STIFEL: Office/Industrial REITs - Bullish Base Case and Bullish Case for REITs. Office & Industrial REIT Metrics Update 9/12/16

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Bullish Base Case and Bullish Case for REITs. Office & Industrial REIT Metrics Update 9/12/16

  • While REITs share prices are proving to be volatile, we are focusing on a base case for the overall capital markets and then attempting to determine where REITs should fit.
  • If one assumes consensus well into 2017 of 1) slower US and global growth, 2) despite a modest fed funds rate hike or two, no pressure on the long end of the curve, 3) TINA (There Is No Alternative) and FOMO (Fear Of Missing Out) driving the U.S. equity markets up via multiple expansion, 4) assuming $125/sh for 2017 S&P earnings and a 20x multiple equates to the S&P reaching 2,500, and 5) continued risk-off and thirst for yield trades; it is relatively easy to project REITs outperforming a healthy U.S. equity market.
Pricing as of close 9/9/16.
 
  • We are also assuming that REIT managements are aware that, while Net Asset Value and other real estate valuation metrics are and will always be important, real estate is late in the cycle, the easy re-leasing spreads are gone, development is everywhere and the incremental investor is focused more on dividend yield and stock valuation metrics than anytime in the past decade. Accordingly, we expect strong dividend increases to be announced in 2H16.
 
  • Despite recent positive performance following 2Q16 earnings calls, we continue to favor Gateway City office REITs. However, we think most of these Gateway City office REITs need to increase their dividends substantially as sub 2.5% yields are a deterrent unless fundamentals are very strong and value creation (not just an NAV discount off an historically low private market cap rate assumption) is obvious.
 
  • These include Vornado (VNO, Buy, $99.45), SL Green (SLG, Buy, $111.00), Empire State Realty Trust (ESRT, Buy, $21.28), Boston Properties (BXP, Buy, $135.22) and Kilroy Realty (KRC, Buy, $69.18) due to a combination of fundamentals, real value-add platforms and attractive valuations relative to suburban or low barrier office REITs. We view suburban office REITs as often (but not always) encumbered by weak fundamentals with a pension fund advisor type, generic platforms.
 
  • In the low barrier office world, our only Buy-rated office REIT is Mack-Cali (CLI, Buy $27.73) due to its 1) substantial valuation discount relative to the other low barrier office REITs, 2) active asset recycling, 3) apartment development potential with low land basis and 4) leasing upside.
 
  • Despite excellent YTD 2016 performance, we continue to like Industrial REITs and have Buy ratings on six of the eight we cover. We expect industrial fundamentals to continue to modestly surprise to the upside and look attractive relative to other property sectors. We also note that the inevitable increase in supply about the time demand subsides continues to get kicked down the proverbial block.
 
  • So, will REITs overall be driven by: 1) the equity markets and a risk-on or risk-off mentality, 2) interest rates at either end of the yield curve, or 3) fundamentals?
 
  • While we think individual stocks and property sectors will be driven by fundamentals, value creation potential and dividends; we expect #1 and #2 and the corresponding funds flows to drive the REIT space overall. Which one? Likely, whichever is most volatile.
 

Below are links to wires we have recently published:

  

Below, we have our 2Q16 Earnings wires for each company under coverage (in chronological order from most recent reporter to first reporter):

 

      
  • Douglas Emmett (DEI, Sell, $36.72) - Staying with the southern California theme, we think the West L.A. and SoCal office markets are solid, but we still have questions regarding DEI. Beach Volleyball. What Else? Maintain Sell.
     
  • Equity Commonwealth (EQC, Hold, $31.04) - Sooner rather than later EQC will have some serious decisions to make regarding the portfolio they want to own in the long term. Javelin Throw? Javelin Catch? Hold.
      
       


Links to our most recent office and industrial REIT sector wires follow:

    

 

  

Japan REIT sector - REITs up despite ex-dividend date for 11 REITs

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Stocks should benefit from BOJ buying, REITs seem also to be in favor

TOPIX rose 2% on 29 August from the previous trading day. The main factor was likely the yen's retreat following the Fed chairwoman's lecture and comments by BOJ Governor Haruhiko Kuroda at the symposium at Jackson Hole, Wyoming, on 26 August. Amid these conditions the TSE REIT index rose 0.5% on 29 August despite it being the ex-dividend date for REITs with August-ending fiscal periods (ie, 11 of the 54 REITs). After nearly doubling its annual ETF buying target to roughly ¥6trn (from ¥3.3trn) at the 29 July Monetary Policy Meeting, the BOJ bought ¥71.9bn in ETFs on both 25 and 26 August, roughly double the daily amount of BOJ ETF buying up to 3 August. Even so, TOPIX continued to fall d-d on 25 and 26 August. On the other hand, the BOJ did not buy REITs on 25 or 26 August, but the TSE REIT index rose each day nonetheless. Judging from these market conditions, our view is that market participants feel safer in REITs than stocks.

Industrial & Infrastructure Fund Investment (3249 JP) (Buy) 16/6: DPU maintained, REIT intends to lift it higher

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Profit recovers, deadline disclosed for solving Shinonome problem

Regarding IIF Shinonome R&D Center, where the sole tenant is scheduled to depart at the end of September, the REIT (IIFI) appears to be in negotiations with a specific candidate tenant to keep the asset as a single-tenant property. However, consideration of selling the property is also under way in case agreement is not reached in negotiations. The REIT plans to determine course in September and have either a leasing agreement or sale contract signed by the end of 2016. IIFI's 16/12 guidance appears to assume the property remains vacant. Elsewhere, contracts have been signed to bring occupancy at the IIF Shinagawa IT Solutions Center to 100%, up from 76.1% at present. Moreover, expansion of IIF Nishinomiya Logistics Center will begin contributing to earnings from 16/12. Since the tenant at Shinonome decided to depart, the REIT has acquired five properties (excluding ownership increases). The high speed of investment has allowed the DPU level to be maintained and the REIT seems determined to improve DPU further. Currently about 20 properties (¥90bn) are being closely examined. That said, LTV has risen to 53%. The focus is therefore on not only the Shinonome outcome, but also capital-raising in combination with additional investment. We use a fair-value dividend yield of 3.0% and fair-value cap rate of 3.75% to calculate our target price. In February we changed to valuing IIFI using discount rates 25bp lower (previously 50bp lower) than respective weighted averages for the 38 REITs we cover. Given the clear deadline for dealing with Shinonome, the stable DPU, the commitment to improving DPU, and the high probability thereof, we return to valuing IIFI at discount rates 50bp lower than the 38-REIT averages.

NOMURA - Frontier Real Estate Investment (8964 JP) (Neutral) 16/6: issues resolved, but retail environment in flux

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Continuing to renegotiate rents with general merchandisers, seek tenants for urban retail spots

In 16/6 Frontier Investment posted a loss of ¥470mn on the sale of Joyfutown Okayama, where the main tenant was Ito-Yokado. However, the REIT drew down ¥340mn in internal reserves and paid the same DPU as 15/12 (¥9,694). The Sport Club Renaissance Hiroshima property was vacated in July 2016, but vacancy has been avoided as a contract was signed with new tenant Kohnan Shoji [7516]. Frontier has been steadily resolving issues on the property management side, but has yet to reach agreement on rent renegotiation for Ito-Yokado Higashi Yamato. Looking further ahead, in October 2017 the Tsutaya Book Store Tenjin (Fukuoka) will lose its whole-building tenant and in the same month rent renegotiation time will arrive for Aeon Shinagawa Seaside. We are also focused on these outcomes. On the other hand, the REIT acquired a 50% stake in Mitsui Shopping Park LaLaport Shin-Misato in August for ¥15.1bn (appraisal NOI yield of 5.0%).We estimate the LTV ratio is currently 41.9%, leaving acquisition capacity of ¥12bn up to an LTV ratio of 45%. This likely puts the focus on what method will be used to fund additional investment. We use a target dividend yield of 3.25% and target cap rate of 4.0% to calculate our target price, continuing to value the REIT using discount rates that are around 25bp lower than the respective weighted averages for 38 REITs under our coverage.

NOMURA - Nippon Building Fund (8951 JP) (Neutral) 16/6 results

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Occupancy higher than projected but unlikely to rise further, making rent revisions even more crucial

Guidance calls for real estate rental revenues to rise ¥0.78bn (2.4%) between 16/6 and 16/12, breaking down as ¥0.44bn from acquired properties and ¥0.34bn from existing properties. For the latter, the REIT has raised its average occupancy projection for 16/12 from 97.8% to 98.2% to reflect generally better-than-expected progress in attracting new tenants together with the full-term impact of new tenancies at NBF Toyosu Canal Front and Celestine Shiba Mitsui Building. Rent revisions involving existing tenants are also likely to remain positive, having turned so in 15/12 for the first time since 09/6. Meanwhile, the REIT has acquired four properties for a total of ¥29.5bn since 16/6, including the Ueno East Tower and the Toyocho Center Building, while at the same posting gains of ¥0.95bn on the sale of the NBF Sendai Honcho Building and the NBF Atsugi Building. We estimate the current LTV at 41.9%, giving the REIT ¥78bn to spend on properties before it hits its self-imposed ceiling of 46%. We use a fair-value dividend yield of 2.75% and fair-value cap rate of 3.5% to calculate our target price. We continue to value the REIT using discount rates that are 75bp lower than the weighted averages for the 38 REITs under our coverage.

Robert Stevenson Update: Community Healthcare Trust Inc (CHCT) - BUY 2Q16 Earnings REITView: Solid results; raising FV to $24

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Flash Takeaways:

CHCT reported 2Q16 FFOPS of $0.32 (Normalized was $0.34). We were at $0.31 per share, while consensus was at $0.32 per share. The 3 acquisitions ($33.5M) in 2Q16 and the 4 in the pipeline ($13.4M) are the main takeaways.

Analysts Notes:

  • Occupancy 93.0% at June 30. At the end of 2Q16, CHCT had investments in 48 properties and mortgages across 18 states, totaling roughly 1.1 million square feet, that were 93% occupied. We note that leases representing 7.2% of CHCT’s annualized rent will expire in 2H16, with roughly 12.2% expiring in 2017.

  • CHCT acquires 3 properties in 2Q16 for $33.5M. The 3 properties were 93.7% leased overall and total 153K square feet. CHCT had previously announced the acquisition of a 13,835 square foot surgery center in Arizona for $3.1M (100% leased) and the 85,000 square foot behavioral hospital in Des Plaines, IL for $20M (100% leased), for which CHCT had previously extended a $12.5M mortgage loan and subsequently exercised their purchase option. In addition to the two previously announced acquisitions, CHCT closed on a 54,611 square foot MOB in Independence, Ohio for $10.4M (82.3% leased).

  • Credit facility increased by $75M; dividend increased by $0.0025. On 8/10/16, CHCT increased the size of their credit facility from $75 million to $150 million, while also reducing their interest rate by 25bps. Additionally, the quarterly dividend increased by $0.0025 from $0.3775 to $0.3800.

  • Pipeline currently 4 properties totaling nearly $13.4M. CHCT has purchase agreements on four properties for a total cost of $13.4M. CHCT estimates an expected return on these properties in the range of 9.16%-9.97%.

  • Increasing 2016 FFOPS estimates. Given 2Q16 results, we are increasing our 2016 FFOPS estimate from $1.37 to $1.39 and our 2017 estimates from $1.53 to $1.57. Consensus is at $1.46 and $1.66, respectively. We are maintaining our Buy rating and are increasing our Fair Value estimate from $23 to $24.

STIFEL: CLI ($27.23, Buy) - Triple Jump. Hop, Skip, Jump Through Apartment and Office Gold Coast Portfolio. Maintain Buy.

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  • 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.

Pareto Securities: Kungsleden - Share rally limits the potential - Update

Pareto Securities:

Share rally limits the potential

We downgrade Kungsleden to Hold (Buy) following the strong share performance over the past two months – the share is up 23% since mid-June. We raise our target price to SEK 70 (67) on the basis of the strong NAV growth in the second quarter but the six-month potential (<10%) is not enough for a positive stance, in our view.

Most of the hard work is done by now

The past three years have transformed Kungsleden into a well-functioning real estate company with a decent property exposure. Management has, with great success, increased the exposure to large cities – Stockholm, Malmö and Gothenburg. In addition, the balance sheet is in good shape and interest costs are now in line with peers on an average of 2.8%. We assume continued operational progress, including divestments in non-prioritised locations, but with limited impact on the risk and company profile.

Strong property market to support values

Although we assume a strong underlying property market will support, and potentially increase, property values further, we do not highlight a general yield decline as the chief value contributor going forward. Project developments, which are a more potent property value contributor in our view, will most likely help Kungsleden lift NAV in the second half of 2016 and in 2017, but the potential is tricky to quantify. When it comes to project gains, we prefer Fabege with its attractive and large project exposure to the prosperous Stockholm/Solna market.

Decent annualised return still achievable

We downgrade to Hold (Buy) as we increase our six-month target price to SEK 70 (67), meaning a relevant, annualised return (~18%), although not enough for a positive stance.

Complete report in attached PDF

http://www.kungsleden.se/en/