Here at StreetAuthority, we’re big fans of Real Estate Investment Trusts (REITs).  They provide solid income backed by real assets that people will always need.

#-ad_banner-#And one of our favorite REITs has long been known for great dividend yields and a very stable tenant. Better still, management at this REIT has put the wheels in motion to deliver an even higher payout in coming years.

I’m talking about Government Properties Income Trust (NYSE: GOV), which is one of the largest publicly-traded landlords for the U.S. government.  Of the REIT’s 82 properties, 32 are leased to the Federal government, 18 to state and local branches and one to the United Nations.

Almost all (93%) of the REIT’s revenue is tied to the public sector, and Government Properties sports a vacancy rate of just 4.6%, well under the 14.8% vacancy for office buildings nationally. That kind of stability has helped generate  a compound annual revenue growth of 21%  since 2007.

I first looked at GOV in February 2013, which was a great time to enter the stock. Although shares subsequently rallied following my article, they’ve recently pulled back and again hold clear value.

The stable tenant and solid yield remain key virtues for GOV, but a plan to sharply boost the real estate portfolio is why it’s time to re-focus on shares.

Despite a strong long-term track record, investors have recently cooled to this business model. A movement for limited government after the financial crisis raised uncertainty about the government’s needs for property. A high fiscal deficit and government cuts also weighed on sentiment and the shares have traded mostly between $22 and $26 over the last four years.

Recent economic data and the mid-term elections may have just cleared those uncertainties. The government deficit has shrunk to just 2.8% of GDP — the lowest since before the financial crisis and well under the 10% deficit reached in 2009. The fiscal situation has improved so much that government spending is now actually contributing to economic growth, adding 0.83% in the third quarter against an addition of 0.31% in the previous quarter. State and local governments have been a net positive for GDP for six of the last seven quarters.

While Congress shifted heavily to the right in the mid-term elections, it was a win for moderate Republicans rather than small-government Libertarians or the Tea Party establishment. Republican candidates defeated Libertarian challengers in both Iowa and Mississippi and calls for limited government have quieted over the last couple of years. Combine this with the stronger economic backdrop and any uncertainty of government leases should not be an issue for the REIT.

New Growth Could Take Shares Higher
In July 2014, Government Properties announced the issuance of 13.5 million shares, in tandem with  $350 million in fresh debt. The capital raise sent shares skidding lower over the following few months, but I think the market is ignoring what the company is doing with that money.

Besides paying down some near-term debt, the REIT acquired 21.5 million shares of Select Income REIT (NYSE: SIR) —  a 35% stake of the total outstanding shares. SIR is set to close its own acquisition of Cole Corporate Income Trust, a non-traded net lease REIT, in the first quarter 2015. Both REITs own properties primarily in the office and industrial segments.

In effect, GOV is diversifying its tenant mix while also jump-starting growth. The government is a great tenant, but it is not likely to boost spending as fast as Government Properties would like. A low vacancy rate means there is not much additional space to lease. For revenue growth to continue, GOV needs to grow its property base and its tenant pool.

The ownership stake of SIR brings exposure to 114 properties in 35 states for GOV. The combined SIR and Cole Corporate Trust will have an enterprise value of $4.56 billion, nearly twice the enterprise value of Government Properties. The share acquisition brings asset and tenant diversification, and a potential complete acquisition of SIR down the road would give GOV greater scale.

Prior to the acquisition, GOV has been delivering solid metrics. Funds from operations, or FFO, jumped 44% to $39.8 million in the third quarter against the same period last year. And FFO for the first nine months of the year was up 12.9% to $100. Occupancy also improved to 95.4% in the quarter.

On a trailing basis, the company’s $115 million in FFO translates to $1.75 per share and a price-to-FFO of 13.1 times. Management does not provide forward estimates, but sales are expected to increase by 8.3% in 2015 to $280.9 million. My own estimate is for fiscal 2015 FFO of $1.98 per share and a price target of $27.72 per unit, an increase of 20% on top of the 7.5% yield. The potential for growth from the share acquisition in SIR could make this a conservative estimate and I would be a buyer all the way up to $25 per share.

Risks To Consider: REITs could come under pressure when interest rates increase, as investors migrate to fixed-income investments. The weakness should be temporary as a stronger economy boosts commercial real estate demand.

Action to Take –> Most of the existing business model for Government Properties Trust appears to have maxed out, but a growth-through-acquisition strategy should set the stage for rising dividends and a higher share price. Meanwhile, it’s awfully hard to find an attractive 7.5% yield with such little business risk.

Not only does our premium newsletter High-Yield Investing love REITs, but we wrote about GOV in August. And we’ve found another investment that, like a REIT, is required by law to pay 90% of profits to shareholders — often sporting yields around 12%. To learn more about the incredible power of these wealth-generating income investments, I invite you to watch this research video.