NorthStar Realty Finance Corp. (NYSE:NRF)
JMP Securities Financial Services and Real Estate Conference Call
October 1, 2013, 9:30 AM ET
Albert Tylis - President and Chief Operating Officer
Debra Hess - Chief Financial Officer
Steve DeLaney - JMP Securities
Steve DeLaney - JMP Securities
Good morning, everyone. We'll start our next presentation. My name is Steve DeLaney. I'm the Senior Mortgage Finance Analyst at JMP Securities. And on behalf of my entire mortgage finance team, including my newest associate Ben Zucker, sitting over here, against the wall, will be working with me on the commercial mortgage REITs.
It's our pleasure to introduce NorthStar Realty Finance or NRF; ticker, NRF. And their stock closed last night at $9.28, and the market cap on the company is approximately $2.3 billion.
The company currently pays a quarterly dividend of $0.20, that's based on the second quarter announced dividend for a yield about 8.5%. And I note that the company has increased its quarterly dividend for eight consecutive quarters and increased it by a total of 100% over the past two years.
Now, NorthStar is an internally managed commercial mortgage REIT. It was created obviously before the credit crisis, survived that well and now is rapidly expanding. It has a nine-year operating history since its IPO in 2004.
The company has total commercial real estate assets under management of approximately $10 billion. In addition to the internal structure, another thing we highlight about the company is the diversity of its portfolio and its revenue stream. The company has invested in both real estate debt, real estate equity, triple net lease properties, and also has a growing asset management businesses based on the management of three non-traded REITs.
Now, with us today, to update us on the NorthStar story are the President and Chief Operating Officer, Al Tylis; and the Chief Financial Officer, Debra Hess. Al, I'll turn it over to you.
Thanks, Steve. Good morning, everybody. We're now going to go through a slide deck reasonably quickly, we'd like to spend some time going through questions as well as just the corporate presentation. This is the corporate presentation that's found on our website from the last time we reported earnings, which was the beginning of August.
As Steve mentioned, we're a diversified commercial real estate investment company asset manager. We have about $10 billion of assets under management. We're internally managed, which I think is somewhat unique. We'll talk about some of those benefits a little bit later on the presentation. We have four offices. We're headquartered here in New York. We have offices in Bethesda, Dallas, and Denver.
Steve also mentioned we have increased our dividend eight consecutive quarters. Our current dividend yield is actually 8.6%, and the cumulative increase over that period has been 100%. As of August, we've committed to $2.6 billion of investments in 2013, since -- through the last time we reported earnings.
As Steve also alluded to, we have four businesses that we are focused on. We have a loan origination business where we originate largely floating-rate loans. We securitize those in the CMBS market or what I guess used to be a CDO market. We've done two of the larger transitional floating rate securitization since the credit crisis.
We have a very strong track record in terms of our originated loans through the credit crisis in our performance, and I think that lends itself well in terms of future securitizations in that bondholders, in our legacy portfolios are all in the CDOs that we originated. The loans under are all going to be made whole and we'll not lose any money, and I think that lends a lot of credibility on why we're able to access securitization market.
Steve mentioned we also have a real estate portfolio. We have about $2.6 billion of diverse commercial real estate investments direct ownership. About half of that is manufactured housing, where we own the underlying rental pad sites. So we don't lend on manufactured housing. We own very few of the homes. It's largely a land-lease business, very low CapEx, high margin, long-term stable cash flow business, which is consistent with a lot of the net lease and healthcare portfolio that we've owned largely since we went public at the end of 2004.
We are a growing asset management business. We have our own broker-dealers. We have over 50 people in our broker-dealer. We just completed $1.1 billion capital raise for our first non-traded REIT, and we've just started selling another $2.75 billion in two separate vehicles in the non-traded REIT space.
When we closed out our last vehicle, we were selling over $100 million per month in capital for our non-traded REIT the last three months. And the economics of that business for NorthStar shareholders is largely 3 points per year of capital for every dollar -- every dollar of capital raised generates about 3 points per year of net asset management fees to NorthStar.
And we've talked, for the company if you look at our performance, you will see some of this on some slides later. We've materially outperformed any legacy mortgage REITs or REITs that have been similarly situated to us through the credit crisis, and one of the things we've always talked about the benefits of being internally managed and it informs our decision making.
We're aligned with shareholders. We own a lot of stock in the company. We care deeply about how the stock does. We don't grow for the sake of growing of for just generating fees. I think it's been critical in our success year, sort of career-to-date, since we went public. But even with all that in mind, if you look at this asset management business, this is now a very real, very stark example of why it really matters a lot to be internally managed.
And if you think about what this is, this is no different than if we had raised a private fund within NRF where shareholders of the direct -- or the GP effectively and the beneficiaries of all those fees. If anybody, who has externally managed raised a fund, that would not be held under that public company. That will be owned by the management company. Here, the shareholders are the direct beneficiaries of what is now a rapidly growing, very high multiple business.
And then the fourth kind of leg of the stool is the opportunistic side, and we were certainly very active in buying a lot of distressed debt during the credit crisis and making multiples on our capital and realizing a lot of those dollars today. I think one place where we found, and we'll talk about this as real estate private equity business, where we've been buying a real estate private equity interest from some very large institutions in structured transactions in a market that was largely illiquid, and we'll talk about that and how in our view today we view that as the best risk adjusted return available in commercial real estate.
This is a Slide that kind of breaks out the $2.6 billion of investments that we've made through August 1. And you could see the opportunistic is largely these real estate private equity fund interests that we've invested in.
This Slide is our projected CAD, for those who are not familiar with NorthStar, it's our main operating metric. It's effectively a free cash flow metric. This is prior to a public offering that we did following our last earnings report where we guided to $1.03 to $1.09 per share. And you could see, compared to last year, you saw the growth of the company last year was $0.74 a share, if you're looking at midpoint of $1.06 per share.
Our payout ratio, which also I think is quite important. You have a lot of REITs that are in particular mortgage REITs that are paying out significant portions of their free cash flow. Last quarter, we paid a $0.20 dividend on $0.27 of free cash flow or about 74% payout ratio.
And part of the reason why our payout ratio is substantially lower than those companies who are similarly situated to us, particularly mortgage REITs, is what we're really -- what we've been able to do in last few years is actually grow our dividend, yet at the same time retain more capital. And part of that is our focus of creating a business that's much more long-term, much more sustainable, less cyclical, and less susceptible to wins of the overall public markets.
This Slide, I think is probably is instructive about the valuation of NorthStar and where we are relative to where we think we are to trade, if you actually take a look through and see what the composition of our assets are. And based on our cash flow for 2013, you could see a vast majority of our cash flow comes from non-legacy businesses, yet at an 8.6% yield, I would suggest we're trading at a yield that's pretty consistent with a legacy mortgage REIT.
Yet, 46% of our cash flow is coming from direct ownership of real estate as well as indirect ownership of real asset. The asset management fees are 14%. This year, it will certainly be higher than next year. I think if you get [indiscernible] what the right yields are for equity REITs or public asset managers, but clearly we're trading at the high-end of I think -- the midpoint or high-end of where legacy finance REITs are. And clearly there are many aspects of our business that are not only non-legacy, but that are not mortgage REIT like in nature and are really in the form of much higher multiple, longer duration, more stable businesses.
And I'd like to spend time on this Slide. This is just a quick snapshot of the assets that are in the company today, high level. This is not to beat us to death, but this is the point about being internally managed, right. And it's maybe a little bit of attempted humor here on our part. Again, this asset management business is pretty stark example.
We're going to earn over $30 million of net asset management fees this year. Put any rational multiple on that, you're looking at hundreds and millions of dollars that's now captured directly for the benefit of NRF shareholders, because we're able to leverage our team and leverage the internal organization that has value, as opposed to having that value being captured directly by management outside of the public vehicle.
This is a quick snapshot. You could take a look at it. It's just our real estate portfolio. As I mentioned of the $2.6 billion, about $1.3 billion is manufactured housing, net lease and healthcare are together about $1.1 billion, then you have a $200 million dollars in multifamily space.
I mentioned the real estate private equity funds are on this page and then the subsequent page, you get a snapshot. This is an industry where you have real estate private equity funds that are owned by very large institutions that have been looking for liquidity. And for many years there were no transactions in this industry.
And one of the main reasons is there are NAVs that are placed on these funds that in order for sellers or owners of these real estate private equity funds to be able to transact, they are largely saddled with their carrying values, which generally consist of the NAVs for these funds. And any buyers would be typically looking for some discount to NAV in order to get the yields that they are generally looking for.
And what we did at the end of last year and we were able to do subsequently this year is affectively create a market, where one didn't exist. And we did a transaction the first one was with TIAA-CREF, where we with $765 million of real estate private equity fund interest that were contributed into joint venture. And we paid NAV, in other words we paid par for a 51% interest in this joint venture, but instead of the cash flows going 51%, 49% between us and our partners, the cash flows were going 85% to us and 15% to them, until we made a 1.5 multiple on our investment.
I think if you play with some numbers, I think you could see the power of the structure and what we were able to do, it was a win-win situation, so we were able to create liquidity for very a large institution. Create a liquidity at a level that they were able to transact, but could get us the returns that that we're very comfortable with in this portfolio.
And then you see the second transaction, which is the reference here as real estate private PE Fund II. This was a transaction we did with the state of New Jersey earlier this year and you could see the illustrative examples on the bottom right where if you remember these are generally top notch private equity fund, some of the top sponsors in real estates. If they earn using the 10% to 15% example, which I think they would tell you off of 2012 NAVs is a low bar for them, off of those NAVs. We're looking at returns for NorthStar somewhere between 18% and 27%.
So you could just see the effective leverage, without leverage of these structures where we were the beneficiary of creating. And it's now become a business where we're getting direct enquires. We have got pension funds, endowments coming to us saying you guys have done the two major transactions in this space, and we want to look, try figure out ways, so we could work together and figure out structures that are mutually beneficial.
So again, one of the point I'd like to make actually about these funds in NAV is what we've seen speaking about the funds broadly, we've seen the NAVs of these funds when the credit crises hit, it definitely took a little bit of time. I think a lot of funds candidly were slow to react to the environment that we were in, but at some point there was a sort of level of capitulation where people had to take their write-downs.
And then you look at where the write-downs went to on these funds and they've started to creep back up and then you compare it to prices of real estate and REITs that have gone up significantly higher. And in both of these portfolios you could see where we show the reported NAV as a percentage of our net cost, we're buying these at roughly 30 point discounts to the cost basis. So in addition to these structures, which have this huge incremental value, we're actually buying these on average 30 point below the costs.
And again, these aren't all top of the market funds. These are a lot of funds that are older 2002, 2003, 2004 funds, are funds in here that are 2010, 2011, 2012 that have done well over the last few years or so. And you think about commercial real estate values, on balance you've seen things generally recovered at peak depending on the asset class. So you kind of take this and what you effectively own through an enhanced structure, an indirect interest in some of the best real estate across the country at a significant discount to its original cost basis.
I'm going to turn it over now to Debra, who is going to discuss little more detail, our asset management business.
Thanks, Al. Thanks, Steve. I know we want to leave some time open for questions, so I'm just going to go through these next few slides, reasonably quickly. Al has already mentioned our asset management business, but in this business we have almost $4 billion either that's been raised or is in the process of being raised. Our first vehicle completely filled up, July 1, $1.1 billion.
We're raising our second fund, which is a healthcare vehicle and we just recently sold our first ticket last week on our third fund, which is our second of that vehicle. It was a slow go when we did this business back a few years ago, a new sponsor debt product and so we spent a lot of time educating the industry about who we are and why we make sense as a sponsor.
And I think why our success is as good as it is, is because we've been able to deliver what we've actually told all of these financial advisors and broker-dealers that we were able to do We've put investments in our first vehicle that more than adequately covers the distribution. So when we go out and we're actually selling the story for our second two vehicles, we can say look what we did do, we said what we would do.
CDO bonds, Al touched upon this. We could go out in the market and we bought our own CDO bonds at steep discounts to par. If you think about this, about discount, call it $0.68, we expect to recover over the upcoming years. I think the tricky part about the CDO bonds because we consolidated our CDOs, you don't actually see those investments anywhere, but that's actually real cash flow that we earn over time.
Here as you all know, we have legacy CDOs. Our loan CDOs in particular have performed extremely well, continue to cash flow and will continue to cash flow until the future. We're focused on deemphasizing our legacy CDO business as it continues to become a smaller and smaller portion of our cash flow over time.
Our corporate capital structure, very focused on non-recourse, non-mark-to-market financing. We maintained very little our corporate leverage and have done so since the beginning.
In terms of our performance, don't necessarily want to compare ourselves to mortgage REITs. We consider ourselves a mortgage REIT today, but there is an element of our business especially going back, since the beginning where that is what we were. But if you look at some legacy mortgage REITs that are out there, we have dramatically outperformed all of them. And if you take a look at this Slide, it doesn't even have on it those that have actually fallen of the page that don't even exists anymore.
And then on the page, as you know there are all of these new commercial finance REITs, which is great, but we had actually done pretty well when you consider how we performed versus them. But I think the most important point on this particular page is we are internally managed, which is very, very different than the other commercial mortgage REITs that are out there today.
Lastly, we have a very seasoned management team, most of which have been together since the beginning of time. As an internally managed REIT, we have a full infrastructure, where we have a loan origination. We have a broker, dealer with over 50 people that we've build person-by-person. We have an asset management business. This isn't some externally managed sponsor, that's kind of directing resources our way to help us run our business. We have a complete infrastructure here across the firm.
And with that, I guess I'll turn it over to questions-and-answers.
Steve DeLaney - JMP Securities
In the back.
What is your GAAP book value presently? [Indiscernible] do you have any consequential unrealized depreciation in your real estate portfolio in terms of that GAAP book value [indiscernible]?
Yes, we actually show the adjusted book value at quarter-end was $6.67 per share, and that reflects depreciation that's added back, the main thing that that does not include is our asset management business, right, and as I mentioned, were $30 million roughly of net fees that we're going to earn this year, and we'll expect that to grow materially. So, there is pretty sizeable value in that as well as our broker-dealer itself, which today doesn't make money, but certainly has independent value and that we could monetize that at some point as well.
Steve DeLaney - JMP Securities
Other questions for Al and Debra?
The first one is a little bit longer, but they are basically four to five years is expected weighted average life. They will go out a little bit out longer in total, but the expected weighted average life is four to five years.
Steve DeLaney - JMP Securities
I would like to follow up on the PE as well. You showed your expected return there is, I guess, 10%, 15% for the funds themselves might lead you anywhere from high-teens to 27%. Transactionally speaking, I guess what has to happen for in terms of the performance of those funds for them to outperform your current expectations?
And then, Debra, the second part of that to you. You've sort of got an earnings accrual rate that you're running, and I think it is in the low 20s for those funds. If that fund performance, since this is going to be a four to five year movie for us to watch, if the fund performance starts to pick up, would you adjust your earnings accrual rate?
So, I'll turn it over to Debra in a second. I think in order for these funds to earn a 10% to 15% return off of already 30 point discounted NAVs, in our view, it doesn't require much. In fact, you would argue that a lot of that is already built in and just where we are in terms of valuations. So, one of the things we've been extremely, pleasantly surprised about is as we've lived with these now, some of these for almost a year now, is that every transaction that we've seen come to a realization has been in excess of the valuation. And so both, the magnitude of the realizations as well as the pace has been, I think, meaningfully in excess of what we were underwriting.
So I think there is a realistic chance, these funds do materially better than those returned. And certainly, these are funds that are shooting for 15 to 20s generally, and we're now looking at a portfolio that's already marked down, so they need to get to that level off of a fairly depressed price or NAV. So, I think there is upside to the overall results of these funds. Debra, can discuss how we're going to deal with it from a reporting standpoint.
I think the simple answer is, yes, to the extent that these actually materially outperform what our underwritten projections are. You will see that translate into a higher yield that we'll book overtime.
Steve DeLaney - JMP Securities
In the back?
Well, I have two questions. One, are you starting any spin offs possibly on any one of these [indiscernible]. And secondly, the company's financial plans -- equity financial plans to [indiscernible]?
We often get asked the first question, it is something that I think a lot of our investors have asked us, and I think the reason we get the question as you do look at the various businesses, and we don't feel like we're getting the right valuation for them. So, you are to think about spinning them off, and we do. One of the things that that we're always mindful of is for a while we were a several hundred million dollar mortgage REIT, and the level of sophisticated institutional investor interest, the level of analyst interest is much lower there than it is now that we are at $2.2 billion to $2.3 billion.
So we're pretty mindful of spinning off kind of smaller companies that may not trade the way you'd want it to trade, and if that's the purpose of the spin off, you have to be obviously careful of that. But that said, we're going to continue to pound the table, and it's really for us, it's an education process, and so educating people about what we earn.
And at some point, I think you have to consider that and we will. I mean, we're aligned with shareholders where we are owners of the stock. We want to create the most long-term value, and if that means spinning off one or more businesses in the future, it's something that we would absolutely consider. I'm getting a sign that says [indiscernible] over there.
Steve DeLaney - JMP Securities
We're out of time here for this session. There will be a breakout directly across the hall in the [indiscernible] room and Al and Debra will be available. Thank you, guys.
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