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How to Play Amazon’s Two HQ2’s

November 07, 2018

Amazon (AMZN) is a big company, and it keeps getting bigger. We’ve seen it continue to expand its collection of businesses—online and brick and mortar sales, online and off-line content, and of course its massive cloud computing services unit. And it is hiring employees by the ocean liner. In just the past twelve months, the company has raised its headcount by over 65%. And this has been a growing trend, with hiring increasing by nearly 50% percent in 2015 and 2016 and another 65% for 2017.

That’s a lot of folks at this company. Yes, I know that much of the workers for Amazon are spread around the nation at its many warehouses, processing centers and other facilities, but the company has grand plans to continue expanding its current footprint as well as reaching into new markets.

Not surprising, then, that Amazon is looking for real estate beyond its Terry Avenue North address in Seattle, Washington—HQ2, as the project has been called.

While nothing has been confirmed, there have been some very credible leaks that Amazon will be splitting up its HQ2 and using Crystal City, Virginia, and Long Island City in the New York City borough of Queens for its two new centers. However, if Amazon alters some part of this plan or it turns out the leaks were never accurate, I think the place it will mostly turn to is Dallas, Texas, a major hub of commerce and finance in the central US, rumored as another strong finalist.

So, given what we know about Amazon and its plans, what are the ways to play Crystal City and Long Island City?

Back in the late 1940’s, Crystal City was nothing like its name implies. It was a stretch of industrial and warehouse properties alongside rail lines and rail yards on the western side of the Potomac River across from Washington, D.C.

But a Russian immigrant by the name of Charles Emil Smith had a better vision for the land and these properties. With some acquisitions and some major work to move rail lines and rail yards in the region, he and his partners began to build a series of apartment and office buildings that started in 1963 with Crystal House, an apartment building with an elaborate crystal chandelier in the lobby.

Other buildings sprung up with the word “Crystal” in their names, and it stuck to become the Crystal City community inside Arlington County.

It has plenty of vacancies in office properties—defense contractors and federal agencies,  have been shifting to other areas around and beyond the Capital Beltway for years.

Crystal City’s collection of Class B and Class C apartment buildings have also seen a number of openings. Add to that the great number of smaller single-family homes (many within walking distance of prime office space) that haven’t soared in price as much as other areas in the Washington metropolitan area.

And while the Metro (the Washington area subway) is severely troubled, it has stations right there connecting into the city of Washington as well as Reagan National Airport just to the south. And there is also a regional commuter rail station and lots of parking. It is really is Amazon “prime.”

Charles Smith’s company sold many of the commercial properties, and many ended up controlled by JBG Smith Properties (JBGS). JBG Smith is a public real estate investment trust (REIT) with a variety of office, retail residential and other properties around the nation. The stock took a huge jump on the latest news. But the Crystal City properties are just part of the company, which has a lot of baggage on its books.

Margins are negative on its operations, and it continues to lose money with a loss on capital of 1.7% and a loss on assets of 1.4%. It has limited cash and debt is high at 73.7% of its equity. No wonder that it trades somewhat cheap, as the shares are valued at only 1.59 times book. And with revenue and profit challenges, it is expensive on a price to sales basis, at 7.4 times.

This is not the way to play Amazon in Crystal City.

The way I’d play it would be to look at the collection of apartment buildings owned and operated by Equity Residential (EQR) and Avalon Bay (AVB). Both of these REITs have a number of buildings in the area as well as the adjacent communities, including some of Charles Smith’s apartment buildings. And both are much healthier than JBG Smith.

Equity Residential is a nicely profitable REIT, with funds from operations (FFO), or the revenue from its actual buildings, rising by 7.2% over the trailing year. The return on its FFO is an ample 11.70%, and it contributes to a nice 6.50% return on equity. Its debts are low, at only 45.2% of capital. It is valued at a reasonable 2.43 times its book and pays a moderate dividend, yielding 3.20%.

Other properties in the area are owned and operated by Avalon Bay. Avalon Bay has similar good performance, with a lower level of growth from its FFO, which over the  trailing year saw a gain of only 2.8%. But it has a good FFO return, running at 11.80%, which drives a nice return on equity of 8.0%. And like Equity Residential, it has debts under control at only 41.4% of capital.

Both of these REITs would make for a better buy over JBG Smith.

As for the other rumored HQ2, New York has its appeal, as I know as a former resident. But I was a Manhattan guy, and while Queens might be nicer now, it still comes with wicked taxes, onerous local government oversight and a strained subway system and bus network.

But it does have vacancies in commercial properties and residential apartments. And getting to LaGuardia is easier than getting to it from Manhattan.

Equity Residential and Avalon Bay are right there, as well. So, whether Amazon does two HQ2’s or sticks with Crystal City, by buying into these two REITs you are covered.

The way I would play Long Island City is to look at its failing infrastructure, including needed upgrades to its sewer line.

My favorite play on this is Aegion Corporation (AEGN) based in my hometown of Saint Louis, Missouri. Aegion has many infrastructure repair products, including those that are perfect for fixing sewer and water lines.

Revenues are up some 11.2% over the past year, and if the Democrats in their new House leadership cooperate with the President in any way on infrastructure, this company will further profit. New York City is already budgeting for Queens, so Aegion will be in the bidding, by my estimates.

As I said, I think we could still see Amazon change its mind ahead of the official announcement and put some portion of its new operations in Dallas, Texas. One last company to take a look at with nice multifamily properties in Dallas and its environs Independence Realty Trust (IRT). This REIT focuses on quality garden and mid-rise apartments that are pleasant and somewhat upscale.

Independence sports a nice 9.2% return on FFO, but has higher administrative costs as a consequence of the style of properties it manages, which results in a lower return on equity of 2.9%. The dividend is ample at 7.3%, and it has a control on debt for longer-term stability.

This REIT is worth take a look at with or without Amazon in the Dallas Fort-Worth Metroplex.