CapLease Inc (LSE) has traded on average 328k shares a day over the past 3 months, so on Thursday, 11/30/12 when its volume spiked to over 6 million something was clearly going on. Back in May CapLease had filed a shelf registration allowing for shares to be issued ad-libitum, so it seemed a probable cause of such large activity. The next day, LSE had a press release confirming this suspicion and providing the finer details of the offering. 5.5mm shares had been issued in a block sale at a price of $4.65 for aggregate proceeds of $25.6mm. As of September 30, 2012, LSE had 66.8mm shares outstanding, so the size of the offering was not huge, but certainly material.
With any add-on equity offering the primary question of concern is whether the issuance will be dilutive to shareholders. We can address this question rather directly with the information CapLease's management provided for us that the proceeds were to be used for acquisitions expected to close before year-end. LSE's third quarter AFFO per share was $0.17 and as a long term contracted triple net lease company we can extrapolate this to full year earnings of $0.68 with a fair degree of accuracy. To maintain equivalent AFFO/share the new shares would have to each generate $0.68 annually through the use of the proceeds. At $.4.65 per share this translates to an annual return of approximately 14.6% for the at-the-market offering to have a neutral effect on AFFO/share. Let us examine the plausibility of such returns within the context of the current environment and CapLease.
3Q12 equity of $428mm and liabilities of $1.246B show LSE at a debt to equity ratio around 2.9. It seems reasonable to speculate that the acquisitions made with the offering proceeds could be levered to the same degree, thus having no impact on the company's overall debt/equity and leaving debt covenants unharmed. Further, let us assume this leverage has a weighted average cost of 5% as this rate is fairly typical for LSE and very attainable in the current environment. With these speculations in place, the only remaining component to make a plausible estimate of potential returns on the offering is the cap-rates of the acquisitions themselves. On an 11/16/12 press release, Paul McDowell, Chairman and CEO of LSE, stated the following:
"Given the continued favorable financing environment for high quality properties like this one, we expect the asset to produce among the widest spreads in the entire portfolio. Our pipeline remains robust with numerous transactions at various stages of review. We look forward to continuing to add accretive, high quality properties for the remainder of 2012 and beyond."
The property to which he was referring is a Class A office building described in the same press release to have been acquired for $35.5mm and at a cap-rate in excess of 8%. In light of this information, and the fact that accretive opportunities were the impetus for the equity offering, I believe it is quite reasonable to speculate acquisitions at a cap-rate around 8%. Now that we have all the pieces, we can calculate an estimate for a postulated rate of return on the offering proceeds.
(A cap-rate of 8%) X (3.9 due to leverage of 2.9X) = 31.2% revenues
Interest expense of 5% X 2.9 (amount of debt) = 14.5%
Yielding annual returns of 31.2-14.5% or 16.7%
The calculated annual return necessary for the offering being neutral on AFFO/share is 14.6%, so if returns around 16.7% are attained, the offering could be quite accretive.
I want to stress that the estimation given above is purely speculative, and that only time can tell the actual accretiveness of the offering. Nonetheless, I feel that each step of the estimation was fair and reasonably conservative so it is very plausible that we could see accretive affects.
CapLease as an investment
The offering pulled LSE under $4.70 and it can still be bought at cheap prices. LSE's 50 day moving average is $5.06 to which it could return quite quickly. At a price/FFO around 7.1, LSE represents tremendous value, especially when compared to other triple net lease REITs.
Annual Yield %
Realty Income (O)
National Retail Properties (NNN)
Gladstone Commercial (GOOD)
American Tower (AMT)
American Realty Properties (ARCP)
American Realty Trust (ARCT)
Lexington Realty (LXP)
Triple net lease companies are loved by their investors (as evidenced by the high multiples) for the stability of the locked-in earnings. Of course they still come with the risks of tenants defaulting or leases expiring at inopportune times. LSE has perhaps more risk than the others due to its high leverage. However, some risk is mitigated through its use of non-recourse debt and aggressive amortization schedules. It also has reduced concern of default due to its properties being overwhelmingly leased to investment grade tenants.
CapLease is the best value amongst the triple net lease REITs, and its value is even more extreme in the current price dip from the offering. Intelligent portfolio design and continued accretive acquisitions with its newly sourced capital could propel LSE way ahead of the competition.
Disclosure: 2nd Market Capital and its affiliated accounts are long LSE, GOOD, ARCP, and LXP. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.