Parkway Properties (PKY: Nyse) is a Real Estate Investment Trust in transition whose beaten-down shares finally look compelling enough to bet long on. The company is an office REIT, and until recently had properties throughout the nation. But that is changing. The company is refocusing its portfolio and future efforts on the Sunbelt region of the United States.
Many of the Sunbelt States like Arizona and Florida were ground zero for the recent credit crisis and property values in these areas have fallen dramatically. But one thing real estate booms and busts have taught investors in recent decades is that as long as there is snow and cold to get tired of, and sunshine to seek, the Sunbelt region always recovers.
Parkway is undergoing an aggressive repositioning of its property holdings towards the sunny side of the States. It recently sold several properties outside its new core focus areas, and is redeploying the funds. The company sold 111 Wacker Drive in Chicago, and Falls Pointe in Atlanta. Parkway is also exiting markets in Virginia, Mississippi and Tennessee to focus on warmer locales.
In all, Parkway disposed of $879 million of properties as part of their new sunshine focused plans. At the end of January, more than 40% of the portfolio was still in what Parkway considers “non-core” markets. But after the recent transactions close, that number will fall to just 8%.
Parkway’s asset sales will also help this REIT improve its balance sheet and credit profile in what has been a difficult commercial real estate environment. It has no significant debt maturities for several years as a result of the completed and pending transactions. Just $22 million of debt matures this year, and $6 million in 2013.
Net debt to EBITDA has fallen from a recent peak of 6.5, to just 5.4 at the end of the year. This should provide Parkway with the financial flexibility needed to take advantage of extreme price weakness and opportunities in many Sunbelt office property markets. Parkway recently announced the acquisition of “The Pointe” in Tampa Florida and the “Hayden Ferry Lakeside I” property in the Phoenix market. This is in addition to purchases in Orlando, Atlanta and another Tampa location that fit the new approach and core market definition put in place by management.
Like many other office property companies, Parkway has been struggling with occupancy and rental rates. There are signs that the commercial market is improving, and rental rates are starting to creep higher. In 2011 the company renewed 228 leases at an average rental rate decrease of 8.7%. The market firmed somewhat in the fourth quarter, however, and 47 leases were renewed at a decrease in the per square foot rental rate of “just” 3%. At the end of January the company reported that the current occupancy rate for the portfolio was 85.7%, a slight increase form the end of October 2011.
The weakness in the market for office properties, and market confusion surrounding Parkways change in strategy understandably resulted in PKY trading miserably over the past year. But that pain is also what is giving us our buying opportunity to bet that recent improvements in rental metrics may have legs—or are at least sustainable. According to a recent research note from BMO capital markets PKY trades at a significant discount to the valuation of other REITs, and appear to be very undervalued. The stock trades at just 8.5 times the estimated funds from operation, and at a 53% discount to Parkway’s estimated net asset value.
That’s a valuation that insiders just couldn’t keep themselves from buying into considering the brighter prospects they are positioning Parkway for. Seven executives and directors invested another $1.4 million in PKY as shares traded around $10 in February. Four of the buyers increased their holdings significantly with their recent purchases. The acquisition by Chief Accounting Officer Mandy Pope also represented her first open-market purchase of shares going back to at least 2004.
No investment is without risk, of course. Parkway does face some challenges, and there may be a few bumps along our year-long investment horizon. The commercial real estate market is still fairly weak, and it may take some time for occupancy and rental rates to rebound significantly from recent stats. Parkway is also a small cap REIT, and may have some challenges accessing debt markets to fund its new strategy. If this happens it will have to turn to the equity markets, and this would result in a likely dilutive secondary.
The risks are more than offset by the potential rewards of owning Parkway Properties, however. The fact is that owning Sunbelt real estate has been a successful strategy for decades. Unless people stop desiring to live, work, and retire in pleasant climates, the current weakness is a major buying opportunity for patient investors.
Parkway has undergone significant management changes in the past year, and the new team has extensive experience in the new core markets. Investors also get paid to wait for the market to improve. Parkway has paid 102 consecutive quarterly dividends, and the shares currently yield 3.1%. Unlike most REITs, however, we’re in PKY for the capital gains that appear likely if the U.S. economy can continue its grudging recovery.
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