This week, Realty Income completed the spin-off of substantially all of its office properties into the newly created Orion Office REIT (ONL), as announced earlier this year.
Realty Income stockholders received one share of the Orion Office REIT for every ten shares of Realty Income stock held, with cash received in lieu of any fractional shares.
The REIT's intent to spin-off its office properties was made known when the merger with VEREIT was announced earlier this year. Shortly thereafter, we provided details of the merger and our belief that it would have no impact on Realty Income's dividend profile here.
As previously noted, offices represented only 3% of Realty's rent but nearly 20% of VEREIT's. Spinning off the office properties of each was a way to get VEREIT's portfolio more in line with Realty Income's core strategy that focuses primarily on retail properties.
Following the spin-off, Realty Income's balance sheet remains strong. Plus, the REIT has reiterated its commitment to maintaining its status as a dividend aristocrat and plans to continue growing its dividend.
In fact, just this week, Realty Income announced a 4.2% dividend increase, its third raise since announcing the spin-off.
The newly-formed Orion will be unique amongst its peers, with its 92 single-tenant offices located in suburban markets. Orion will look to expand its portfolio of suburban properties in areas with solid fundamentals and demographic tailwinds.
Orion plans to operate similarly to Realty Income, with financial conservatism and a portfolio of properties with net lease contracts.
The office property REIT has yet to establish a dividend policy but plans to pay regular distributions after the board has figured out the details. Once the dust settles, and more information is made available, we will provide an update specific to Orion if warranted.
In the meantime, we estimate Orion's initial dividend will yield around 6 to 7% based off where shares are currently trading. While that yield is appealing, it could be a signal of increased risk relative to other office REIT's with lower yields.
With only 92 properties, half of which are rented by the REIT's top ten clients, Orion could be one tenant disruption away from needing to cut its dividend. That risk is heightened when you consider a majority of the REIT's leases expire in the next few years.
While Orion's properties are mostly filled with high-quality investment-grade tenants, we believe investors would be better off owning a more diversified office REIT with less imminent renewal risk over the next few years.
To stay invested in Orion will require a firm conviction in the REIT's niche suburban office strategy, whose success will depend on how much office space businesses decide they actually need as the economy strikes a balance between in-office and remote work.