscores why it is critical to ascertain if management incentives are aligned with common shareholders.

3. It illustrates that a good rule-of-thumb when considering buying REIT shares is to take a very close look at any management agreement between an external manager and the trust.

Should Select Income REIT still be considered by investors?
I would have to answer that question almost resoundingly in the affirmative.

Back in December 2013 I wrote a Motley Fool article about rule-breaking with a positive conclusion regarding Select Income REIT. That article didn't focus on the management issues, but rather on the business model and related risk factors.

It concluded, that what appeared to be a geographic concentration risk, actually was a huge competitive moat.

A single-tenant triple-net business model with a twist
I think all the parties can agree that the Pacific Ocean is a significant body of water between the U.S. mainland and Hawaii.

Select Income REIT rather uniquely owns ~17 million square feet of land on which there are over 200 buildings that tenants own. Select Income gets paid land rents. A great thing for shareholders is these payments are reset, and marked-to-market every 5 or 10 years. The tenants are responsible for the building expenses as well.

The balance of the Select Income REIT portfolio is located on the U.S. mainland: 37 office and industrial properties containing over 8.2 million square feet. The company has acquired 29 of these buildings since its 2012 IPO, with a weighted average cap rate of 8.8% and a 12 year remaining lease term.

A conservative balance sheet as well
Select Income REIT has a solid balance sheet with far less debt than its peers. A prudent use of additional leverage to fund accretive growth represents significant upside potential for stockholders.

Chart below is from the Lakewood letter Exhibit A:

Projections for full year 2014 and 2015 estimates certainly will vary depending on assumptions. It should also be noted that cap rate calculations can vary as well. Although these estimates appear to be reasonable, investors should always perform their own due diligence.

Summary of pros/cons regarding Select Income REIT

  • The heavy lifting was done regarding eventually ousting RMR as external manager when control of the CommonWealth board changed in May 2014. Pro or Con is up to you.
  • A REIT stock trading below its NAV provides investors a margin of safety. Pro.
  • The dividend currently yielding 6.4% appears to be solidly covered, estimated by RMR to be 63% of normalized funds from operations, or FFO, per share as of March 31, 2014. Pro.
  • Prudent use of debt leverage can increase FFO and dividends moving forward. Pro.
  • The ongoing battle between stockholders and board of trustees is a risk factor and distraction. Con.

Investor takeaway
It rarely makes sense to volunteer yourself to get between a dog and the fire hydrant. However, given the facts as I understand them, I feel that Select Income REIT is still a rule-breaker worthy of your consideration.