The S&P/ASX 300 Index (ASX: XKO) stock Centuria Office REIT (ASX: COF) is down heavily from its former heights. It has fallen more than 50% from September 2021, as we can see in the chart below.
When the value of a real estate investment trust (REIT) falls significantly, it's a smart idea to reevaluate the business. Properties don't typically fall in value that much — they can usually provide a measure of stability.
However, the effects of COVID-19 and higher interest rates have created volatility in certain sectors. For an office REIT like this one, the increased work-from-home trend has not helped investor confidence.
However, I believe this REIT is worth considering as a contrarian opportunity for several reasons.
Rental income is holding up well
The business recently reported its FY24 result, which included a number of positive statistics that showed stability in the face of the disruptions the sector is facing.
It reported that it had a portfolio occupancy of 93% and a 4.3-year weighted average lease expiry (WALE). That's certainly not the longest WALE in the sector, but it gives the ASX 300 stock's investors a good level of income visibility for the next few years.
The business said it had addressed significant FY25 expiries, which affected around 5% of the portfolio net lettable area (NLA). More than 70% of the REIT's NLA now expires during or after FY27.
Centuria Office REIT added that 72% of rental income was generated from government, multinational corporations and listed entities. In other words, blue-chip tenants generate a significant portion of its rent.
The business expects funds from operations (FFO) — net rental profit — of 11.8 cents per unit in FY25. This is lower than FY24 for several reasons.
First, rental income decreased after it enacted some divestments of non-core assets, with the proceeds used to repay debt.
Secondly, it has made "prudent downtime assumptions for known existing vacancies and expiries within the portfolio."
Third, it's expecting higher debt costs in FY25.
However, I'm excited by the prospect of the business working with ResetData for an 'edge data centre' of up to 1.5MW using proprietary liquid immersion cooling technology.
This installs a data centre within an office building, potentially increasing the value of that property by at least 10%. Further opportunities are being explored across the portfolio to address vacancies and near-term expiries.
The ASX 300 stock's fund manager, Belinda Chueng, had this to say:
We are seeing signs of improving office sector tailwinds with return to office mandates coinciding with limited new office developments and population growth leading to a larger whitecollar workforce.
Investment in transport infrastructure, such as the Sydney Metro and Brisbane Cross River Rail, will also improve commutability, especially to metropolitan and near city office markets. These tailwinds are expected to positively impact COF's portfolio over the medium term.
…Looking ahead, we maintain an optimistic outlook on the medium term trends for the office sector. Overall office supply is expected to diminish, caused by rising economic rents that are materially above the prevailing rents in most Australian office markets, including those where COF's portfolio is situated.
This outcome is impacting new and existing office feasibilities as well as projected replacement costs above COF's current and implied portfolio values.
Large discount?
The business reported that it had net tangible assets (NTA) of $1.80 as of 30 June 2024. At the current Centuria Office REIT unit price, it's trading at a 33% discount to its reported underlying value.
We can't be sure what the true underlying value is unless the business were to sell all of its properties.
However, it did sell four non-core properties during the period for $139 million at an average discount of just 2% to the prevailing book values. So, investors may be able to have some confidence in that NTA figure.
Significant passive income from the ASX 300 stock
With the business trading at such a large discount to its reported underlying value, the REIT is able to provide a significant distribution yield.
It expects to pay a distribution per unit of 10.1 cents in FY25, which translates into a forward distribution yield of 8.4%.
Until interest rate cuts arrive to help lower debt costs and possibly boost the value of the properties, this level of investment income can be pleasing for investors in the shorter term.
While I wouldn't call it the best ASX 300 stock to buy, it's an interesting investment proposition. I believe the market may be undervaluing this business, with interest rates seemingly at their peak and cuts getting closer, along with the possible positives in the future that were mentioned by Chueng.
