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WashREIT Is Transforming Its Portfolio, But 1 Analyst Is Skeptical

One of the largest REITs in the D.C. area is embarking on a significant transformation of its portfolio, but at least one analyst thinks it may not be the best course of action.  

Morning Calm Management's Mukang Cho and WashREIT's Andrew Leahy at a 2018 Bisnow event

WashREIT last week announced it is selling eight retail properties in Maryland and Virginia totaling 1.6M SF in two separate deals that will help fund the acquisition of 2,113 suburban Class-B apartments it announced in April. 

The deals will significantly change the makeup of WashREIT's portfolio. Prior to the deals, it had 28% of its net operating income in multifamily and 22% in retail, with the remainder in office. Following the deals, it will have 45% of NOI in multifamily and just 6% in retail. 

"These sales were a part of our ongoing transformation of the organization," WashREIT Vice President of Investments Andrew Leahy told Bisnow. "Over time we've simplified the story going from having six asset classes not long ago, now our long-term strategy is really focusing on value-add multifamily and Class-B office." 

The Bradlee Center retail property in Alexandria, one of the shopping centers WashREIT is selling

One of the retail sales, a five-property portfolio totaling 800K SF, will generate $485M. WashREIT did not disclose the price for the second sale, which includes three power centers totaling 850K SF, but it said the estimated cap rate for the two sales comes to 6.2%. 

Green Street Advisors analyst Daniel Ismail, who covers WashREIT, said the deals make sense because today's market values apartments better than retail properties. But he thinks it would have been smarter to only sell the retail without using the proceeds for multifamily. 

"We would argue selling these assets and shrinking the company would have been better capital allocation," Ismail said. "Given that their stock trades a good 15% below where we thinks its [net asset value] is, generally that's a signal that selling assets and shrinking the company is a preferred capital allocation move."

WashREIT sees significant growth potential in the value-add suburban office properties it is acquiring, Leahy said. In addition to the $461M portfolio acquisition it announced in April, WashREIT also said last week it is under contract to buy a $70M value-add multifamily property.

With the deals, its multifamily portfolio will consist of 90% value-add, Class-B apartments in D.C., Maryland and Virginia, with just 10% in the Class-A segment. 

The Point at McNair Farms community in Herndon, one of the properties WashREIT acquired

Because much of the region's new development consists of high-end Class-A apartments and it can be difficult to build new affordable properties, Leahy said there is a significant advantage to owning Class-B apartments. He said there is enough demand for Class-B apartments and a large enough rent gap between them and the Class-A segment that WashREIT can renovate the properties and raise rents to achieve revenue growth. 

"We see a disconnect on affordability where you have potential renters who don't have the ability to acquire a home in that area and may not have the ability to stay closer into the urban core and afford the rental rates there," Leahy said. "You've got folks who are desirous of good schools and want to be in suburban communities but need a quality, Class-B product they can afford."

WashREIT is building new apartments on some of the properties it acquired that were able to support additional density. After its 2015 acquisition of The Wellington, a 711-unit Columbia Pike apartment complex, WashREIT began construction on a new 401-unit building on the property that it expects to deliver in Q4.

It also acquired Alexandria's 1,222-unit Riverside apartments in 2016 and unveiled plans to add 550 units to the property. 

"The Wellington and Riverside are great examples of how we think we can play D.C. differently," Leahy said. "Due to the fact we have strong in-house development expertise, we can take advantage of opportunities like that."

He said building additional density was not part of the calculation for its latest apartment portfolio acquisition, but having the capability to do so in the future gives WashREIT a competitive advantage. WashREIT does envision redeveloping some of the remaining retail assets in its portfolio, he said. 

Following the latest portfolio sale, WashREIT will own eight retail properties in the region, including shopping centers in Chevy Chase, Alexandria, Springfield, Takoma Park and Rockville. He said it doesn't have immediate plans to sell those properties and is exploring opportunities to redevelop the assets. 

"They are interesting opportunities for us in terms of value creation and potential redevelopment," Leahy said. "That's why we decided to hold onto those." 

Green Street's Ismail said he thinks it would be a better strategy for WashREIT to sell its remaining retail assets rather than pursue development opportunities. He said the REIT's stock trading below net asset value, the same reason he did not think it should pursue acquisitions, also gives it a cost of capital disadvantage for development. 

"Certain developments can look attractive on an individual project basis, but once you factor in the cost of capital disadvantage, that would lower the attractiveness of the development," Ismail said. "Unless these were really home run redevelopments, there's a pretty large hurdle for external growth whether it be development or acquisition given where the stock is trading."