3 Floundering REITs Diving Into Trouble: February 2024

The upheavals in the housing market last year dealt a heavy blow to real estate investment trusts (REITs). Soaring mortgage rates and plunging home sales created an air of uncertainty, leaving investors wary of once-reliable REITs in their portfolios. With signs of impending shifts on the horizon, investors now stand ready to pivot.

Yet a glimmer of optimism emerges. Mortgage rates show early signs of easing, while home sales inch up after hitting rock bottom. So while most REITs still linger in the shadows, trading at a median 15.8% discount to their net asset value, some careful optimism prevails.

Nonetheless, this budding confidence is not without its caveats. As the 2024 election cycle gets underway, the threat of political volatility injects fresh uncertainty into an already skittish market.

In this crucible of change, investors face critical decisions in distinguishing stable REITs from precarious ones vulnerable to decline. Three such REITs – Hudson Pacific Properties (HPP), Medical Properties Trust (MPW) and Orion Office REIT (ONL) – may not emerge unscathed.

Storm Clouds Gather Over Hudson Pacific Properties

Hudson Pacific Properties (NYSE:HPP), a major Los Angeles-based office REIT, faces a tempest on multiple fronts. With an Altman Z score of 0.23, it shows signs of encroaching financial fragility.

Its plight is most visible in the office segment, its core holding, where dwindling rents collide with stubbornly high operating expenses. This margin compression gets amplified by a 31% free fall in its stock value over 2022.

HPP’s third quarter financials underscore the narrative of decline: revenues dropped 11.1% year-over-year to $231.4 million, missing Wall Street estimates.

Adding to its woes, occupancy rates continue to slide despite aggressive discounting. A wave of looming lease expirations further jeopardizes future cash flows, placing revenues under more strain.

Already battling market headwinds, HPP also confronts forces beyond its control. The secular shift toward remote work casts doubt on the vitality of its sprawling Los Angeles office holdings. Meanwhile, the 2023 Hollywood production union strikes delivered yet another blow to its studio operations.

With its core film production and office segments under siege, HPP occupies precarious ground. Its capacity to maintain revenues while avoiding a dangerous debt spiral remains uncertain. Turbulence likely lies ahead.

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Medical Properties Trust Faces Deepening Distress

Medical Properties Trust (NYSE: MPW) was once a darling in the healthcare REIT space. Yet today it epitomizes the fickle nature of markets and the volatility inherent in REITs.

Over 2022, MPW shares went into free fall, plunging 75.2% amid a crisis of confidence. Its decision last August to slash dividends triggered a market shock, laying bare its financial troubles and fueling doubts about its future.

In the wreckage, MPW still boasts a towering forward dividend yield near 19%. But this ostensibly generous payout comes wrapped in red flags. Despite struggling to cover its existing dividend, another cut may still loom amidst deteriorating tenant finances.

So while value hunters may be lured by MPW’s apparently deep discount, extreme caution remains warranted. The threat of yet another dividend reduction and subsequent investor exodus cannot be dismissed. For now MPW hangs in the balance, its fate uncertain.

Orion Office REIT Confronts an Uncertain Future

Since its high-profile corporate spin-off from industry giant Realty Income (O) in late 2021, Orion Office REIT (ONL) has been on a rollercoaster. Its shares plunged over 50% amid broad doubts over the durability of its business model.

Orion’s niche focus on single-tenant office properties may prove its undoing. With over a quarter of leases expiring soon, it stares down the possibility of having to overhaul – or dump – entire vacant buildings.

At first blush Orion may look like a bargain, trading at a fraction of its book value and sporting a forward dividend yield over 8%. But behind the superficial affordability lies deeper flaws. Orion’s basement-level valuation reflects legitimate doubts over its ability to renew leases or re-lease space in a radically shifting office market.

Though the outlook appears gloomy, Orion’s fate ultimately depends on broader economic winds. An unexpected rebound in demand for office space could propel its comeback. But the odds appear long, with storm clouds gathering on the horizon.

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