Business context and reporting period
Easterly Government Properties, Inc. filed its first full-year 10-K for the year ended December 31, 2015. The internally managed REIT acquires, develops and operates commercial properties leased primarily to U.S. Government agencies through the GSA. At year-end it owned 36 properties totaling approximately 2.6 million square feet; the portfolio was 100% leased, with a weighted-average remaining lease term of about seven years.
The company completed its IPO and formation transactions on February 11, 2015. Consequently, 2015 results combine predecessor activity before the IPO with company results thereafter, while 2014 results principally reflect the predecessor. Accounting also shifted from investment-company fair-value accounting to historical-cost accounting, making year-over-year comparisons materially limited.
Financial and operating metrics
| Metric | 2015 |
|---|---|
| Total revenue | $71.4 million |
| Operating income | $4.0 million |
| Net loss, consolidated | $6.0 million |
| Net loss attributable to Easterly common stockholders | $1.7 million; basic and diluted loss per share $0.08 |
| FFO / FFO, as Adjusted | $32.6 million / $34.7 million |
| Operating cash flow | $30.0 million |
| Investing cash flow | $(164.6) million |
| Financing cash flow | $111.3 million |
| Cash and cash equivalents | $8.2 million; restricted cash was $1.7 million |
| Total debt | $238.2 million: $154.4 million revolver borrowings and $83.8 million mortgage debt |
| Revolver availability | $245.6 million under the $400 million facility |
| Annualized lease income at year-end | $85.4 million; $32.52 per leased square foot |
| Dividends declared for 2015 | $0.76 per common share, including a prorated first-quarter dividend |
Fourth-quarter revenue was $22.2 million and net income attributable to the company was $0.1 million; reported quarterly EPS rounded to zero. Fourth-quarter FFO, as Adjusted, was $10.7 million. The annual net loss included a $5.1 million unrealized investment loss associated with the predecessor’s pre-IPO accounting; FFO measures are supplemental, non-GAAP measures and are not cash-flow measures.
Approximately 71.6% of debt was variable-rate at year-end. Management estimated that a 25-basis-point rate change would alter annual interest expense by about $0.4 million. The revolver was subject to financial and distribution covenants, with which the company reported compliance.
Material changes versus the prior comparable period
- Revenue rose from $6.3 million in 2014 to $71.4 million in 2015, primarily reflecting the post-IPO property portfolio and rental operations. This is not a like-for-like growth comparison because of the IPO, acquisitions and accounting change.
- The predecessor reported $67.8 million net income in 2014, largely due to a $71.4 million unrealized investment gain under fair-value accounting. In 2015, the consolidated company reported a $6.0 million net loss, including depreciation, interest and the pre-IPO unrealized loss.
- After the IPO, the company acquired seven properties for an aggregate purchase price of approximately $170.9 million. Year-end real estate properties, net, were $772.0 million, compared with no such balance in the 2014 balance sheet, which instead reported $267.7 million of real estate investments at fair value.
- Cash from operating activities was $30.0 million in 2015 versus cash used of $22.4 million in 2014. Cash-flow classifications changed with the transition to historical-cost accounting, limiting comparison.
Outlook, risks and unusual items
Management stated that cash, operating cash flow and available revolver capacity were expected to fund anticipated needs for the next 12 months, including debt service, tenant improvements, distributions and other obligations. No numerical earnings, FFO or acquisition guidance was provided. The company intends to pursue acquisitions and build-to-suit development, renew leases and control property expenses; it also anticipated regular quarterly distributions, subject to board discretion, liquidity, debt restrictions and REIT requirements.
- Tenant concentration is substantial: U.S. Government agencies accounted for 96.2% of annualized lease income. The DEA, FBI and IRS together represented approximately 46.0%. California represented 31.8% of annualized lease income.
- Eight tenants, representing 21.3% of rentable area and 21.8% of annualized lease income, had exercisable early-termination rights at year-end. Additional rights become exercisable in 2016 and 2017. Separately, leases representing about 28.0% of annualized lease income expire by the end of 2019.
- Key risks include government lease termination or nonrenewal, budget or mission changes, refinancing and interest-rate exposure, property development risks, geographic and tenant concentration, environmental liabilities, natural disasters and REIT qualification and distribution requirements. Management reported no known environmental liabilities expected to have a material adverse effect and no material litigation.
- The DEA–Pleasanton property was acquired from an entity indirectly owned by director and executive vice president Michael P. Ibe. The acquisition included a $15.7 million floating-rate mortgage and an eight-year tax-protection agreement; review the related-party terms and governance disclosures.
- The $400 million revolver was described as terminating approximately three years after the February 2015 IPO, with two six-month extension options, while the contractual-obligations schedule shows a substantial revolver principal-and-interest payment in 2019. Investors should reconcile the facility maturity and extension terms with that schedule.
- The company intended to qualify as a REIT beginning with the 2015 tax year. It reported $11.1 million of taxable income subject to distribution requirements and stated that 2015 distributions were characterized as 85.06% ordinary taxable dividend and 14.94% return of capital.
- A subsequent event: on February 17, 2016, the company acquired a 71,100-square-foot, fully GSA-leased property in Albuquerque under a 15-year lease.
Important facts for investors to verify
- Reconcile the debt maturity disclosures, especially the revolver’s stated termination timing versus the 2019 contractual payment schedule.
- Review property-level soft-term and lease-expiration exposure, especially the IRS–Fresno lease and 2016–2019 expirations.
- Assess whether FFO, as Adjusted, and the $0.76 declared dividend are supported by recurring property cash flows after interest, capital needs and the REIT distribution requirement.
- Examine variable-rate exposure, covenant headroom, available borrowing capacity and the timing and cost of refinancing.
- Review the Pleasanton related-party acquisition, tax-protection agreement and mortgage, as well as potential share and unit sales following the Easterly Funds’ liquidation.
- Distinguish reported GAAP results from the predecessor’s fair-value results and from the company’s post-IPO operating period when evaluating trends.