Orion Office REIT (ONL) continues to navigate a challenging office market. Their Q1 2024 earnings call, on the surface, tells a familiar story of lease expirations, shrinking portfolio size, and pressure on earnings. However, a deeper dive reveals a subtle but potentially significant shift - a hint of optimism cautiously veiled within their cautious language. While most analysts are focused on the company's shrinking asset base, could this be the calm before a profitable storm?

The most striking detail lies in the company's leasing momentum. ONL has already completed over 522,000 square feet of new and renewal leasing in 2024. This figure more than doubles their entire 2023 leasing activity and signals a potential turning point. Paul McDowell, CEO of Orion, acknowledged this, stating, "We definitely feel better about the forward pipeline." While he cautioned about the ongoing difficulties in the office market, the sheer volume of new leases suggests a renewed interest in ONL's properties.

Interestingly, this leasing surge includes significant activity from the United States government. The government, ONL's largest tenant, renewed a 413,000 square foot lease in Covington, Kentucky, just before its July expiry. This renewal, following a year of negotiations, demonstrates the government's continued commitment to ONL's properties. Additionally, ONL signed a new 15-year lease with the government for 86,000 square feet in Lincoln, Nebraska, bringing the property to full occupancy. These transactions, along with a 17-year renewal in Eagle Pass, Texas, paint a picture of a landlord successfully catering to a key tenant segment.

"But here's where the hypothesis gets intriguing. ONL is currently in discussions with the General Services Administration (GSA) for a "significantly longer-term extension for a substantial portion of the tenant's existing square footage" at the Covington property. This potential extension, coupled with the recent renewal, could lock in a substantial portion of ONL's revenue stream for years, if not decades to come."

The potential impact on ONL's future earnings is significant. Consider this: their current annual revenue is approximately $192 million. If even half of the Covington property's 413,000 square feet is secured on a long-term lease at current market rates (a conservative estimate), it could represent an additional $10 million to $15 million in annual revenue. This potential revenue boost, combined with ongoing leasing momentum, could offset the anticipated revenue decline from asset sales, creating a more stable and predictable earnings base.

Leasing Activity Breakdown (Q1 2024)

Reference: https://seekingalpha.com/symbol/ONL

Now, let's address the elephant in the room - ONL's shrinking portfolio. While the company has sold 17 properties since its spin-off, generating $59 million in proceeds, this strategy has understandably raised concerns about future growth. However, ONL is focusing on selling "non-core" assets, often vacant properties that were dragging down earnings due to high carrying costs. In fact, vacant property operating expenses reached $11.5 million in 2023. By shedding these underperforming assets, ONL is streamlining its portfolio and freeing up capital for reinvestment in their core properties.

Portfolio Size and Vacant Property Expenses

Reference: https://seekingalpha.com/symbol/ONL

The company's focus on tenant retention and attracting new leases, particularly long-term government leases, suggests a strategic shift towards creating a smaller but more profitable portfolio. This strategy echoes a broader trend in the REIT industry, where companies are increasingly prioritizing quality over quantity, focusing on well-located, high-demand properties.

This hidden gem in ONL's transcript—the potential for long-term government leases to stabilize revenue and offset the impact of asset sales—has largely flown under the radar. While the road ahead for Orion Office REIT remains challenging, this subtle shift in strategy might be the key to unlocking future growth and profitability.

"Fun Fact: Orion Office REIT is named after the constellation Orion, the hunter, which is known for its prominent belt of three stars. Perhaps, like the celestial hunter, ONL is strategically aiming for a specific target - a leaner, more profitable portfolio of high-quality assets."