Beethoven's 5th Symphony is arguably the best and most famous composition in the history of classical music. The opening four notes are profound and have become so ingrained in people's memories that they are iconic among music aficionados. A little known fact about this masterpiece is that Ludwig composed its first draft in 1804. He was dissatisfied because it was nowhere near being what he thought it could be. After many revisions, he finished it five years later in 1808 and gave the world a masterpiece having much enduring value. By doing what he did he showed that genius can be 1% inspiration and 99% perspiration.
The RAIT Financial Trust (NYSE:RAS) is not noted for musical compositions and it is not likely to achieve anything so spectacular. Nevertheless, the "news flow" relating to it continues to get better and better, with the latest item being Wednesday's (December 4, 2013) announcement about the upcoming issuance of 20 year convertible bonds. This is a profound development and I will write about its significance below.
A Brief Look Back in Time
RAIT had its IPO in 1998 and prospered during the real estate boom in the early part of the past decade (who didn't?) and it got its comeuppance during the real estate bust that followed (who didn't?). It then had to do a 1-for-3 reverse split of its stock in 2008 and also eliminated the dividend. Reverse splits are often a sign of desperation and doom for a company. But there are times when a survivor recovers and goes on to prosper. Such has been the case with RAIT. Having got a close up look at what hell was all about during the real estate bust, the board of directors and corporate officers got religion and sweeping changes were made in the ways RAIT does business.
Inspired by new leadership at the top and five years of perspiration, the company now has a revamped business model and it is prospering much to the delight of shareholders who bought into to this turnaround situation. They saw their dividend rate increase each quarter from 8 cents per share in Q2 of 2012 to 15 cents in Q3 of 2013. They also saw the stock perform well in the market during that time span. So on a total return basis, they were well rewarded for having confidence in the stock's investment potential. Dividend income can have a nice musical sound when it is pocketed as part of one's return on his investment and then reach a crescendo when the he (or she) goes shopping and opens his wallet when he responds to the cash register's demands at the checkout counter.
It is at those astute investors who bought into this turnaround situation that this article is directed. And my focus will primarily be on (1) the significance of the new financing arrangement, (2) recent shareholder returns and (3) the promise of more to come.
The Prudent Man Rule
The prudent man rule as legally defined (by a federal judge in the 1830s) is as follows: "An investment operation is one, which after thorough analysis, promises safety of principal and a satisfactory return. All other operations are speculative." You and I are not bound by the rule in our personal investments but its guidelines are worthy of serious consideration by every investor.
In the years leading up to mid 2012, RAIT could have been considered a very speculative situation. It was (1) just starting to gain traction with its loan origination activities, (2) badly in need of source funding, and (3) paid dearly for the funding that it got. And, it was also starting to ramp up its activities in apartment ownership and management.
It came a long way since then and is now solidly established in its two diverse business lines, those being (1) loan origination and (2) apartment ownership and management thereof for its own account and other parties. The stock is now much less speculative than it was because the company's earning power and the dividends have well defined growth potential. It would be a stretch to say that the stock is now a "blue chip" among the REITs. But the trend toward becoming one is at an advanced stage now that the company is about to solve its source funding problem. As a result, I think that the stock could soon be worthy of an investment grade valuation (as opposed to speculative grade) in the market. At $8.51, the stock's dividend yield is north of 7% while the average for the REITs as a group (excluding the mREITs) is about 4.8%. I think that spread will narrow.
It's Hats Off to the Past and Coats Off to the Future
With the stock priced at $8.51 (after today's 38 cents or 4.7% gain) to yield 7.2%, I think it is very conservatively capitalized by the market. And now I'll tell you why it was easy for me to jump to that conclusion.
In recent years the company's growth potential was capital constrained. The financing arrangements were costly until late 2012. Such arrangements eased considerably since then when warehousing arrangements were made with three banks and two common stock issues were floated (albeit very successfully but still causing dilution however accretive they may have been). By issuing the long duration bonds, the company will be able to use part of the proceeds to retire 7% bonds and use the remainder for general corporate purposes. This indicates to me that to a large degree the company will no longer be capital constrained as it expands its loan origination and apartment ownership activities. That in a nut shell is why RAIT should be able to pursue profitable growth opportunities in 2014 and beyond.
The Notes will be senior unsecured obligations of RAIT and they will pay interest semi-annually. The interest rate, conversion rate, offering price and other terms of the Notes will be determined at the time of the offering.
Our Investment Objective
As shareholders, all we get from our investment in this (or any other stock) are the capital gain or loss plus the dividends received while holding a position in the stock. RAIT's fundamental investment merits were stellar in 2012-2013 as evidenced by growth in revenues, AFFO and the dividend rate. And the outlook through 2014 was favorable even before today's announcement. That begs the following question: What is an investor to do when the company's operating performance remains stellar and his stock is getting bounced around in the market? I pose this question now because the stock market is near its record high level and looks toppy, economic growth is sluggish, there is a continuing political divide in Congress, the Fed is still struggling with ineffective monetary policies and the REITs (as a group) are out of favor and laggards as far as market performance is concerned. Many of them are currently trading at or near their lows for the year. This is an investment climate in which an investor ought to be very discriminate when making investment decisions.
Because of the news item referred to, I think RAIT is now a "special situation" that could buck a correction in the general market. It has already proven that it could buck weakness in the REIT sector when many of its more highly regarded industry counterparts faltered.
Let's Look at the Technical investment Merits of the Stock
(click to enlarge)
(1) The bold black line on top is price and the bold pink line below it is relative strength. (2) The three dotted lines (black, blue and red) are moving averages and there is a set of those for price and a similar set for relative strength. They are used to define trends and detect trend reversals. (3) The 5 sets of gray parallel lines that frame the price action are 22-day and 11-day trading ranges. Their progression shows how the trading ranges shifted during the 110 days charted.
Either of the items listed as (2) or (3) is independent of the others and it could be considered as a valid technical indicator for making buy or sell decisions. But in order of importance, the moving averages are of primary importance while the trading ranges are of importance.
Analyzing a chart like this is easy. It is also a pleasure because I have been bullish on the stock since I wrote my first of five articles on RAIT in November of 2012. The price line and the relative strength line are both riding above their moving average trend lines while the trading ranges continue to shift upward. That is a favorable reading and it augurs well for continued outperformance by RAS. The stock at $8.51 is at its high for the six months charted, and it is well off its low of $6.18. The high for 2013 (and also since 2008) was $8.85. The recent performance is in sharp contrast to that of many prominent REITs. While they are down sharply and making new lows, RAS is outperforming the market and it looks like a new high for the year is within reach.
Up until today, I was advising investor caution when buying any of the REITs (including RAS) because of general weakness in the group. And I was opposed to buying any of REITs that were making new lows such as Realty Income (NYSE:O), Glimcher ((NYSE:GRT), Health Care REIT (NYSE:HCN) HCP, Inc. (NYSE:HCP), Ventas (VRT), Digital Realty (NYSE:DLR), and W.P. Carey (NYSE:WPC) until "after" there was evidence on their charts that they had in deed bottomed. While my attitude toward the group has not changed, my opinion on RAIT has changed and I would be inclined to buy some shares at the current price of $8.51.