The relative value rotation
REITs are generally stable in their business models, even those that are still growing externally are growing through buying similar assets to what they already own. To me, this stability makes valuation the primary differentiator between REITs. Market price changes far more rapidly and wildly than fundamental value, so we attempt to use market price changes as a means of maximizing the fundamental value of the stocks we own.
Among the ~180 REITs, we like the fundamentals and valuation of about 30 to 45. Within this group, some are better relative values than others and it is often the relative value delta that drives our trades.
The Gladstone Commercial (GOOD) sale is a perfect example of this as essentially nothing has changed at the company. Its fundamentals remain slow and steady as they have been for decades. We continue to like Bob Cutlip and the direction in which he is taking the company. It simply appreciated in market price to a point where it is only slightly cheap from a valuation perspective. I think it is a fine hold, but STAG and FPI have a bigger value delta at the moment due to recent pullbacks.
STAG dropped on an overnight equity issuance which will almost always drop a stock price 2 to 5 percent. FPI dropped on the flow of news about farm conditions which only minorly affects the value of the underlying land.
All 3 are companies of which we like the long run fundamentals, but we saw an opportunity to increase the value of what we own by selling GOOD which was trading about 5% below its intrinsic value and buying STAG and FPI which are 10% and 40% below intrinsic value respectively.
Presently, 2CHYP has 15 holdings, but I think of it more as 30 long term holdings where at any given time we hold the 10-18 best valued. This process is not flawless. We can be wrong about intrinsic value and therefore wrong about which are better relative values, but the idea is that the methodical rotation should allow us to capture more value than continuous ownership of all 30.
The market is quite concerned about upcoming debt maturities due to major banks boycotting the industry. I shared this concern, so I had a call with CXW management today to discuss their capital availability. They have quite a few sources of capital available including a largely undrawn line of credit and the use of an aggregation of smaller banks. Thus, there is minimal risk of not being able to source capital, but we do anticipate cost of borrowing will rise 100 to 150 basis points – a relatively minor cost relative to what the market is pricing in.