Sunday, January 31, 2010

PennyMac's big discount

Of all the 2009 MREIT IPO's PennyMac Mortgage Investment Trust (PMT) trades at a worst discount to book value. This creates plenty of head scratching as to if PMT is pregnant with opportunity or pregnant with something else.

Reading the S-11's gives a number of reasons not to invest in PMT beyond those concerns with the target asset class; credit impaired residential mortgage assets requiring intensive servicing.

  • The people who run this REIT, are same ones who created this mortgage crisis.
    "Certain of the officers of PennyMac who are former employees of Countrywide, including Stanford L. Kurland, our chairman and chief executive officer, who was chief operating officer of Countrywide until September 2006, have been named as defendants in lawsuits in which Countrywide and other employees and former employees of Countrywide are defendants."
  • The management fee structure is not attractive. (1.5% base + 20% xs 8%), incentive fee's in a structure with potentially high leverage (typical of RMBS/Residential investors) can be dangerious
  • The external manager has split ownership (37% Blackrock, 37% Highfields Capital, and only 26% "Management") which raises potential issues of stability and management buy in at the external manager level.
    "BlackRock and Highfields Capital, PennyMac's strategic investors, are not obligated to provide us with any assistance and could compete with us."
  • There is a built in cash leakage due to the assignment of servicing to party related to the manager yet outside the REIT: PennyMac Loan Servicing (PLS). It is so important when dealing with externally managed company's to look at all sources of potential cash leakage in favor of management. What you are trying to avoid is any sort of "gross asset" based compensation arrangement, which is very open to abuse.
  • There is an even worse conflict of interest in that PLS may earn origination fee's.
    "This may provide PLS with an incentive to refinance a greater proportion of our loans than it otherwise would and/or to refinance loans on our behalf instead of arranging the refinancings with a third party lender. It may also provide PLS with an incentive to provide financing to facilitate sales to third parties with regard to the disposition of real estate that we acquire through foreclosure."
  • The public REIT is competing with two PennyMac managed private investment funds for investment opportunities and does so without co-investment rights. These funds have roughly $300M+ in uncommitted capital.
    "No assurance can be given that PCM will act in our best interests with respect to the allocation of personnel, services and resources to our business."
  • Finally the fairly unique risk now facing holders of residential loans: a hostile court system.
    "The borrowers under sub-performing or non-performing mortgage loans may have a variety of rights to contest the enforceability of the mortgage loans and prevent or significantly delay and increase the cost of any foreclosure action, including, without limitation, allegations regarding fraud in the inducement by the original lender or broker, failure of the lender to produce the original documentation, improper recordation of the mortgage, various theories of lender liability, and relief through the U.S. Bankruptcy Code and similar state laws providing debtor relief." This sort of thing has been a real stinger, as judges have been known to vacate a mortgage over the holders inability to produce documentation, or are otherwise unsympathetic to the holders of sub-prime loans.
  • Another issue is the companies long URL: No one is ever going to remember or bother to type that into a browser.

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Monday, January 25, 2010

Terreno IPO on ice.

It appears that Terreno Realty (TRNO) has postponed its IPO, because Goldman Sachs couldn't find enough IPO investors. I have mixed feelings about this, because I was honestly impressed by the companies road show. I went in as a complete skeptic, and was more convinced afterwards.

The management team (Blake Baird, Mike Coke) showed a profound understanding of how to build a quality real estate portfolio vs a just a very big one. They explained how they intended to side step the snare of merchant building and excessive hard leverage.

There are some places I thought the sales effort could have been better. My perspective is that of a vulture gliding through the sky, so things can be very different on the ground, and I hate to second guess anyone.

  1. Underwriting team. You need the smaller banks that do more REIT business vs a bulge bracket firm. Look at all the successful REIT ipo's of 2009-2010 and see who was underwriting.
  2. Concerns about industrial real estate. This remains a real headwind, somehow you have to convince people that this will not end up a deathtrap of high vacancy and low rents.
  3. A better explanation of what the existing public players did wrong (too much leverage, too much merchant building, too many low cost/low desirability assets) so that folks can distinguish the new platform from the old.
  4. A better growth strategy than "raise a lot of equity". Chances are that REIT equity will remain more expensive than sensible debt financing. It's good to talk a low leverage game, but equity REITs are a business where some amount of leverage is needed to obtain reasonable returns. One problem with a strategy of funding via unsecured debt at the REIT level is that maturities become lumpy.
  5. A discussion of leveraged real return, via leases with built in rent escalation financed with fixed rate debt. This is the best argument in favor of investing in equity real estate, and especially NNN real estate. You want to able to show how even if the company does nothing, there will still be dividend growth.

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Sunday, January 24, 2010

Fresh S-11 for Verde Realty

Verde Realty filed an S-11, to take this existing and operational REIT public. According the filing Verde already owns a multifamily rental portfolio of 14 properties totaling 4,790 units, an industrial distribution portfolio of 87 properties totaling 12.0 million square feet. In addition to the operating portfolio, the company has a land bank of approximately 1900 acres for multifamily/industrial development as together with roughly 33,000 acres in New Mexico for "low-density residential lot development." Verde's management team is lead by C. Ronald Blankenship, who was previous involved with the Security Capital companies and various bits of REIT drama in the 1990-2002 period. Outgrowths of this work included the formation of Prologis and Archstone Comunities trust, which eventually became Archstone-Smith (ASN). Per the S-11
Historically, Verde has been focused on major southern and U.S.-Mexico border markets. As we seek to deploy capital that we raise in this offering, we intend to leverage our senior management team’s broad geographic experience and focus on multifamily rental properties and industrial opportunities within our existing U.S. and Mexican markets, as well as select targeted markets in the western and southwestern United States, which may include: Los Angeles, California; Las Vegas, Nevada; Phoenix, Arizona; Riverside-San Bernardino, California; San Francisco, California; Seattle, Washington; and Denver, Colorado.
What makes Verde somewhat hard to figure out is the poor operating metrics (aka negative FFO), which are perhaps offset by by four multi-family properties which are coming online due the completion of construction during 2H09-1Q10. My guesses that the lease up should push the company into break even territory and that Verde's management will have some explaining to do during the IPO roadshow.


Wednesday, January 20, 2010

Latest REIT S-11 filings (Halvern, Chesapeake, Callahan Capital)

Three new amended S-11's filed today; all equity REITs.
  1. Halvern Realty files an updated S-11. Halvern is trying to "acquire, own and manage a portfolio of office properties which will be located in Southern California."
  2. Chesapeake Lodging Trust files an updated S-11 reducing the proposed offering by 40%. The company is now offering 7.5 Million shares of Beneficial Interest ($20/sh) down from 12.5 million. I am a bit surprised at this since Chesapeake has some built in sponsorship from Hyatt Hotels (H), which I would expect to be attractive to pre-IPO investors.
  3. Callahan Capital Properties files an updated S-11 discussing plans to "acquire, own, lease, redevelop and manage a portfolio consisting primarily of Class A office properties" to be located in Boston, greater Los Angeles, New York City, San Francisco, Seattle and Washington, D.C

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Sunday, January 17, 2010

More S-11's

There was a rush to file S-11's on last friday; in front of the federal National Plagiarism Awareness holiday on January 18th.
  • S-11/A Chatham Lodging Trust. Chatham trust is run by Jeffrey H Fisher who was CEO of Innkeepers USA Trust (KPA) a New York Stock Exchange-listed hotel real estate investment trust, or REIT, from its inception in 1994 through its sale in June 2007 to Apollo Investment Corporation (AINV). Seven of the eight members of the board of trustees of Innkeepers at the time of its sale in June 2007 have agreed to serve as trustees of our Chatham Lodging Trust.

    More or less Chatham will be Innkeepers 2.0. The new trust is wisely going after upscale extended stay hotels, since these are less sensitive to tourist traffic and more to the mobility of the business classes. To help the trust get its start, Fisher has assembled an initial portfolio of hotels for the REIT to purchase.
  • S-11 Colony Financial. Colony is filing for a secondary offering. The best part of the S-11 is the discussion of events subsequent to the filing of CLNY's last 10-Q. The joint venture with the FDIC is data point, from which you can draw many ideas about the future direction of the company. I remain very optimistic about this company's ability to obtain high IRR's for external shareholders even with the burden of the incentive fee (20% xs of 8%).
  • S-11/A Pyramid Hotels & Resorts, Inc. Pyramid is a weird kind of beast. It's an internally managed REIT which is designed to gradually absorb the resources of Pyramid Hotel Group. The S-11 contains a very frightening risk disclosure section, which can be interpreted as management having a good grasp of the risks involved (a good thing), or it is perhaps scary enough to scare anyone from investing in Hotel REITs (a bad thing).
  • S-11/A Terreno Realty Corp. More updates from the ex-AMB folks. The current market has shown little love for the existing industrial equity REITs, and that makes it hard to see what is compelling about this IPO at the conceptual level. Terreno is a bet that fresh money will be in better shape over existing players who are grappling with de-leveraging.
In the interests of full disclosure: I own some shares of Colony Capital (CLNY)

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Sunday, January 03, 2010

Growing by your own bootstraps

Let's say we own shares in MREIT with a BVPS of $10.00 per share, and in which each $1 of book equity when fully leveraged/invested is good for generating $0.10/year in FAD (funds available for distribution).

Now imagine that the REIT is trading at $12/sh and does a secondary public offering which causes fully diluted BVPS to become $10.50/sh for all shareholders. The REIT's earnings power post-money has just grown by 5%; for both existing and new shareholders. Assuming a constant price to book multiple, the market value of the company increases each time it raises capital.

This ability to grow by your own bootstraps has certain limitations:

  1. The stock must be trading sufficiently above BVPS that new capital raises will be accretive to earnings. Usually this means at least a 10% premium to book.
  2. Management must be able to invest the new capital with enough speed to meet the now larger dividend obligation that results from having more shares outstanding.

The speed at which new capital can be deployed, depends on the amount of thought and work needed to evaluate and acquire new assets. Generally buying securities takes less time than buying more customized assets such as self originated loans or equity investments. This really shows with the Agency RMBS REITS (E.g NLY et al) for whom the Agency RMBS+repo market can satisfy any amount of new investment.