3Q2016 Update Quarterly analytics are designed to keep you informed about portfolio performance, positioning and strategy. Performance The 3rd quarter of 2016 was an atypical quarter characterized by wild price swings and tepid fundamentals.  Our active management approach is designed to capitalize on anomalous opportunities and it performed well in this odd environment with 10.75% outperformance over the MSCI total return REIT index (RMS).  Specifically, 2CHYP was up (+9.21% source: IB) in 3Q16 while the RMS was down (-1.54% source: SNL Financial).  This should not be considered a run rate and while we make every effort to outperform, there will certainly be quarters going in the opposite direction.

Positioning going forward

Shown below is the current  2CHYP portfolio as of 10/4/16 as of 2:53 CST.

We believe these stocks position us well with better valuations and higher yield.  Specifically, 2CHYP’s dividend yield is 6.21% as compared to the SNL US REIT index which only yields 3.7%, and our average P/FFO of 11.48X is substantially cheaper than the index at 20.1X.

Portfolio strategy

Both high yield and low valuation can easily be found with a simple screen.  Unfortunately, these areas of the market are filled with value traps and unsustainable dividends that get cut causing severe damage to the stock price.  Instead, we analyze fundamentals and only select those which we believe have strong outlooks and sustainable dividends.

Essentially, our goal is to fill the portfolio with a diversified basket of stocks which collectively have a combination of growth, yield, and value that is superior to the index.

Our active management does not stop at stock selection.  We use every tool at our disposal in an attempt to enhance profits and control damage.

  • Trade timing

Predicting market movement is considered by many to be a fool’s errand.  We agree, but that does not eliminate the benefits of intelligent trade timing.  One does not need to predict market movement to take advantage of pricing that has already occurred.  We cannot see the irrational fluctuations coming, but we are ready and waiting to jump on them when they do.  Real time trade alerts are designed to translate our timing to you with minimal margin of error.

  • Risk mitigation

We recognize our fallibility and stress test our ideas continuously.  Ideally, we can find our mistakes before losses get too large.

American Farmland Company (AFCO) AFCO 8.65 0.00 0.00%

AFCO is really a play on Farmland Partners (FPI), as it is in the middle of a merger with them.  Essentially by buying AFCO, we are getting FPI for a discounted price that has fluctuated between 6% and 8% cheaper.  This difference represents an arbitrage spread that will be received upon completion of the merger likely in late 4Q16 or 1Q17.

In addition to the arbitrage opportunity, we like it because the prospects of Farmland Partners are quite favorable.  It has become the dominant aggregator of farmland in the REIT space.  As it achieves scale, it will get 3 distinct benefits, each of which will improve FFO/share.

  • Pooled purchasing for its farmers: FPI can use its size to negotiate better deals which will save their farmers money on seeds, fertilizer, and pesticides.  In return, FPI gets a cut and a loyal tenant.
  • It will become the go-to buyer for farmers looking to sell their land because it can defer their taxes through the use of OP units to make the purchase.
  • REIT farmland will be seen as a legitimate asset class which should bring multiple expansion.

Armada Hoffler (AHH) AHH 9.19 -0.29 -3.06%

AHH is one of the most solid companies in our portfolio.  It is run by Louis Haddad who has operated the business for 20+ years.  For most of these years, the company was private and he still runs it as if it is.  They don’t do anything flashy, instead, they execute with remarkable efficiency.  Its property portfolio is highly concentrated in the Virginia Beach area where they own the City Center properties which claim the highest rent and are viewed as the premier location.  Along with this property, they have some adjoining parcels which will provide development growth potential which they are timing with the growth of the MSA.  Virginia Beach has a young demographic with lower unemployment than the national average and it positioned for slow but steady growth going forward.  Armada Hoffler can leverage its long-standing relationships with the local government and businesses to be the primary developer as the city builds out.  Since the REIT owns the development arm, its ROIC is a good 100 to 200 basis points higher than most REIT acquisitions.  We anticipate long-term FFO/share growth at a slow to medium pace which is a very strong outlook for a company trading at such a low multiple.

Ashford Hospitality (AHT) AHT 0.62 -0.02 -3.77%

AHT is a hotel REIT with excellent properties and corrupt management.  Our $12.00 price target may seem ambitious with a current market price around $6.00, but it still only represents a 7.8X multiple on AHT’s estimated $1.54 FFO/share.  This is a true deep value play with it trading at a massive discount to intrinsic value that is partially counterbalanced by Monty Bennett, who runs the company like his personal piggy bank.  While this certainly presents a risk, the risk is priced in so extensively that we believe the weighted average outcome is favorable to investors.  Essentially, if Monty can restrain himself enough to keep the massive G&A at the same level, the tremendous cashflows of the underlying properties will reward shareholders.  Note that the $1.54 of FFO/share is an AFTER G&A figure, so there is also substantial upside if the expensive external manager AINC can be ousted.  Our thesis does not rely on removal of management, this is merely a favorable possibility.

CBL and Associates (CBL) CBL 0.25 -0.01 -3.35%

CBL is a good company trading at an extremely cheap valuation due to secular headwinds affecting retail. There is no question that Amazon is hurting brick and mortar retail, but the extent of it seems greatly exaggerated to me.  At its current market price, there is an implied demise of CBL in which tenants vacate without replacement.  This seems overly pessimistic and I believe the bears are missing the fungibility of mall space.  While they will be unlikely to replace a J.C. Penney with another apparel type store as nearly all apparel is hurting with the barebones pricing and excessive competition, CBL has the optionality to put in some restaurants or entertainment destinations.  These sorts of businesses pay more rent per square foot than a big box store and they are also resistant to Amazon because the customer must be physically present to enjoy fresh food or a big screen movie.  The plausibility of this sort of tenant replacement is backed up by the facts.  Even as retailers announce massive store closures CBL has gained SSNOI and FFO/share.  Retenanting efforts have largely been successful and in places where they are not, CBL has divested of the mall.  This is a flat to slightly growing company trading as if it is about to fail and we see about 80% upside to share price.


Communications Sales and Leasing (CSAL) Unfortunately, we could not get stock quote CSAL this time.

CSAL is a high yield infrastructure REIT with very stable cashflows.  It is priced at only 13X forward FFO which is a cheap multiple for this kind of asset because of the extremely low capex.  In fact, CSAL has only ~$6mm in annual capex with over $800mm in annual revenues meaning capex is less than 1%.  In contrast, hotels have capex of around 5% of revenues and offices are closer to 10%-20% of revenues in the form of leasing commissions and tenant improvement.  Industrial assets require roof replacement every~15 years and have a similar but smaller leasing commission/tenant improvement problem to office.  Retail and multifamily assets operate on a much shorter leasing period so there is a constant need to spruce up the appearance.  This results in maintenance capex with about a 3 to 5 year shelf life and represents true depreciation.  CSAL’s assets consist predominantly of cables safely buried under the ground and metal towers that can be as ugly as the environment makes them.  These assets serve a very functional purpose and little is wasted on cosmetics.  There are also no leasing commissions or tenant improvement costs as it was signed as a 15-year lease with 4 five year renewal options.  So while a 0.5% escalator may be weak for a typical real estate asset, it is a very healthy growth rate for an asset that generates cashflows that are closer to a perpetuity.  When CSAL does perform tenant improvements, it is at their discretion and they get paid for it.  In December of 2015, CSAL capexed $43.1mm on a distribution system for Windstream and this raised the contractual rent by $3.5mm annually.  That is an 8.1% cap rate on the capex, while offices tend to perform expensive tenant improvements as a gift to the tenant.

Easterly Government Properties (DEA)DEA 22.80 -0.06 -0.26%

DEA is a particularly safe office NNN REIT.  It has long-term contractual cashflows from its primary tenant, the US Government.  This provides its solid 4.8% yield with a fair degree of predictability and it should grow over time as DEA’s excess liquidity is spend on acquisitions.  Fundamentally, there is nothing we know about this company of which the market is not fully aware.  It is simply mispriced due to its small size and relative newness.  As it grows and becomes more accepted as the stable REIT that its fundamentals demonstrate it to be, we anticipate its multiple will expand closer to that of highly respected NNN peers.  This is the basis of our target price.

Global Net Lease (GNL)GNL 16.43 -0.40 -2.38%

GNL is trading at approximately half the valuation of NNN peers with similar tenant and property mixes.  This large discount is the result of association with Nick Schorsch who has committed fraud at ARCP (now known as VEREIT).  Global Net Lease comes from the same parent company (American Realty Capital) so it will likely trade at a discount for quite some time.  While this stigma may affect its market price, the cashflows are very clean.  High credit rated tenants, diversified properties by type and geography and a very long remaining lease duration suggest GNL will be able to support its dividend for the foreseeable future.  This makes it a clean 8%+ yield that is virtually non-existent elsewhere in the low-interest rate environment.  Our buy thesis only requires the dividend for this to be a successful holding, but there is additional upside potential if yield-starved investors are willing to hold their nose and buy despite the stigma.

Gladstone Commercial (GOOD)GOOD 17.55 -0.73 -3.99%

GOOD has successfully completed its heavy lease expiry period which is arguably the most dangerous time for a NNN REIT.  With a freshly extended remaining lease duration and diversified tenants, GOOD’s 8% yield is very safe.  Peer NNN REITs with similarly safe cashflows trade at multiples in excess of 20X forward FFO so GOOD is a bargain by comparison.  For this reason, we anticipate material multiple expansion.  For the past few years, GOOD has struggled to grow FFO per share as its high payout ratio coupled with the cheap market price made it hard to raise the capital required for growth.  However, it is now of sufficient size that the G&A is more manageable and its growth trajectory should pick up.  With its healthier stature, GOOD has been able to refinance debt at cheaper rates and still has some remaining opportunities here.  We estimate FFO/share growth of around 5%-10% over the next 2 years which should supplement the multiple expansion.

Gramercy Properties Trust (GPT)GPT 0.00 -27.48 -100.00%

GPT is a high-quality company valued at a low-quality multiple.  Gramercy itself has an ugly history as a former mREIT that barely survived and the company it bought, Chambers Street, was not much better.  However, neither of these origins are reflective of the company that it is today. Gordan DuGan is a highly disciplined CEO who came in after the troubles and has set GPT on the right path.  Under his leadership, GPT is up over 200% and still remains cheap because much of the return was matched with FFO/share growth.  Presently, Gramercy is transitioning to a 70%/30% industrial/office portfolio which should garner a substantially higher multiple than that at which it is currently trading.  Additionally, the longer lease duration and generally better tenant quality have yet to be reflected in the price.  We see material room for dividend growth and FFO growth going forward as it completes the transition.

Hersha Hospitality (HT)HT 5.06 -0.21 -3.98%

HT has found itself in an unfortunate situation in which the premier markets (NYC and Miami) where most of their properties are located are simultaneously getting hit with powerful headwinds.  New York has a rampant oversupply of hotels which is compounded by excessive Airbnb listings, while travelers are scared away from Miami due to the Zika virus.  These headwinds are very priced into the stock with it trading at just 6.2X FFO.  I want to draw an important distinction between poor performance by error and that caused by chance.  Hersha has made virtually no mistakes in its history as a REIT and has outperformed hotel peers over the long run.  Zika was completely unforeseeable at the time HT entered Miami, and the reduced inbound travel will likely not persist once the media discourse attenuates and health remedies are implemented.  Oversupply will correct itself over the course of a cycle with the stronger operators surviving, and Airbnb is facing increasing regulatory pressure as NYC has deemed many of the listings illegal.  HT is priced as if these headwinds are permanent, so there is material upside if and when HT can return to normal profitability.  This upside is amplified by a series of accretive maneuvers which HT’s management has opportunistically taken.  HT sold a large portion of its NYC portfolio at peak market pricing and has used the proceeds to buy back its very cheap shares.

Lexington Properties (LXP)LXP 10.39 -0.04 -0.38%

LXP is a triple net lease REIT in the optimal time of its cycle.  Generally speaking, NNN REITs ignore the economic cycle and instead have periods of heavy re-leasing followed by long periods of steady cashflows.  Plenty of things can go wrong during the re-leasing phase of the cycle so stocks tend to be more volatile and investors may sell the stock down.  LXP has just completed its re-leasing phase and now has a freshly lengthened remaining lease duration.  The refresh was acceptable with some negative rent rolls and some positive rolls to balance it out.  It is very rare for things to go wrong mid rent cycle due to the contractual nature of cashflows, so we view LXP as a stream of cashflows rather than as an operating company.  These cashflows are roughly 10% of its market cap annually which is dramatically oversized in today’s environment.  As the chatter about lease renewal dies down, we believe the market will recognize and reward LXP’s large and very well covered dividend.

Medical Properties Trust (MPW)MPW 18.01 -0.37 -2.01%

MPW is the premier hospital REIT with substantial first mover advantage.  In addition to existing relationships with some of the strongest operators throughout the US and Europe, MPW is well known enough to be sought out by hospital operators in need of financing.  Despite its large size and favorable reputation, MPW trades at a pauper’s multiple of just over 10X.  We view this as a clear case of mispricing predicated on a misunderstanding of its business.  ACH (acute care hospital) and LTACH (long-term acute care hospital) operators are experiencing volatility at the moment as healthcare regulation is in constant flux and labor costs threaten to soar.  These negatives are balanced out by a demographic super trend that promises to fuel healthcare facilities with ever increasing demand.  Strong operators will thrive and MPW has some of the best with EBITDAR coverage that dwarfs the competition.  Beyond the sheer quality of MPW’s platform, we are impressed by their accretive external growth.  MPW has an acquisition pipeline with a sizable cap rate spread over WACC that facilitates a continuation of their long history of FFO/share growth.

NextPoint Residential Trust (NXRT)NXRT 33.44 -0.64 -1.88%

(NXRT) is a small multifamily REIT with exceptional organic growth potential.  Its modus operandi is to buy low-end apartments and fix them up for a substantial rent bump.  Thus far, it is averaging over a 20% ROIC on renovations and there is still quite a bit of runway.  This organic growth does not seem to be fully priced into the stock as it trades at a massive discount to multifamily REIT peers with a 14X multiple as compared to around 20X.  Its share price has already come up from around $12 to over $19, but the remaining discount combined with the growth trajectory suggest there is still some upside.  NXRT’s management comes from Highland Capital which is one of the more successful money managers and these guys are quite capable.  They also have a distinctly different perspective which seems to be more shareholder value focused as opposed to other REIT executives who view the company as their legacy.

Omega Healthcare (OHI)OHI 30.30 +0.62 +2.09%

OHI  has a phenomenal track record of FFO/share growth and dividend growth, which combined with its conservative capitalization would typically garner a multiple of around 15X-17X.  The market, however, is nervous about the outlook for SNFs (skilled nursing facilities) which could be greatly impacted by the trend toward bundling as hospitals are becoming increasingly incented to route patients to certain kinds of post acute facilities.  While there is still demand growth in the SNF space and it will do quite well overall, it seems likely that there will be both winners and losers.  The rising tide of healthcare demand will not lift all boats. Thus far, OHI has not felt any strain with its operators maintaining a healthy EBITDAR coverage ratio, but there is some speculation that their relatively low average star ratings could hurt them going forward.  At such a cheap multiple, much of the risk is priced in and we believe the weighted average outcome will be positive for OHI shareholders.

STAG Industrial  (STAG)STAG 28.84 -0.38 -1.30%

STAG is an industrial REIT with a highly intellectual approach to the business.  Rather than relying on colloquial purchasing rules, Ben Butcher and his team have developed a dynamic process that attempts to identify which opportunities are the greatest value.  At the moment, STAG is picking up an extra 100 to 200 basis points of annual return over the life of an asset by recognizing the paucity of demand for class B properties with shorter remaining lease terms.  The markets for 15-year leases or class A properties are overbought and less accretive. We have reviewed his process and find it to be superior which makes the stock a great value as it is trading at the lowest multiple in the sector.  STAG has executed well and is positioned to outperform over the long run.  Dynamic decision making is more difficult but greatly outperforms static quantitative algorithms and rules-based targeting which are unfortunately the gold standard for REITs.

UMH Properties (UMH)UMH 11.89 -0.40 -3.25%

UMH is the only manufactured housing REIT that doesn’t trade at a sky-high multiple.  The rest of the sector is expensive because of the strong fundamental outlook which portends an ROIC that greatly exceeds other kinds of real estate.  MH communities can be developed at a remarkably low price, yet the expense of alternatives (houses or apartments) affords charging a reasonably high rent.  This sort of industry dynamic would typically usher in excess supply, but the difficulty of attaining zoning permissions prevents supply growth and allows existing zones to enjoy outsized returns.  UMH has existing zoning which they are redeveloping into more productive and higher occupancy communities.  We see this as driving double-digit growth for the next 5 years which is out of line with UMH’s trading multiple which does not bake in much growth.  Therefore, if UMH can deliver on its opportunity, the stock could appreciate materially.

Washington Prime Group (WPG)WPG 0.71 -0.04 -5.50%

WPG has not gotten credit for its portfolio transformation as it is still trading at a multiple of a company with deteriorating fundamentals.  We do not see this as appropriate given the transformation they have largely completed.  Their remaining mall portfolio is performing well with positive SSNOI and even growth to sales per square foot.  Additionally, shopping centers make up a large portion of WPG’s portfolio and these are typically valued at a higher multiple. From an investment perspective, this is a simple value stock.  At current pricing, its FFO yield is 14.7% which is more than double that of most REITs.  Its properties are worse than average, but not to the extent indicated by this yield.  10X would be closer to a fundamentally proper multiple and is how we derived our price target.