This Mission-Critical REIT Is 'Poised To Profit'

Upgrading OFC from Buy to Strong Buy.

Summary

  • Upgrading OFC from Buy to Strong Buy.
  • The dispositions are done and the company is laser-focused on its critical mission strategy.
  • The biggest catalyst is that defense spending is likely to increase to 14%.
  • We believe OFC is "poised to profit."

According to the Congressional Budget Office (or CBO) “spending for the Department of Defense (or DoD) accounts for nearly all of the nation’s defense budget. The funding provided to DoD covers its base budget - which pays for the department’s normal activities - and its contingency operations in Afghanistan and elsewhere overseas.

CBO analyzes the possible consequences of planned reductions in funding for the military’s force structure and acquisitions. The agency also studies the budgetary implications of DoD’s plans, including those for military personnel, weapon systems, and operations.”

Funding for support functions consumes more of the defense budget today than it did in the 1980s, CBO finds. The largest increases were in healthcare, DoD management, communications infrastructure, and the science and technology program.

The U.S. military’s readiness to respond to current and future threats depends on the quality and availability of military forces - personnel, weapon systems such as ships and aircraft, and other material resources such as ammunition and fuel.

In turn, the quality and availability of military forces depend on the support infrastructure. The military uses that support infrastructure -such as bases, depots, and schools - to recruit personnel, train units for deployment, acquire and maintain equipment, construct facilities, provide healthcare, facilitate communications, and more.

From the mid-1980s to the early 1990s, the Department of Defense’s (DoD’s) funding for support functions rose substantially relative to funding for forces. The ratio of funding for support to funding for forces has fluctuated since then, but it has not returned to the lower levels experienced through much of the 1980s.

From the 1980s to the 2010s, the funding for support activities in DoD’s base budget rose in relation to funding for forces. Between 1980 and 1989, a period marked by the rapid defense buildup against the threat of the Soviet Union, support costs accounted for 43% of DoD’s nearly $500 billion base budget, on average.

Between 1990 and 2000, during the defense drawdown after the Soviet Union’s collapse, the average share of DoD’s base budget devoted to support costs grew to 49%. In the post–9/11 period, from 2001 to 2016, it rose further - to 50% (see below).

The FY 2017 DoD budget of $532 billion was signed into law in May and the 2018 DoD budget request of $575 billion would be an 8% increase. The House passed $605 billion, which is up from the $575 billion that President Trump wanted – almost 14% year-over-year (*).

Congress has 8 days to avoid a government shutdown, with the current short-term funding bill expiring on Friday, January 19th. Lawmakers are expected to pass a fourth continuing resolution for the fiscal year, which began last October, buying another few weeks for Congress and the Trump administration to reach an agreement on the 2018 budget.

Last week the White House asked Congress for $18 billion over 10 years to pay for a border wall with Mexico, an idea Democrats have repeatedly rejected.

President Trump has said funding for the wall must be part of any deal that is made to protect the children of illegal immigrants who could be deported once the Deferred Action for Childhood Arrivals (or DACA) program expires in March. In response to the administration’s request, Sen. Richard J. Durbin (D-IL) warned,

President Trump has said he may need a good government shutdown to get his wall. With this demand, he seems to be heading in that direction.”

The White House downplayed the risk, with White House Budget Director Mick Mulvaney saying he doesn’t think the government will have to close as a result of a budget showdown. “There are some folks in the Democratic Party who are interested in shutting the government down over DACA. Again, I do not think it’s going to come to that,” he told Fox News.

One big misconception, as it relates to a temporary shutdown, is the impact to DoD spending. To put it bluntly, a government shutdown will have zero impact on national security, the government will continue to pay all obligations (including rent).

So what’s up with Corporate Office Properties (NYSE:OFC)?

A Mission-Critical REIT On Sale

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