REITs

Easterly Government Properties: The Long-

Term Treasury Bond Of REITs
Mar. 22, 2021 6:00 AM ET | Easterly Government Properties, Inc. (DEA) | 48 Comments | 25 Likes

Summary
DEA owns Class A-quality properties specially designed for tenancy by federal
government agencies and departments.

DEA's stock price acted much like a Treasury bond during the initial market
disruption in Spring, 2020.

And why shouldn't it? Leases are backed by the full faith and credit of the U.S.
government.

As the finances of the federal government erode, more government-owned

properties may become government-leased properties, giving DEA more
acquisition opportunities.

However, DEA is vulnerable to rising interest rates.

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Photo by MediaProduction/E+ via Getty Images

Investment Thesis
Easterly Government Properties (DEA) is a landlord to the largest employer in the
world as well as the largest office tenant in the United States. That entity is the U.S.
government. As such, DEA (an acronym which, in this article, will refer to the REIT, not
the Drug Enforcement Administration) mostly deals with the General Service
Administration ("GSA"). In fact, DEA is the second largest landlord to federally leased
real estate in the country, at 3.7% market share.

The REIT boasts a weighted average remaining lease term of over eight years, which
makes it reminiscent of a portfolio of intermediate- to long-term Treasury bonds, backed
by the full faith and credit of the U.S. government.

In fact, DEA acted much like a Treasury bond during the peak panic months at the
onset of the pandemic. Similar to the rapid spike in Treasury bond prices when
investors sell risk assets and rush into safe havens, DEA's stock price shot up 20%
during the pandemic after a brief wobble.
Data by YCharts

It's as if, in the middle of the stock selloff, investors realized that the leases in DEA's
real estate portfolio are guaranteed by the same entity that guarantees the interest
payments on Treasury debt. DEA acted as a safe haven asset during the market
disruption.

Now, this is not always the case. In late 2018, when Federal Reserve chairman Jerome
Powell insisted that the Fed Funds rate would continue to rise and quantitative
tightening would continue, DEA was naturally included in the selloff because of the
relatively long duration of its contractually fixed revenue streams.
Data by YCharts

Aside from risk asset selloffs due to the threat of rising interest rates, however, DEA
looks like a great, income-producing safe haven asset to hedge against future market
disruptions or panics.

The Portfolio
DEA is a real estate investment trust that owns Class A government buildings leased to
various agencies and federal departments. Specifically, DEA's target market consists of
single-tenant federal government office buildings around 40,000 square feet or larger.
There are around 500 such properties across the country, plus another 50 properties
leased to Veterans Affairs.

The REIT owns 79 properties across the country, primarily concentrated in the
Northeast around Washington DC and in California.
Source: DEA March Presentation

Office space is the primary usage of DEA's properties at 70%, followed by VA outpatient
medical at 10%, laboratories at 9%, courthouses at 5%, and various other uses
(including warehouse & distribution) making up the remaining 6%.

For a variety of reasons, not least of which being security, DEA's office properties are
unlikely to be disrupted by the growing work-from-home trend. The Federal Bureau of
Investigation, the Immigration and Customs Enforcement, the Drug Enforcement
Administration, the Department of Interior, and the Health Resources and Services
Administration, among others, all operate with confidential information that requires
centralized operations in secure buildings.

The weighted average remaining lease term sat at 8.2 years at the end of 2020, and
DEA's portfolio is 99% leased.
Source: DEA March Presentation

Most of DEA's properties are specialized, build-to-suit buildings that fit exactly the
government's particular uses of them, whether they be gated office buildings,
courthouses, or research facilities. There are two ways of looking at the specialization
of DEA's buildings.

The "glass half empty" view would be that these are very specialized buildings, and that
if the government tenant ever decided to leave, it would be difficult to find a
replacement tenant. In many cases, significant investment into redevelopment would be
required in order to retrofit the building and premises for a private sector tenant.

The "glass half full" view asserts that it's also unlikely that the government agency will
leave anytime soon because of the high cost of developing a new building into which to
move its operations.

DEA insists that it performs deep due diligence on each government agency (in addition
to real estate-related due diligence) to assess the long-term essentiality and criticality of
its mission within the government.
Source: DEA March Presentation

The REIT wants to own properties leased to tenants that aren't going anywhere
because their operations are so deeply entrenched in the functionality of the federal
government.

Moreover, as the federal government becomes ever more deeply indebted, with the
potential of rapidly rising interest expenses if rates rise, it becomes more likely that
GSA-owned real estate will be monetized as a source of immediate cash. Since 1998,
GSA-owned real estate has dipped by a little over 1%, while GSA-leased real estate
has increased by over 23%.
Source: DEA March Presentation

It's hard not to think that this trajectory will continue, since the federal government's
finances are not exactly getting better.

Generally, DEA's leases are structured as modified gross leases, meaning that DEA
pays for much of the building maintenance, property insurance, and real estate taxes
but is often reimbursed for part of it. Despite rent rates being held flat over the course of
the initial term — typically 10-20 years in length — renewal rent rates are reset to the
"market rate" based on CPI inflation, up-to-date replacement cost of the building, and/or
enhancements that have been done to the property during the initial lease term.

So, is DEA more of an office REIT or a net lease REIT? It bears elements of both.
While the lease terms regarding landlord responsibilities lean more toward office, DEA's
long lease terms, high renewal probability, and stable revenue streams are more similar
to the net lease model.
Source: DEA March Presentation

Lastly, I'll mention that DEA's balance sheet is strong. At 6.0x net debt to EBITDA, one
might presume debt to be on the high side, but that is primarily because of the lower
cap rates of its target property group and the lower EBITDA margin inherent in its
modified gross leases. Net debt to total enterprise value is a mere 31.8%, which implies
that the majority of capitalization is in equity.

What's more, DEA's average interest rate is a mere 3.56%, giving the REIT a weighted
average cost of capital of around 4.55%, by my estimate. Comparing this with the
weighted average acquisition cap rate of 6.25% for 2020, we find a 1.7-point spread
between WACC and asset yields. That is by no means a wide margin, but it is adequate
for DEA to maintain profitability. And on a risk-adjusted basis, it's a pretty attractive
spread.

With a dividend of $1.04 per share and FFO guidance of $1.28 to $1.30 per share in
2021, the payout ratio is set to be slightly over 80% this year.

Bottom Line
After dropping nearly 30% from the peak reached in April 2020, has DEA become
attractive again?
Data by YCharts

Given that DEA's management fully expects its dividend yield to hover in the range of
4%-5%, it would make sense to buy DEA when it is trading at the top end of that range.
Due to the slumping stock price, DEA is steadily moving back toward that 5% yield
area.

Data by YCharts
If DEA hits a 5% dividend yield, or a price of $20.80 per share, the stock becomes a
very attractive income-generating hedge against market disruption, in my opinion.

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This article was written by

Austin Rogers
12.64K Followers

Author of High Yield Landlord

Become a “Passive Landlord” with our 8% Yielding Real Estate Portfolio.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in
DEA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not
receiving compensation for it (other than from Seeking Alpha). I have no business relationship with
any company whose stock is mentioned in this article.

25 Likes 48 Comments

Comments (48) Sort by Newest

GuyRien1 25 May 2021, 1:23 PM

G
Premium Comments (2.91K) | + Follow

What an interesting REIT. It is trading at close to its 2020 lowest price. I can't think of too
many other REITs that are doing that!

Reply Like (2)

JBTCP 25 May 2021, 2:07 PM

Comments (265) | + Follow

@GuyRien1 it's certainly one of the few solid REITs out there that is trading at an
attractive valuation.

Reply Like

GuyRien1 25 May 2021, 2:18 PM

G
Premium Comments (2.91K) | + Follow

@JBTCP Sure but why is it trading so close to its 2020 low?

Reply Like (1)

 JBTCP 25 May 2021, 2:46 PM

Comments (265) | + Follow

@GuyRien1 my guess is that it's effectively the unwinding of the covid trading
environment. When Covid just hit and the market took a huge hit as the economy
shut down, DEA was a standout in the market and increased to all-time highs, as
investors took solace in the safety of its cash flows given the portfolio is fully leased
to the fed govt. Now that the economy has/is reopening and investors are moving
out along the risk spectrum, short-term money is no longer "hiding" in safe plays
such as DEA. To me, this represents a buying opportunity, but that's what makes a
market.

Reply Like (5)

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malka 18 May 2021, 2:58 PM

M
Premium Marketplace Comments (1.01K) | + Follow

Added more on the down swoon. I like the premise.

Reply Like (2)

Austin Rogers 18 May 2021, 3:00 PM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @malka As did I.

Reply Like

voopster 27 Apr. 2021, 1:36 PM

V
Marketplace Comments (64) | + Follow

I have held DEA for over a year. My concern is their method of financing acquisitions
through share dilution rather than debt. This keeps a lid on the stock price

Reply Like
 JBTCP 27 Apr. 2021, 2:55 PM

Comments (265) | + Follow

@voopster I think to more hone in on the matter of equity financing, DEA hasn't
been the as opportunistic in terms of issuing equity as it could have been, i.e.,
they've often issued new shares at times where their cost of equity was higher.
Equity financing in and of itself isn't a roadblock to stock price appreciation if used
correctly. Realty Income is a prime example, as they've done a top notch job of
utilizing equity financing at times when their cost of equity is relatively low, and
paring back on equity financing and veering toward debt capital at times when their
cost of equity is high. It's one of the reasons why O has been such a great long-term
performer, due to stellar capital markets management. So I'm not opposed to DEA
utilizing equity financing, I just wish they could be more deliberate about when they
use what type of financing a la Realty Income.

Reply Like (3)

Philip Russell 12 Apr. 2021, 8:59 PM

Marketplace Comments (266) | + Follow

Why doesn't DEA increase its dividend?

Reply Like

Austin Rogers 12 Apr. 2021, 10:28 PM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @Philip Russell The dividend was increased through 2017, and
then FFO was flat through 2020, and now FFO is projected to begin growing again.
So dividend growth should following in the coming years.

Reply Like (1)

A Serious Man 09 Apr. 2021, 11:10 PM

A
Comments (960) | + Follow

Thanks, I like the idea and the price, and I have a mid-position. But I am not seeing that the
government being pretty much the only client makes DEA a super-safe bet. In fact, there is
an inherent risk associated with that, and not a negligible one.

Reply Like
 Austin Rogers 10 Apr. 2021, 11:58 AM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @A Serious Man What is the inherent risk you see to it?

Reply Like

A Serious Man 10 Apr. 2021, 11:34 PM

A
Comments (960) | + Follow

@Cashflow Capitalist The inherent risk is that the government policies can always
change, and at some point government austerity might actually happen. Not to
mention DEA is not necessarily immune to WFH and just plain politicking.

Reply Like

JBTCP 11 Apr. 2021, 8:48 AM

Comments (265) | + Follow

@Cashflow Capitalist main risk is the current insanity of the left that is in charge.
They believe that since certain groups in our society commit crimes, the way to
achieve "equity" is to cease enforcing the laws. There are already tangible calls to
eliminate ICE, and other law enforcement agencies such as DEA (the agency, not
the company) and others to whom the DEA (the company) leases buildings could
be next. Crazy what is going on with that political party now, but sadly that is the
reality.

Reply Like (7)

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Navy Fightin' Blue 09 Apr. 2021, 8:39 AM

N
Comments (761) | + Follow

Yes, one of the few bright spots in this overvalued market.

Reply Like (1)

5ofDiamonds 30 Mar. 2021, 7:06 PM

Premium Comments (4.22K) | + Follow

$DEA near 52WL today looked like a good place to park some cash @Cashflow Capitalist
Thx!

Reply Like (1)

Hillandale Advisors 30 Mar. 2021, 8:38 PM

Contributor Comments (416) | + Follow

@5ofDiamonds What changes the two largest headwinds: 1.) interest rates going
higher leading to REIT outflows and higher cost of debt and equity and 2.) cap rates
going lower due to tons of capital leading to lower investment spreads?

Reply Like

JBTCP 31 Mar. 2021, 2:50 PM

Comments (265) | + Follow

@Hillandale Advisors on the first point, there actually isn't a strong long-term
correlation between rise in interest rates and REIT stock prices. Without question it
does an impact in short-term price changes, but over the long-term the impact is de
minimis.

On your second point, can you clarify what you are referring to? Given there is a
limit supply of tangible real estate assets, I'm not seeing how investor's appetite for
these assets will lead to lower valuations. Perhaps I am misunderstanding the point
you are trying to make.

Reply Like

Austin Rogers 01 Apr. 2021, 1:21 PM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @5ofDiamonds Yes, I've been parking a little more cash in DEA
every day as the price drops. Good for both a long-term hold as well as a short-term
hedge against market/economic disruption.

Reply Like (2)

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JBTCP 24 Mar. 2021, 10:52 AM

Comments (265) | + Follow

Very well written article, and I agree with your core thesis.

Reply Like (1)

AnthonyGiordano 24 Mar. 2021, 6:00 AM

Marketplace Comments (1.02K) | + Follow

Hi CC. Thanks for an article on DEA of which I’m long and dripping, and may add more on
this downturn. Appreciate you tying DEA to movement of treasuries and the comments of
other readers as well, as that makes sense to me and how DEA reacts to market
conditions. Long DEA.

Reply Like (1)

Hillandale Advisors 23 Mar. 2021, 4:24 PM

Contributor Comments (416) | + Follow

Great assets (young, long-leased) to best tenant (US Gov) at great yield.

Reply Like (4)

airlarr 22 Mar. 2021, 3:36 PM

Comments (892) | + Follow

CC, the federal government can borrow for 2% cost. Why do they pay DEA over 6%? In this
day and age, there is no limit to how much the feds can borrow. Please explain.
Larry

Reply Like

Austin Rogers 22 Mar. 2021, 3:54 PM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @airlarr You are correct that there is no real limit to how much the
government can borrow, but with a higher debt load, even small rises in interest
rates can meaningfully increase the government's interest expenses. As for DEA's
properties, the 6.25% cap rate is simply the market rate (or what both parties have
agreed to) for the respective properties. Rather than being a Treasury bond, DEA's
properties have leases tied to specific properties.

Reply Like
 airlarr 28 Mar. 2021, 4:02 PM

Comments (892) | + Follow

@Cashflow Capitalist My real problem is why invest subject to Federal Government

vagaries?? Biden or any President can cut this cord anytime and SAVE big money
for the taxpayers.
Except for this, your work is excellent!!

Reply Like (1)

JBTCP 28 Mar. 2021, 8:35 PM

Comments (265) | + Follow

@airlarr "Biden or any President can cut this cord anytime and SAVE big money for
the taxpayers."

While in theory you are correct, I have yet to see any president in my lifetime,
Democrat nor Republic, demonstrate any true desire to save money for taxpayers.
So to me at least, this is not a real concern. The bigger concern is if the current
craziness around abolishing ICE and other law enforcement agencies actually gains
any steam, and with the current administration, that could happen. This wouldn't be
due to any desire to save us money, but just the insanity currently percolating that if
enforcing our laws is causing problems for certain groups of society, the solution is
to get rid of the agency enforcing the law. Silly of me, I always thought the solution
is just for everyone to follow the law, but my line of thinking is outdated.

Reply Like (6)

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Stewo234 22 Mar. 2021, 1:06 PM

S
Comments (383) | + Follow

you mention DEA’s average interest rate of 3.56%... Seems high compared to other REITs
like O, STOR, WPC etc.
could DEA refinance into lower rates now and increase profits... and the dividend?

Reply Like
 Austin Rogers 22 Mar. 2021, 1:08 PM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @Stewo234 Frankly, that is a fairly low interest rate already, but it
likely can go lower over time as DEA rolls over its loans.

Reply Like

A-ASTON 22 Mar. 2021, 12:20 PM

A
Comments (1.6K) | + Follow

DEA peaked on 26 January 20201 and it still continues it downward slope.

Reply Like (1)

Austin Rogers 22 Mar. 2021, 1:09 PM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @A-ASTON That's true if you look only year-to-date, but it actually
peaked in early April of 2020.

Reply Like

Jussi Askola 22 Mar. 2021, 9:54 AM

Marketplace Contributor Premium Comments (20.99K) | + Follow

Thank you for the article! I hope that prison REITs slowly get out of operations and become
more similar to DEA.

Reply Like (1)

Austin Rogers 22 Mar. 2021, 11:45 AM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @Jussi Askola I would guess that if prison REITs can transition
away from operations and to state (rather than federal) tenants only, then the
market would begin to look more favorably on them. Unfortunately, with the Biden
presidency being outspoken against private prisons, the narrative is overwhelmingly
negative against them. But gutsy contrarians such as yourself might be richly
rewarded someday for jumping in now :)

Reply Like (1)

Lawrence J. Kramer 22 Mar. 2021, 7:59 AM

Premium Comments (11.21K) | + Follow

DEA appears to present pairing opportunities whenever its price diverges from IEF/TLT.
Presumably, it's in REIT ETFs, so it moves in the short-term with REITs generally. Then,
people realize that it's really a Treasury security, and the price adjusts. Right now, DEA
appears not to have "caught up" with the recent Treasury sell-off. If it holds true to form, it
will fall further in price unless Treasuries rally.

Reply Like (1)

Austin Rogers 22 Mar. 2021, 11:46 AM

Contributor Premium Marketplace Comments (2.65K) | + Follow

Author's Reply @Lawrence J. Kramer Exactly. I've been tracking DEA's fall
compared to long-term Treasuries, and generally they've moved in the same pattern
in recent months.

Reply Like

gastro4 22 Mar. 2021, 7:02 AM

Premium Marketplace Comments (1.47K) | + Follow

Thanks so review. Long and dripping DEA.

Reply Like (2)