I'm 6'3". So I'm not a big guy but not a small guy either. In the business world, I suppose I'm average. However, as a college basketball player, I was often the biggest shooting guard while at the same time the smallest power forward. To be honest, I was great bench warmer too.
But while I was the so called "big man on a small campus" (Presbyterian College in Clinton, SC) I always looked up (or actually down) to Mugsy Bogues. Don't worry I never played against Bogues but I was always fascinated by his amazing agility and speed, let alone his amazing 44-inch vertical jump (source: Wikipedia).
At 5'3" (one foot smaller than me) Bogues was the shortest player in the NBA and what he lacked in size he made up in skills. To put it bluntly, Bogues had game!
This REIT Has Game
In REIT-dom, there are also some up and coming players that are so small that they don't get the attention of the larger blue chips. Many of these small-caps lack exposure and unless they aren't putting points on the board, they often get ignored.
After all, there are some impressive veteran REITs that have been putting up points for decades and some even have "top shelf" brands that carry incredible weight among the Index Funds. It's simply hard to get noticed as a smaller player and the odds of scoring consistently is a difficult feat.
But like Mugsy Bogues, there's always an outlier.
Whitestone REIT (NYSEMKT:WSR) with a market cap of around $275 million is one of the smallest shopping center REITs in REIT-dom. Once a non-listed REIT (founded in 1998), Whitestone listed its shares in August 2010 and the Houston-based REIT now owns 49 Community Centered Properties™." Here is roster of the shopping center REITs based on market capitalization.
In terms of the number of properties, Whitestone is not the smallest, but the company still dwarfs the larger name brand REITs like Kimco Realty (NYSE:KIM), Regency Centers (NYSE:REG), and Weingarten Realty Investors (NYSE:WRI). Whitestone has a differentiated platform of buying "turn around" properties and seeks to add value through renovating and re-tenanting the centers into Community Centered Properties™.
The company seeks to accomplish this goal by (1) stabilizing occupancy, with per property occupancy goals of 90 percent or higher; (2) adding leasable square footage to existing structures; (3) developing and building on excess land; (4) upgrading and renovating existing structures; and (5) investing significant effort in recruiting tenants whose goods and services meet the needs of the surrounding neighborhood. (source: Whitestone REIT website).
Also different than many of other peers, Whitestone seeks to expand its geographic diversification by strategically acquiring commercial properties in high-growth markets. The company's acquisition targets are located in densely populated, culturally diverse neighborhoods, primarily in and around Phoenix, Chicago, Dallas, San Antonio and Houston; five of the top 15 markets in the U.S. in terms of population growth.
Whitestone has a diverse "small tenant approach: that consists of 1,101 tenants that occupy over 4.4 million square feet of retail space. The company's diverse tenant base is concentrated on a variety of categories such as medical, educational, and casual dining. The Whitestone tenants tend to occupy smaller spaces (less than 3,000 square feet) and, as of Q1-13 provided a 60% premium rental rate compared to the larger space tenants.
No one tenant accounts for more than 1.5% of Whitestone's Annual Base Rent (or ABR) and as evidenced below, the number of tenants has grown considerably (from 773 in 2009 to over 1,100 today).
Also part of Whitestone's differentiated investment strategy revolves around the lower occupancy levels that create higher upside (higher risk-adjusted yields). As of Q1-13, Whitestone's occupancy was 86% and that has been fairly consistent over the last five years (see below):
This value-added strategy is one of the biggest attractions to Whitestone: To grow occupancy by acquiring partially vacate centers and then growing revenue by re-developing, re-positioning, or re-leasing.
As some of you know, I was a developer from 1988-2002 and I would buy and renovate shopping centers similar to the ones that Whitestone owns today. I recall a property that I acquired in the early 90's from a Life Insurance Company. The 100,000 square foot center had been foreclosed and I made a bid to buy the property for around $750,000 ($7.50 per square foot). Dollar General (NYSE:DG) was the only tenant and there was around 90,000 square feet vacant.
Knowing I had a few tenants already lined up, I purchased the center and within a year's time I had the center occupancy up to around 95%. In addition to positive cash flow (before debt service) of around $250,000, I was able to sell off an outparcel for around $400,000. The return on this deal was extraordinary!
The key to the success was LOCAL MARKET KNOWLEDGE. Had I not had the experience in the market and the key tenant relationships, I would not have been as fortunate.
The point here is that Whitestone has been successful because the company has a core of competence in certain key strategic markets as well as a track record for filling up centers. In a recovery market (like today), there is tremendous opportunity in acquiring and repositioning assets that in turn generate substantial returns.
Let's Look at Whitestone's Track Record
In the first quarter (2013), Whitestone's property NOI grew 32% on a year-over-year basis, and funds from operations (or FFO) core increased 35% from the prior year. In less than three years, Whitestone has added over $225 million in 15 additional high-quality, value-added Community Centers, consisting of 1.4 million square feet and 2 future development land parcels. Here is a snapshot of Total Revenue and G&A:
NOI growth has been strong as Whitestone has increased revenue by over 88% since Q2-2010 (Q1-13 revenue was $9 million):
As noted above, Core FFO has also remained strong at $4.2 million (in Q1-13), a $1.1 million or 35% increase from the first quarter of 2012. On a per share basis, FFO-Core was $0.24 per diluted share in the first quarter due to the timing of the deployment of capital and the additional issuance of shares during 2012 as compared to $0.24 a year ago.
How Fit is The Balance Sheet?
Whitestone lowered its overall weighted average interest cost as of the end of the first quarter to 4.4% as compared to 5.9% a year ago. Also Whitestone increased its pool of unencumbered properties, that is properties without secured mortgages, to 25. The cost bases for the pool of unencumbered assets now exceeds $230 million, which represents over half of the cost basis of total assets.
Whitestone's total debt to market capitalization is around 43% and the number has been reduced from around 48% in 2010.
Also during the first quarter, Whitestone improved its unsecured credit facility by amending and increasing the borrowing capacity by $50 million to $175 million (also added an accordion feature that allows the facility to further increase to $225 million). Whitestone also reduced the interest rate by approximately 1%, which translates to $950,000 or $0.05 per share on the balance currently drawn.
Whitestone has approximately $98 million of fixed-rate debt, with $87 million maturing in 2013 and early 2014. The weighted average fixed rate for this debt is 6.1% and the company expects to renew the debt with current lenders or new lenders at a 3% to 4% fixed interest rate. The expected reduction in interest rate will result in approximately $1.8 million to $2.7 million in annual interest expense savings or $0.10 to $0.16 per share.
Here is a snapshot of Whitestone's Total Capitalization:
What's a Small Player Worth?
So now we get to the most essential part of the score card: Value. Whitestone is certainly one of the smaller REITs in REIT-dom and with a market cap of around $275 million, it's plain to see that the value is not in its physical side. Instead, the value must be in the experience and perhaps its ability to score points.
With a P/FFO multiple of 15.7x Whitestone does not stand out as an incredibly valuable player. In fact, Whitestone is below the peer group multiple of 17.1x but not a screaming bargain.
As the FAST Graph below tells us, Whitestone has maintained a relatively boring growth profile that includes modest earnings growth and flat dividends. One concern that I have with Whitestone is the FFO payout ratio (FFO adds back for certain non-cash items such as depreciation, in order to determine the amount of profits that are available) that is 123%. Most REITs that I follow tend to have a FFO payout ratio between 80% to 90%.
Of course, it's fairly common that REITs with higher FFO payout ratios have higher dividend yields. In the case of Whitestone, it's most obvious to see that "big things often come in small packages." To put it in sports terms, Whitestone can score.
With a current dividend yield of 7.06%, Whitestone has the highest dividend yield in the shopping center sector, surpassing the peer group by a considerable margin:
Should Whitestone Be In The Starting Five?
As outlined above, Whitestone has skills. The company has shown that it can produce strong and consistent dividends. However, the trade off (or risk) is the less concentrated credit tenancy as well as the higher leverage fundamentals (as compared with the peer group). In addition, the smaller tenant portfolio is a good measure for diversification; however, the geographic footprint lacks diversity and that is a potential risk.
The management team is experienced and the veteran executives have decades of experience in recycling retail assets. In addition, having a "circle of competence" in select growth markets has been the key differentiator for Whitestone's success and the reason that the company has maintained consistent occupancy levels.
I do fear that when interest rates do begin to rise, Whitestone's tenants will be subject to higher rent stress. That is something to pay close attention to as the costs of capital will increase at a higher multiple as many of Whitestone's tenants are "mom and pop" chains and their borrowing costs will be magnified.
However, based upon my research, I recommend Whitestone with a Target Price of $16.00. The dividend yield is strong, and given the significant upside with leasing and refinancing, the prospects for growth appear good. Here is a snapshot of Whitestone's total return performance from December 2011 through March 2013.
Sometimes big things do come in small packages. I'm not Mugsy Bogues and I dare say that I'm LeBron James. I would like to point out that I score my points in REIT-dom where I publish a monthly newsletter (The Intelligent REIT Investor) aimed to assist individual REIT investors with the skills to sleep well at night.
Source: SNL Financial, FAST Graphs, Whitestone European Family Office & Private Wealth Management Forum
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.