CLI — Market News — The Closing Table

After a speedy Mack-Cali overview and an extended gold medal property tour from Jersey City to West New York along the Hudson River's "Gold Coast", we remain bullish on the management team's ability to execute and our Mack-Cali investment thesis.
Our thesis is that CLI continues to have a complexity discount, execution concerns and a bit more leverage relative to their low barrier office peer group. The implied cap rate gap is roughly 150-180 bps. We believe this gap will narrow as Mack-Cali executes its business plan.

The strategy remains multi-faceted: continued office lease up in core submarkets, apartment development, asset recycling and ownership simplification.

While we initially really liked the idea of an entity-level investment and a market-provided valuation for Roseland Residential Trust (RRT), we now appreciate that the potential loss of control aspects and cost of a sizable capital infusion may both be too dear. Optionality here is key, however.

By rejiggering forward capital commitments, development starts and funding sources, CLI maintains maximum optionality and can fund its commitments through 2018 without compromising its strategic vision. RRT capital commitments can be funded in three ways: 1) a smaller entity-level investment, 2) joint ventures on $300-400mm of developments or 3) selling stabilized assets. We are positive on all three of these options.

At the CLI level, we like the continued non-core office and flex asset sales, which are expected to total $750mm in 2016 with additional sales in 2017 and beyond. These asset sales will further focus the portfolio and management efforts into higher quality locations commanding better net effective rental rates and a higher propensity to grow versus degrade NAV.

In addition, increased portfolio density increases cash flow via reduced G&A and operating costs. The lease-up of assets recently and currently under construction and debt refinancings will also increase cash flow.

We expect the evolution of CLI to take 1-2 more years, even this management team could not build Rome in a day. During the course to stabilization we expect lumpy, but growing FFO, increased NAV and long winded answers to our succinct questions.

Market wise, Jersey City and the Gold Coast offer high quality options at a good value relative to the other side of the Hudson for both office and apartments. We do expect apartment overbuilding, and think the Mack-Cali advantage is a very low land basis: particularly in Jersey City.

We believe the real estate metrics are very attractive relative to other low barrier office REITs. We value the apartment portfolio (Roseland Realty Trust) at $1.1B, vs. the CLI internal valuation of $1.28B.

The office/flex portfolio trades at: 1) Implied NOI, Cash Flow and CF less G&A cap rates of 8.5%/4.7%/3.4%; 2) the office portfolio valued at $155/SF, which is a (56%)/(24%) discount relative to our recently adjusted estimates of gross/adjusted replacement cost of $355/$204/SF; and 3) the implied cap of 8.5% is above our 7.5%-8.0% NAV range.

We are not adjusting estimates at this time, but will likely do so after the full CLI investor day on 12 September.

Target Price Methodology/Risks

Our $30/sh target price equates to 14.1x/33.7x multiples of our 2017 FFO/FAD/sh estimates and an 7.8% implied NOI cap rate on current numbers.

Risks to obtaining our target price include: 1) execution risk related to asset sales and the values achieved (including the recapitalization of Roseland); 2) lease-up risk for the remaining assets; 3) development risk related to multiple multifamily assets currently under construction or in planning; and 4) interest rate and general economic risks.