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JBG SMITH (JBGS: $41)

Coverage initiated May 16, 2019 at $41 in the REAL ESTATE portfolio.

Company Overview. JBG SMITH is a Maryland-based REIT that invests in both commercial and multifamily real estate. The $6 billion company has 61 commercial assets and 4,500 multifamily units. The company also has nine projects under construction and another 40 future development sites for a total of over 22 million square feet of development opportunity. They own, operate, develop, and/or invest in a portfolio of nearly 19 million square feet all concentrated in attractive submarkets in the Washington, DC region. Over 98% of their office portfolio is located near Metro stations.

The company was formed in the 1957 by a trio of local attorneys-turned-real estate professionals. They were among the first development companies to redevelop properties in the D.C. area for a set fee, which enabled the company to survive through a recession in the 1990s. Over the next 20 years, the company became the most active developer in the D.C. area. That led to the 2017 merger with the Charles E. Smith Companies, once a subsidiary of real estate giant Vornado, a specialist in residential multifamily properties.

Market Analysis. The commercial real estate (CRE) market is currently booming, thanks to continued strength in the underlying economy. 2018 saw the ninth straight year of industry growth, as both rents and valuations continued to appreciate. With interest rates remaining steady, 2019 should be another banner year for the CRE industry. 2019 is shaping up to be a positive year for the CRE industry, especially for the premium end of the market. Both office and industrial CRE have seen steady upticks in valuation, with Retail being a mixed bag overall.

Competitive Landscape. There are 225 publicly-traded REITs, which hold around $2 trillion in gross real estate assets. REITs invest across a broad spectrum of asset classes, with commercial being one sliver of the entire pie. Additionally, some REITs utilize a multi-strategy approach. Annaly, for example (another BMR pick), is mostly a Mortgage REIT, but has begun diversifying into other sectors including CRE.

Given JBG SMITH’s dominance in the Washington, D.C. metro area (one of the most affluent American cities, and one with long term staying power given the strength of the lobbying industry), as well as the company’s relationship with real estate powerhouse Vornado (another BMR pick), JBG is well-positioned among its peer group to continue to grow into a national force in real estate development.

National Landing. JBG owns National Landing, an interconnected neighborhood which houses Crystal City, and parts of Pentagon City and Potomac Yard. Entirely walkable, National Landing is one of Washington, D.C.’s best-located urban developments, and contains a diverse cross-section of real estate assets, including offices, apartments and hotels.

In November, the company announced the sale of over 4 million square feet of National Landing to Amazon, for the development of Amazon’s second headquarters. One of the most sought-after development deals in the country, the Amazon account provides JBG with with a major reputational boost, as the REIT locks in one of the premier American companies as its client. Amazon will bring 25,000 employees and $4 billion of investment to the area, which could lead to 100,000 new residents over the next decade. As the largest land holder in the region, JBG stands to benefit from this demographic reshaping – all thanks to the Amazon headquarters deal.

The Numbers. Funds from operations (FFO) was $35 million for 1Q19, which is 15% less than the $41 million FFO posted in 1Q18. That said, the REIT disposed of several key properties throughout the year, which resulted in one-time earnings but reduces the overall FFO. Some rental abatements ended over the course of the year, so the company was forced to pay higher rates, which decreased net operating income (NOI). NOI decreased 6% to $320 million for the quarter. So there were several one-time events which occurred throughout the year which make the 1Q19 numbers look lower relative to their 1Q18 counterparts. The underlying business is strong, however. The commercial portfolio was 90% leased and 85% occupied, with the multifamily portfolio 96% leased. And the Amazon deal is a harbinger of wonderful things to come.

The REIT has $400 million in cash, and $2 billion in total debt. That 5:1 debt-to-cash ratio isn’t bad for a REIT, which typically carries heavy loads of debt compared to its cash on hand. Remember, REITs have to pay out 90% of their income in dividends, which is why FFO is a better measure of a REITs health.

Recently, the REIT aimed to sell 10 million shares of stock in order to raise over $400 million, but the sale ended up oversubscribed and JBG ended up selling 11.5 million shares, for a total of $470 million. That type of oversubscription illustrates just how strongly investors want to be a part of this company.

Stock Performance. JBG went public in 2017 at $37, and the stock traded within a tight 20% band until 4Q18. The stock finally cracked $40 after details of the Amazon deal were released, only to sink back down into the mid-$30s as the broader market collapsed under the company’s feet. Yet the stock has been resilient, and has now climbed up to all-time highs, rising 19% YTD so far.

We’ve experienced a floor price in the mid-$30s, which is where the stock fell after the market tanked in December. So there’s limited downside here, and the only major risk is another market collapse. The solid fundamental business and the Amazon deal signal more price appreciation ahead for the stock as the company’s 22 million square feet of development pipeline becomes operational over years.

Risk Factors. As mentioned, the major risk factor here is a recession. Should the underlying economy collapse, this would negatively impact real estate prices and hamper expansion plans from other large corporations who may ink leasing and development deals with JBG. That said, the economy is chugging along quite strongly, so there is limited concern of a major recession in the near term.

Another sensitivity is interest rates. Rates rose significantly last year, but the Fed has signaled its willingness to slow the rate hikes, or perhaps even lower them. It’s entirely possible we experience zero rate hikes this year. Even if the Fed decides to raise rates at some point, the days of aggressive rate hikes are clearly in the past.

BMR Take:  JBG is a dominant regional player (the D.C. metro area) that’s on the verge of breaking out into a national brand. D.C. is one of the best markets for real estate, given its affluence and staying power, so JBG could continue to mature in this market alone and still grow significantly. Vornado is a perfect example of this tactic, as over 90% of the real estate giant’s portfolio is based in New York City. Another possibility is for JBG to go the Equity Residential route, and develop high-end commercial properties in upscale urban locales across America.

The Amazon deal is clearly a game changer for this company, and propels JBG into a higher stratosphere of real estate development. We believe that 10 years from now JBG’s name will be on par with the Vornado’s and Equity Residential’s of the world, and now is a chance to own the acquire while the company is still just a regional player (albeit the dominant one in the D.C. area).