Corporate Office Properties Trust, Inc.OFC

Although the Washington, D.C. office market may remain weak in the near term, as the federal budget is reassessed and the market works through high vacancies, the area has been very good historically for landlords, and its long-term dynamics remain attractive. Constraints on building incremental supply combine with relatively steady demand for space from both U.S. and multinational entities to keep the long-term outlook favorable for landlords.

COPT's NOI margin is meaningfully below its early-2000s average near 70%. As COPT leases vacant space, it should be able to meaningfully expand its margin and cash flow.

COPT owns roughly 1,700 acres of land, which it could eventually develop into roughly 20 million square feet of additional office space, representing an option on future growth.

COPT's in-house expertise in the areas of property acquisitions, developments, redevelopments, and property management and leasing is a differentiating factor and allows the firm to consider multiple avenues for value creation throughout the commercial real estate cycle.

Tenants sign long-term leases that include regular rent payments and a share of operating expenses. In the long term, this should result in a nice stream of recurring revenue for COPT and provide some protection against inflation. Read more 

COPT's mainly suburban office buildings won't fully participate in the favorable long-term dynamics of Washington, D.C.'s city center properties.

Although COPT has a large land bank, much of it is in areas where incremental demand for office space is unlikely to materialize anytime soon to the level required to justify complete buildout. In the meantime, the land represents a sunk cost earning no immediate cash return.

With the federal government running a large deficit, its budget will probably be under pressure in the future. We expect this to have some spillover effects in the private sector as well. Office demand in and around Washington, D.C., which historically has been one of the best markets in the United States, could suffer for years.

We estimate COPT's dividend is not covered by expected AFFO, and we think it has lower-than-average future growth prospects.

In the current low-rate environment, investors may have bid up prices of other sources of yield, such as REITs. There is risk that capital will flow out of REITs should interest rates rise in the future, pressuring asset values. Read more