Wednesday, July 27, 2022
HomeValue InvestingMessy Stability Sheet, Probably Pursuing a Sale

Messy Stability Sheet, Probably Pursuing a Sale


Multi-family REITs have been one of many stronger actual property beneficiaries of covid, notably these with properties situated within the solar belt.  The WSJ just lately reported that nationwide asking lease rose 10.3% in August, with asking rents rising greater than 20% yr over yr in sunbelt cities like Phoenix, Las Vegas (HHC!) and Tampa.  With the tailwinds of migration developments, elevated inflation driving lease development and loads of liquidity in search of secure returns, all of those elements have pushed down cap charges considerably to the 4.0-4.5% vary.  
One little bit of semi-surprising M&A information/rumors, in mid-September, Bloomberg reported that Bluerock Residential Development REIT (BRG) was exploring a possible sale, the corporate hasn’t commented on the report or confirmed they’re exploring strategic alternate options.  Bluerock is a sophisticated story, one crammed with associated get together transactions and a large number on either side of the steadiness sheet, but when the reporting is correct, Bluerock’s frequent inventory might be considerably undervalued.  BRG was previously an externally managed REIT, nonetheless in 2017 the construction was technically internalized, however solely form of, administration maintains a number of associated pursuits in different Bluerock entities that earn charges off of BRG making the market skeptical of a sale.

Beginning with the left facet of the steadiness sheet, Bluerock has pursuits in 60 multi-family properties, principally within the low class-A, excessive class-B vary, assume $1300-$1400/month backyard and midrise model residences within the first rung of the suburbs in solar belt cities like Phoenix, Austin, Atlanta, Raleigh, and so forth.  

Of these 60, 35 are consolidated properties the place BRG owns the overwhelming majority and operates the property like a standard multi-family REIT and the remaining 25 are extra credit score model investments the place they’ve a most popular fairness, mezz mortgage or floor lease curiosity within the multi-family property (a few of these are new developments).  

This second credit score funding bucket could cause points when attempting to display screen BRG as you should again out these investments to find out an implied cap fee for the working portfolio when arising with a sum-of-the-parts valuation.  The credit score investments bucket additionally has the potential to make a sale trickier, the working portfolio ought to have loads of consumers, but when they insist on together with the miscellaneous different credit score stuff it might shrink the customer pool.  The credit score investments are additionally typically tied to associated get together developments that administration has an outdoor curiosity in (apparent query could be if these are really market/arm’s size phrases), in a sale, administration might need to take this pool and purchase it into one in every of their different autos or promote it to a business mREIT like entity.

On the best facet of the steadiness sheet, Bluerock has a heavy slug of most popular inventory of their capital construction basically making the frequent inventory an fairness stub.  There are presently 4 separate collection of most popular inventory excellent, the collection C and D most popular are fairly conventional in that they’ve a $25 liquidation choice and are trade traded.  The collection B (nonetheless excellent, however discontinued) and T are non-traded and positioned by means of RIA channels with buyers (much like a non-traded REIT) through an affiliate of administration, Bluerock Capital Markets LLC, the place administration receives a ten% fee/payment (damaged up right into a 7% and three% part) of the whole cash raised.  The B/T even have a wierd function the place after 2 years, the corporate can redeem the popular shares for frequent inventory, so naturally administration pitches this as a pretty capital elevating technique the place they’ll repeatedly difficulty the popular after which convert the popular to frequent at opportune occasions.  There’s some validity to that, however clearly some conflicts of curiosity too.  The issue is the inventory has continued to commerce at low cost to friends and a theoretical NAV, they’ve transformed some most popular over to fairness this yr, however the place non-public property are being valued after this current spike in lease development, it is in all probability worth harmful to proceed to transform the popular inventory.  

The the bull case is why administration would possibly really be in search of an exit, they do personal loads of the inventory (technically models within the working partnership) because of their incentive plan and the 2017 internalization transaction, the capital construction is stuffed stuffed with most popular inventory, how far more can they realistically difficulty?  From the Q2 convention name (tikr.com):

We have now a buyback out there that present help for the inventory. So I would not be shocked should you noticed us redeem a part of the B money. I would not be shocked if we take a break from redeeming the B, to loads of inventory — the frequent to soak up and get well. We have now — as you understand, we personal north of 30% of the fairness — frequent fairness right here as administration. So we’re very delicate to the inventory value, ensuring that we ship worth for the shareholders.  

For the reason that capital construction is so levered to the frequent, the upside if somebody is prepared to pay prime greenback might be fairly big.  On the bear facet, administration may preserve issuing most popular inventory, earn their 10% levy, repeatedly convert these shares after two years in perpetuity and drain loads of worth from minority shareholders.  Once more, that is technically internalized construction however nonetheless feels externally managed.  Right here is BRG mapped out in my typical back-of-envelope model, that is for a sale situation so does not embody overhead or among the different accounting noise in BRG’s monetary statements, and there might be errors:

Then an excellent primary situation evaluation primarily based on potential transaction cap charges and assuming the credit score investments are valued at e book worth:

The mixture of excessive upside in a sale situation with the uncertainty that administration would really promote even when an amazing deal presents itself pushes me to love name choices on this case.  I can take part within the upside if a deal occurs and restrict my draw back if it finally ends up being an unfounded rumor or one thing administration planted to get the inventory value up so they might convert the popular at extra advantageous phrases.

Different ideas:

  • REIT M&A exercise is above or close to all-term highs because of a mixture of low charges, PE cash sloshing across the system, plus it looks like non-public values for actual property did not fluctuate practically as a lot as publicly traded REITs did in the course of the pandemic. A few of that mispricing is being mounted by means of take non-public transactions.  One instance, Condor Hospitality’s (CDOR) proxy assertion got here out, as anticipated there have been loads of consumers they usually all coalesced across the identical worth (I am additionally anxiously ready for the same consequence at CorePoint Lodging (CPLG)).  If BRG is certainly working the same course of, I might anticipate related outcomes, loads of consumers and affords coming in at or under a 4.5% cap fee.
  • BRG has a value-add part to their portfolio, much like the Nexpoint Residential Belief (NXRT) thesis, they’ll earn 20% IRRs on their capital by doing a little floor upgrades to issues like kitchens and loos or including smart-locks to their doorways.  About 4,300 of their 11,500 working models are nonetheless unrenovated, offering some extra development levers, or it might be a part of the thesis of a brand new purchaser that makes paying a low 4s cap fee palatable.
  • One other odd associated get together transaction that’s in all probability nothing, however BRG does have an Administrative Companies contract with different Bluerock entities the place BRG pays one other entity the bills to the run the REIT, it’s finished at value, however simply one other unusual association for a supposedly internally managed REIT.
  • In 2018/2019, Harbert Particular Alternative Fund supplied $12.25/share (under the place it’s buying and selling as we speak) however obtained the chilly shoulder from administration, possible another excuse the market appears to be discounting the Bloomberg sale report.
  • Administration persistently talks about stepping into the MSCI US REIT Index (RMZ in ETF kind), they’re presently outdoors the index, one in every of administration’s acknowledged causes they’ve transformed the Collection B most popular inventory to frequent is to extend the float/market cap to fulfill index inclusion parameters.  I do sympathize with this thesis, I consider (have no actual knowledge) that REITs are over owned/represented in ETF/indices as a result of retail buyers like REITs and their yields.  It is one other presumably motive aside from the clear conflicts why BRG is undervalued, its additionally a part of my NexPoint Strategic Alternatives (NHF) thesis, which needs to be formally changing quickly to a REIT and shortly after will probably be eligible for the index.

Disclosure: I personal name choices on BRG (together with shares in CDOR, CPLG and NHF)

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