On April 15th (just over 60 days ago) New York Recovery REIT (NYSE:NYRT) listed shares on the NYSE. The same day NYRT launched a concurrent tender offer to purchase up to 23,255,814 common shares for $10.75 per share, for a maximum tender offer of $250 million worth of common stock.
New York REIT, formerly known as American Realty Capital New York Recovery REIT Inc., was American Realty Capital's first non-listed, New York City-dedicated REIT. In February, American Realty Capital rolled out a second non-listed, New York City-dedicated REIT, American Realty Capital New York REIT Inc., with plans to offer up to 30 million shares of its common stock in a best-efforts offering. At the time, Michael Happel, who helped American Realty Capital launch in 2010 what would later become New York REIT, called its planned public listing a "milestone" event for the company.
NYRT was Nicholas Schorsch's (CEO of NYRT) 6th liquidity event as Chairman and CEO of Realty Capital Securities (NYSE:RCAP) and based on the 60+ days of trading, this "pure play" NYC REIT is off to a good start.
As I explained in a recent article, NYRT is the only exchange-listed REIT focused exclusively on New York City properties. SL Green Realty Corp's (NYSE:SLG) and Empire State Realty Trust Inc.'s (NYSE:ESRT) reaches extend beyond the city limits. Other REITs with exposure to New York real estate include Vornado Realty (NYSE:VNO) and Boston Properties (NYSE:BXP).
The Inside Scoop on This Pure Play NYC REIT
Recently I caught up with NYRT's President, Michael Happel. He previously served as Executive Vice President, Chief Investment Officer and observer to the board of directors for NYRT's non-listed predecessor, New York Recovery REIT, Inc. Happel has over 20 years of experience investing in real estate, including office retail, multifamily, industrial, and hotel properties, as well as real estate companies.
From 1988 to 2002, he worked at Morgan Stanley & Co., specializing in real estate and becoming co-head of acquisitions for the Morgan Stanley Real Estate Funds, or MSREF, in 1994. While at MSREF, he was involved in acquiring over $10 billion of real estate and related assets in MSREF I and MSREF II. In 2002, Happel left Morgan Stanley & Co. to join Westbrook Partners, a large real estate private equity firm with over $5 billion of real estate assets under management at the time. From October 2004 to May 2009, he served at Atticus Capital, a multi-billion dollar hedge fund, as the head of real estate with responsibility for investing primarily in REITs and other publicly traded real estate securities. Happel received a B.A. in economics from Duke University and a J.D. from Harvard Law School.
Thomas: NYRT listed shares in early April with a tender offer of $10.75 and the shares are now trading at $11.79, up almost 10%. Most non-traded REITs that list usually see a decline in the first few weeks; however, NYRT hasn't. What do you think is causing that?
Happel: At the end of the day, the share price is all about supply and demand for the stock. I think you have a lot of new investors interested in buying into the stock and not too many old investors interested in selling out of the stock. My sense is that most of our existing shareholders bought NYRT as a longer-term growth story and are not in a hurry to sell. The stickiness of our existing shareholder base is partly evidenced by our tender offer that was significantly undersubscribed with only about $150 million tendered back to the company as part of our $250 million tender offer to buy back our stock at $10.75 per share. Then you have new investors that are just learning about our company and many of them like what they see.
As we execute on our business plan, as analysts begin to initiate research coverage and as our stock gets added into some of the major market indexes like the Russell 2000 or the Morgan Stanley REIT Index, I expect to see more new investors coming into the stock. Even at $11.79 per share we are still trading well below the multiples of some of our peers. The current share price of $11.79 is only 22 times our estimated 2015 AFFO of $0.54 per share and many of our peers are trading at 30 times AFFO. As we prove ourselves in the public markets, I expect to close that multiple gap.
Thomas: NYRT invests is the only "pure" New York City REIT. Can you tell us about your investment platform?
Happel: Our company invests exclusively in New York City commercial real estate and we focus primarily on Manhattan office and retail properties. I believe there is a lot of upside in our portfolio because it is not yet stabilized and the overall market is improving. Due mainly to lease up and burn off of free rent, I expect our existing portfolio to generate 13-15% same store cash NOI growth between calendar 2014 and calendar 2015. That's huge upside. But, even after that there will still be untapped growth embedded in our portfolio because our existing in-place rents are 10 to 15% below today's market rents which continue to rise. Our average lease term is approximately 10 years so it will take time to fully unlock those below market rents, but it is a "hidden asset." Over time I expect us to generate 4 to 5% same-store cash NOI growth even after the portfolio begins to stabilize in 2015.
New York City is arguably one of the best real estate markets in the world for long-term investors and I would argue that in the public markets our stock provides the only "pure play" for public market investors looking to invest in New York real estate. There are two other public companies with a focus on New York City - SL Green and Empire State - but both of those companies also own suburban real estate portfolios so they are not pure plays in the same sense we are.
Thomas: NYRT invests in office and retail (as well as one hotel). Can you tell us what type of office product and how does your strategy differentiate with the other NYC REITs?
Happel: We're bullish on the office market in Manhattan even though it is clearly recovering from the troughs of 2009 and 2010. First, we are still buying office buildings below replacement cost. Second, we're still buying with positive spreads - meaning our going in cap rates are higher than our borrowing costs - which is not always the case in Manhattan. Third, average office rents in Manhattan are still 17% below their previous peak levels so there is plenty of room for rent growth ahead of us.
By focusing on just this one market we think it gives us a competitive advantage and many of the deals we do are off-market or quasi-off-market. We have capital, we know the market, and we can move quickly. We're seeing a lot of deal flow. We're also growing off of a relatively small base so just a handful of smart investments could really transform this company and translate into real outperformance of our stock.
As an example, we own 49% of a property called Worldwide Plaza and also have a fixed price option to buy the rest of that property at approximately $670 per square foot compared to estimated replacement cost of more than $1,200 per foot. If we did nothing else except exercise that option the size of our portfolio would grow by roughly 33%. That's moving the needle and I promise you we will do much more than just exercise that one option.
Thomas: You have a hotel in your portfolio? Why? Do you plan to increase your hotel exposure?
Happel: Our portfolio is currently about 80% office, 10% retail, and 10% other (including the one hotel you mentioned). Our focus is on office and retail and over time I'd like to make sure our portfolio is always at least 80% office and retail so I'm comfortable with the mix of property types we have now. We're not looking to build a hotel portfolio but may buy hotels selectively and opportunistically as long as our "other basket," which includes hotels, isn't more than 20% of total assets. The one hotel we did buy has been a great acquisition. It is the Viceroy hotel located on 57th Street. It was an off-market purchase and we expect it to stabilize at about a 7% cap rate which is fantastic for a newly constructed hotel in that location.
Thomas: Can you tell us about your balance sheet? Do you intend to maintain a conservative capital stack?
Happel: We have a strong balance sheet and are committed to maintaining an investment grade-like balance sheet. This will translate into a low cost of capital and serve our shareholders well over the long term. Currently, our debt to enterprise value ratio is only 35%. Our debt service coverage ratio is 3.5x and we have staggered debt maturities with an average debt term of 6.4 years. We also have dry powder for acquisitions with approximately $100 million of cash and close to $400 million of undrawn commitments on our credit facility.
Thomas: As you know, I'm not a big fan of external management. Do you expect to internalize in the future?
Happel: I do expect to internalize and our board will make the decision on the optimal time to internalize. As we gain scale I think it will make more sense to internalize management but at our current size it is more cost effective to be externally managed. The cost of our external management structure is approximately 50 basis points per year but I estimate that if we were to internalize today the fully loaded cost would probably be more than 100 basis points so it is cheaper to stay externally managed until we gain scale. Of course, our board will also monitor the potential impact on our multiple of an external management structure versus an internal management structure and factor that into the decision on when to internalize.
Thomas: I like NYRT's high dividend (3.99%) - compared with the peer group. How sustainable is the dividend?
Happel: The dividend is very sustainable and I expect it to grow over time. Based on our estimated 2015 AFFO of $0.54 per share, the dividend of $0.46 per share represents an 85% AFFO payout ratio. That's healthy. Over time, we want to keep our AFFO payout ratio under 90% so with an 85% payout ratio we are already in a good position to grow the dividend as our AFFO grows.
I'd also like to point out that our dividend yield of approximately 4% is even more attractive than many people realize because of the tax efficiency of our dividend. Last year 93% of our dividend was tax deferred so our 4% dividend yield is equivalent to more than a 7% dividend yield on a pre-tax equivalent basis. The reason for this is that all of our properties have been purchased recently so our depreciation is high. By comparison, most publicly traded REITs have long since burned through their depreciation and very little of their dividend is tax deferred.
Thomas: Can you tell us about your background?
Happel: I've been investing in commercial real estate for more than 25 years so I've now invested through three major real estate cycles. I spent the first 14 years of my career at Morgan Stanley where I learned the business and became co-head of the Morgan Stanley Real Estate Funds ("MSREF"). I then spent several years at Westbrook Partners and joined a hedge fund named Atticus Capital in 2005. I joined Atticus partly because I was concerned, as early as 2005, that U.S. real estate prices were getting frothy.
So I was out of the direct investing business from 2005 to 2009 and expressed my view on U.S. real estate by shorting many U.S. real estate stocks rather than buying buildings in the direct investment market. After the crash of 2009, I sensed an opportunity to start buying buildings again and that is when I joined American Realty Capital. I was hired by American Realty Capital specifically to launch and build a company focused on buying New York City real estate. We've built this company one building at a time since our first acquisition in 2010 and our recent listing on the New York Stock Exchange was an important milestone. But, I'm fond of saying the listing was just the beginning of "chapter two" for our company. Now the real work begins and I'm excited about our prospects.
Thomas: Thanks for your time and best of luck, except when your blue devils are playing my tar heels!
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Sources: SNL Financial.
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
Disclosure: The author is long O, DLR, VTR, HTA, STAG, UMH, CSG, GPT, ARCP, ROIC, HCN, OHI, LXP, KIM, WPC, DOC, UDF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.