What a difference one week makes!
Last week it appeared that a cease-fire had been declared in the war over control of the Select Income REIT (NASDAQ:SIR) board of trustees. It appeared that the two sides, CommonWealth REIT (NYSE:EQC) and the Select Income incumbent board of trusties controlled by REIT Management & Research, or RMR, were going to wait it out in the trenches until the next shareholders meeting.
An unexpected RMR chess move
I never saw this one coming!
Select Income external manager RMR, also controls the board of several other publicly traded equity REITs including Hospitality Properties Trust, Senior Housing Properties Trust, and Government Properties Income (NASDAQ:GOV). The treasury of Government Properties is the latest source of funds to be used by RMR to purchase a controlling interest in Select Income REIT announced on July 9, 2014.
The purchase price of $31.51 per share rewarded CommonWealth shareholders with a premium of $1.50 compared to the closing price on July 8th.
Business models with little in common besides RMR
One of the reasons it seems so peculiar for either CommonWealth or Government Properties to own a de-facto controlling interest in Select Income REIT is that these companies don't have the same business model.
CommonWealth REIT operates in the office space REIT sector owning properties in central business districts as well as suburban office parks. These are typically multi-tenant properties leased to a diverse group of industries. Current CommonWealth internal management described the sale of its Select Income shares as "non-strategic."
Eponymous Government Properties is also an office REIT, however, it primarily leases its office buildings to U.S. federal and state governmental agencies. Government Properties owns approximately 10 million square feet of office space located in 31 states and Washington, D.C.
Select Income REIT is a single-tenant triple-net landlord. Peers include Realty Income, Lexington Realty Trust, and Stag Industrial. This has been a very successful REIT sector, partially due to the low interest rate environment caused by the Federal Reserve quantitative easing program -- currently expected to expire after October, 2014.
RMR managed REITs in four different sectors are yielding over 6%
Dividend investors are being rewarded with high-yields across the board. However, there are ongoing battles by shareholders attempting to influence RMR to align its interests more closely with shareholders. Recent RMR actions certainly have the potential for conflicts of interest.
Why is Select Income REIT worth fighting over?
Although Select Income REIT has many single-tenant triple-net peers, it has a rather unique blend of assets. Approximately 40% of revenues are derived from land leases surrounding Pearl Harbor on the Hawaiian island of Oahu.
Select Income has over 200 tenants in Hawaii who own buildings situated on more than 17 million square feet of land. Unlike most triple-net lease portfolios on the mainland, these land leases are marked to market every five or 10 years. Since 2004, the land rent increases have averaged ~37%, and in 2013 they increased more than 47%.
Typical single-tenant triple-net annual rent increases on the U.S. mainland have increases, or rent bumps in the range of 1% to 2%.
Select Income also has a rather conservative balance sheet compared to its peers. It is well positioned to issue take on prudent debt to fund future growth from acquisitions accretive to earnings.
RMR has an additional motivation to control the board
Quite simply, the fee income which is derived from being contracted as the external manage of Select Income REIT. This is where shareholder interests and RMR interests may not be closely aligned.
Wells Fargo has two completely different views
On one hand, Government Properties utilized a new $500 million unsecured term loan from Wells Fargo and Citibank as partial funding for the ~$705 million purchase of Select Income shares from CommonWealth REIT.
On the other hand, a July 10, 2014 Yahoo Finance article reported that:
Wells Fargo views Government Properties' (GOV) stake in Select Income REIT (SIR) negatively as it believes the deal was done to give Government's external manager RMR increased control of SIR. Wells does not see a benefit to Government Properties holders by taking the stake and it thinks the deal supports the "long-held concerns" that RMR's incentives aren't aligned with shareholders. It lowered its price target range for Government Properties shares to $20-$22 from $21-$23 and keeps an Underperform rating on the stock.
I remain a big fan of Select Income REIT based upon valuation, dividend yield, and its competitive moat in Hawaii. The fact that the boardroom tug-of-war is over, and has been won by RMR is a mixed blessing.
RMR has too many dogs in this fight. I have concerns that concerned Government Properties and Select Income REIT shareholders will voice loud objections. However, I applaud CommonWealth REIT for its ability to get out from between the dog and the fire-hydrant, and do so profitably for all of its shareholders.