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Joe X

 
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  • ARCP Provides Update on Business Priorities, Lender Consent and Dividend [View article]
    Not surprisingly, ARCP's bank lenders are getting a little restless and seem to have required ARCP to eliminate the common dividend in return for another extension on the financial statements. ARCP also said that when the dividend was reinstated, it would be at a rate consistent with peers.

    ARCP is in the midst of a fairly serious operational, financial and portfolio restructuring. The end result will probably be a stronger company with a stronger balance sheet, but all of these changes are going to be dilutive to FFO. The company also said that it has retained Korn Ferry to search for a new executive team. That's good news, but anyone coming on board is going to want to start with a clean slate. That means less leverage and less goodwill.

    The winner in today's announcement might be the ARCP preferreds. Ultimately there is going to be improved preferred dividend coverage and probably less leverage above you. That said, fallout from the common dividend news could cause some volatility across the board.

    Rgds,

    Joe X.
    Dec 24, 2014. 06:29 AM | Likes Like |Link to Comment
  • Heads roll at American Realty Capital; shares -10% [View news story]
    Today's announcement regarding Board and executive changes is good news over the long term, but places increasing doubt on ARCP's maintaining the current common dividend.

    My read is that the independent directors have a very firm grasp on ARCP's need for a complete restructuring of the company's governance and business profile. Morgan Stanley has already been hired to advise on Cole, and the Board has now moved very decisively to make a complete change of the C-suite, Chairman, and ties to Schorsch-related entities. ARCP shareholders, and potential ARCP shareholders, should feel comfortable that these structural issues are now going to get fixed.

    I'm not sure I agree that the removal of David Kay and Lisa Beeson implies that there are additional financial statement problems waiting to be be disclosed. The Board would certainly have used this opportunity to update investors if that was the case. I think the Board understands that ARCP is in need of a very broad makeover (get ready for a name change down the road), and that replacing Kay and Beeson simply had to be part of the process. Given ARCP's profile as one of the largest net-lease REITs, it probably shouldn't be too hard to find experienced managers to fill these roles. Realty Income better be locking in their top managers because you know they'll be getting calls...

    Today's management announcement is just the first step for ARCP. The company must also deal with the complexity of Cole, and that means selling it or spinning it off. Net-lease REITs are first and foremost specialty finance companies, and can only survive they have a lower cost of capital than their tenants. Business complexity and variability work against this, so that implies that Cole needs to exit the picture sooner rather than later. Don't know if Morgan Stanley's mandate stops at Cole, whether there are additional sub-portfolios that are going to get shopped, or whether it's simply prep the company for sale. Since you only want to clean house once, now's the time to put everything on the table.

    The last step is cleaning up the balance sheet. Too much goodwill and more leverage than you'd like to see. This is not rocket science - the goal should be to resemble Realty Income or National Retail Properties in as short a time frame as possible.

    To sum up, the Board took a very decisive first step in ARCP's overall restructuring. There's more to come and ARCP's continuation as an independent public company is perhaps less certain. In my view, all of this increases the probability that the common dividend is going to be lowered.

    Rgds,

    Joe X

    Dec 15, 2014. 11:18 AM | 6 Likes Like |Link to Comment
  • American Realty settles lawsuit with RCS over Cole [View news story]
    As noted above, ARCP has effectively cancelled the sale of Cole Capital and will instead receive a breakup payment of $60 million from the former buyer, RCS Capital. This is the strongest indicator yet that the value of Cole Capital has diminished over the last several weeks. In fact, the value has diminished so much that a knowledgeable buyer is willing to pay $60 million just to walk away.

    In my view, today’s announcement reinforces the risk of potential impairment charges to the $2.3 billion of goodwill on ARCP’s balance sheet. Of this amount, $548 million (as of 6/30) is related to Cole Capital’s business value and is specifically attributed to “growth from new income streams and the ability to offer new products.” While Cole at one point may have been a growth story, today’s breakup fee suggests otherwise, and heightens the risk that the auditors will be taking a hard look at these goodwill balances for the next set of financial statements.

    Rgds,

    Joe X
    Dec 4, 2014. 08:08 AM | 10 Likes Like |Link to Comment
  • American Realty Capital Properties' Dividend: What We Know, What We Might Know, And What We Can't Know [View article]
    Guys, thanks again for all the comments on ARCP. Here's another risk to the sustainability of the common dividend...

    One of the most negative things about ARCP is the $2.2 billion of goodwill created in the 1Q'14 acquisition of Cole. According to the 6/30 10-Q, approximately $1.7 billion of goodwill is attributed to such items as a lower cost of capital, critical mass, and an enhanced access to capital. Another $548 million of goodwill is attributed to Cole Capital for its "growth from new income streams and the ability to offer new products."

    While it's bad enough to create the goodwill in the first place, it's going to get even more interesting when the auditors need to test these values for impairment. Hard to tell whether the 9/30 balance sheet will take a hit since the accounting issues surfaced after that date. But the 12/31 balance sheet is going to get a real scrubbing, and it's hard to see these values holding up.

    I know some will say writeoffs of non-cash items have no impact. But bond covenants and bank covenants usually work off of book values, and because goodwill represents 25% of shareholders' equity it could be a material item. In particular, goodwill writeoffs will raise leverage ratios at a time when ARCP's credit metrics are under the most scrutiny.

    If book equity gets reduced through writedowns, ARCP may need to sell assets to reduce leverage - and that's where the current $1 dividend could take a hit. Net-lease dividends are a function of asset yield, interest rates on debt, and leverage. The obvious risk here is that if assets have to be sold to reduce bank debt, there's simply that much less cash flow available to drive the dividend. And just because the company punted and paid $0.08333 for December doesn't mean they're committed to paying $1 in 2015.

    It takes a lot of moxie to put $2.2 billion of goodwill on a REIT balance sheet, so take a good look, might not be there much longer.

    Rgds,

    Joe X
    Nov 30, 2014. 08:11 PM | 4 Likes Like |Link to Comment
  • American Realty Capital Properties' Dividend: What We Know, What We Might Know, And What We Can't Know [View article]
    Mark - thanks for pointing out the yield on the ARCP preferred stock. Looking at recent prices (WSJ preferred stock table for 11/25), the ARCP 6.7% preferred closed at $21.76 while Realty Income's 6.625% preferred closed at $26.70. That's nearly a $5/share gap on almost identical dividend payments.

    While it's going to be awhile before ARCP has navigated through the mess it's created, there seems to be an opportunity here for the ARCP preferreds to close the gap on benchmark Realty Income. Even if ARCP were to make up $2 of the $5 discount over the next 12 months, that would give you a 16.9% one-year return.

    Key risks are going to be a common dividend cut, which might temporarily unnerve the ARCP preferred too, and the timing of resolving the issues with Cole, the relationship with Nick Schorsch, and cleaning up shareholder lawsuits. But the risk profile could look a lot better by the end of 2015 than it does now. In the meantime, you're getting paid to wait.

    Rgds,

    Joe X
    Nov 26, 2014. 06:03 AM | Likes Like |Link to Comment
  • I Found A Nice Margin Of Safety In Omega Healthcare Investors [View article]
    I would be careful about placing too much reliance on the rating agencies for credit predictions, particularly in real estate. All three (Fitch, Moody's, S&P) were spectacularly wrong when it came to analyzing residential real estate in the form of RMBS and CDO's. Their ratings for commercial mortgage-back securities (CMBS) were also faulty during the peak volume years of 2005-2007. About the only place they were actually on the conservative side was the REIT sector, which has seen only one default over the last 25 years (General Growth) and no losses.
    Jun 12, 2014. 07:00 AM | 1 Like Like |Link to Comment
  • A Brand New Mortgage REIT That May Deliver Something Special [View article]
    Brad - thanks for bringing United Development Funding (UDF) to everyone's attention. However, I'm going to agree with more than a few of the guys above that UDF has a ton of intrinsic risk that is not nearly offset by an 8% dividend.

    At the bottom of the housing cycle, there is nothing more worthless than undeveloped or partially developed residential lots. While it's true that there is equity below UDF's loans, that equity will quickly vaporize when the cycle turns, and borrowers will not be able to stand up to their commitments. If you want an example of how this might play out in a public REIT format, look no further than iStar Financial, which is still trading 70% below it 2007 peak and hasn't been able to reinstate a dividend. Going into the downturn, iStar prided itself on itself on its custom-tailored financing solutions to smart borrowers. The company then spent years fighting these same borrowers through foreclosure, and STAR is now the successor owner to a lot of commercial and residential land deals. Sure that's a good thing when the cycle turns up, but STAR's pre-crisis investors were almost completely wiped out.

    If I were looking to take residential development risk, I would look to the established public homebuilder stocks such as Lennar or Pulte, where at least I get the upside of fat development profits on the upside of the cycle to compensate me for the intrinsic land risk. I would also take a hint from these same battle-scarred public homebuilders, who generally try to keep the land risk off their balance sheets.

    The good news I suppose is that we're still in the early innings of the housing cycle, and if you follow basic residential housing stats you find that the uptrends can easily go on for 10-20 years before the inevitable downturn. So it's entirely possible that UDF could have a nice run here. But with such a small balance sheet and concentrated loan portfolio, UDF's price would need to drop a lot more in order to make the value proposition more attractive. I would also keep in mind that an 8.20% dividend yield cannot be UDF's total cost of equity. So if UDF can't lever up (difficult given the collateral) or widen lending spreads (maybe more likely to shrink), then it's hard to see how the dividend is going to grow much. In this scenario, the stock price will then sink to where the dividend yield equals the cost of capital, likely double digits.

    Rgds,

    Joe X




    Jun 8, 2014. 08:09 AM | 6 Likes Like |Link to Comment
  • Healthcare REITs May Not Post Healthy Returns In A Rising Rates Environment [View article]
    User 5842391 - congratulations on getting the timing right if you indeed jumped into the net-lease sector toward the end of 2013. However, the gain you are sitting on should make you more cautious, not less. Let's address your points in order...

    1) If rates are at 11-month lows, the risk to companies with long-duration flat cash flows is greatest, not lowest.

    2) The liability side of the balance sheet (leverage) is a secondary issue. It's the asset side that's the problem. Properties under 20-year lease with generally reasonable extension options pose a risk in a rising rate environment. While you may eventually grow your way out of the problem, the typical 1.5% annual lease escalation is not sufficient to offset sudden jumps in market rates.

    3) While it's true that FFO yields might be higher than bonds, this ignores two really key items. First, FFO yields are not the right metric. Many health care REITs, especially the large-cap ones like HCP, HCN and VTR, own properties that require ongoing capital expenditures. Second, "FFO" is often the subject of dubious adjustments to make it look better. Omega Healthcare, in particular, likes to add back tenant credit losses, financing costs, and management stock compensation expense. All of these items combine to lower the yield premium to bonds and should not be ignored.

    Finally, net-lease REITs such as the health care names have much longer duration than the bond market. The weighted average maturity for the entire US bond market (AGG) is 6.9 years. In contrast, the net-lease REITs are usually sitting on something like 10-11 year average remaining primary lease terms, but that doesn't include extension options that can tack on 5-10 years after that.

    Let me also add my thanks to the Chilton REIT Team for providing a timely and thoughtful article on investing in the health care REITs.

    Rgds, Joe X
    May 2, 2014. 07:48 PM | Likes Like |Link to Comment
  • Omega Healthcare Investors: The 'Realty Income' Of The Senior Care Market [View article]
    If you like nursing home risk, OHI is the stock for you. However, there is no free lunch, and in the event of any future cutbacks to Medicare reimbursement - or just nominal increases - that can place pressure on OHI's tenant base. The economics of this business are basically the same for all of OHI's operators, so if one goes under the others are likely to feel the pinch.

    This is a bullish analysis of OHI, but leaves out some important questions. Such as, if demographics are so great, why is industry occupancy flat at best? OHI's own occupancy was last reported at 83.8%, which illustrates that the great demographic wave still hasn't moved the needle. Another health care REIT, HCP, has been seeing cash flow coverage decrease in their SNF portfolio (run by Manor Care), to the point where investors are becoming concerned. Investors should also ask themselves what steps the government will take to control costs if and when demand does increase due to demographics. In summary, that rosy future for nursing home operators might still be a long way off.

    OHI is not just another health care REIT. Diversified companies like HCP, HCN and VTR have a much lower risk profile. I agree that OHI's management is experienced and does a good job running the company within this sector. And there's nothing on the near-term horizon that looks particularly threatening. Just be aware that OHI's higher going-in cap rates and higher dividend yield are there for a reason.

    Rgds,

    Joe X
    Dec 2, 2013. 06:31 AM | 8 Likes Like |Link to Comment
  • A Series Of Unfortunate Events For Digital Realty [View article]
    Jerry - from the data you presented I don't know why you see the pricing of DLR's preferreds as irrational. They are each trading with a current yield of 7.7% to 7.8%, which makes sense as they are each pari passu with respect to payment priority.

    I suppose you could say that the varying lengths of call protection (i.e. between 3 and 5 years) should perhaps be reflected in differences in current yield. But the potential for refinancing any of these preferreds is very low - rates have moved higher, seem likely to go higher still - and DLR's preferred issues are here to stay for a long time. It would take a very extraordinary environment again - incredibly low rates, recovery in real estate markets - to produce the kind of market demand where DLR would have the chance to reissue preferreds with lower coupons. This window in time has shut.

    I do agree that if DLR is ever liquidated along the way or purchased by an AAA conglomerate, then the Series G preferreds might be the ones to own. But absent that kind of scenario, all of DLR's preferred stock should (and apparently does) trade within a very tight band. Hope this is helpful.

    Rgds,

    Joe X.
    Nov 14, 2013. 09:00 AM | 4 Likes Like |Link to Comment
  • HCP - Cleared For Liftoff? [View article]
    Jon - you're correct that the last sentence was a little on the murky side. What I was trying to express so badly is that net-lease REITs (such as HCP) with their long-duration cash flows are fairly sensitive to changes in the rate environment. When long-term rates started to move in the early summer, the entire REIT sector sold off pretty badly, especially REITs with longer term leases. So rather than spending a lot of time at the moment trying to choose between HCP, HCN, VTR, etc., investors might be better off thinking about whether they want to be in the net-lease sector in the first place, and if so at what level of concentration in their portfolio. Hope that's helpful.

    Rgds,

    Joe X.
    Oct 31, 2013. 05:37 PM | Likes Like |Link to Comment
  • HCP - Cleared For Liftoff? [View article]
    Ricky - thanks for the comment. Regarding the negative $1.1 billion, you need to add back the $1.9 billion of non-cash depreciation charges (I'm looking at the Sept. 30 balance sheet) that HCP has taken on its real estate properties. When you do, you find that cash earnings have covered the dividends. Under GAAP accounting, non-cash depreciation charges tend to mask the true dividend capacity of real estate companies, which is why most REIT analysts focus on FFO/share rather than EPS as an earnings metric. Hope that's helpful.

    Rgds,

    Joe X.
    Oct 31, 2013. 05:12 PM | Likes Like |Link to Comment
  • I Don't See A Margin Of Safety In Healthcare REIT [View article]
    Geez, this is what happens when you get old and your Varilux prescription doesn't correct as well as it used to. Per the most recent proxy filed on 4/5/13, it's Debra A. Cafaro.

    Rgds,

    Joe X
    Oct 28, 2013. 04:58 PM | 1 Like Like |Link to Comment
  • I Don't See A Margin Of Safety In Healthcare REIT [View article]
    Apologies for the spelling error - Debra F. Cafaro is indeed correct as noted by the OP.
    Oct 28, 2013. 04:44 PM | Likes Like |Link to Comment
  • I Don't See A Margin Of Safety In Healthcare REIT [View article]
    Thanks for the in-depth review of Health Care REIT (HCN) versus Ventas (VTR). I would be cautious however in extrapolating VTR's historical outperformance into the future. Here's why...

    Ventas was formed in 1998 when the former Vencor spun off its real estate into a separate public company. Owing to cuts in Medicare reimbursement and charges of over-billing, Vencor filed for bankruptcy in September 1999. This had a severe impact on Ventas of course, which forced the real estate company to eliminate its dividend and enter into restructuring talks with its own lenders.

    This is where Deborah Cafaro enters the picture. Cafaro was a former real estate attorney who was just coming off a successful CEO assignment at an apartment REIT (company was fixed and sold). The challenge for this new CEO at Ventas was to re-negotiate the leases with Vencor, deal with the bank group, and try to keep Ventas out of bankruptcy. To everyone's credit, all of this was accomplished. However, what needs to be remembered is that when the leases were restructured with Vencor (now Kindred), they were struck at below-market rates in order to give Kindred some breathing room and make it into a more viable tenant. In return for the below-market rates, the lease pools (there were four of them) were also structured with resets that would allow Ventas to recapture some of the upside in these properties over time.

    All of this background helps explain why VTR has had such strong dividend growth versus HCN and HCP (see the first graph in this article). This graph captures the recovery phase of the Kindred leases, but neglects to include the early part of the story when REIT investors would have incurred severe losses of income due to the dividend elimination. HCN and HCP were also dealing with tenant-related issues at the time, but managed to keep their quarterly dividends intact. Ventas also paid more for its debt in the early years, but has seen its cost of debt capital (a key earnings driver) improve as its ratings have reached parity with HCN and HCP.

    A lot of the upside in the Kindred leases has now washed through Ventas' income statement, and Kindred has now been reduced from a 99% portfolio concentration to 12% of NOI according to the latest supplemental. It's certainly been a great ride for investors, but some of that is just the reversal of a really bad ride for a few years. Today, VTR is one of the three large-cap health care REITs with a nicely diversified portfolio and a low cost of capital. Growth rates going forward are going to look nothing like the past, because leases are now at market rates and the high rate of balance sheet growth is unlikely to persist. If you take a look at the graph again, VTR's more recent growth rate, while positive, is much closer to its peers (HCN, HCP).

    In conclusion, VTR (today) is a well-managed and nicely diversified health care REIT with a low cost of capital. But so is HCN for that matter, and as you point out HCN has a much newer portfolio that is positioned very nicely to appeal to upscale boomers as they move through their senior years. While you would have been much better off owning VTR in 2002 when it was just emerging from a painful restructuring, it doesn't seem like there's a major case for outperformance looking forward.
    Oct 28, 2013. 07:23 AM | 34 Likes Like |Link to Comment
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