American Realty Capital Properties IPO: Not A 'Sleep Well At Night' Investment

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A new free-standing equity REIT, American Realty Capital Properties (ARCP), began trading on September 7th on the NASDAQ capital markets platform. The New York based REIT sold a total of 5,580,000 shares, capitalizing the $12.50 a share stock with around $69.75 million. ARCP will begin paying an initial 7% dividend, or $.875 per share. The launch pad portfolio consists of 63 assets with a weighted lease term of 9.6 years.

Upon further review, ARCP appears to have a focused free-standing REIT model with significant experience in the non-traded REIT sector. The Chief Executive Officer and Chairman of the Board, Nicholas S. Schorsch, has completed over 1,000 acquisition transactions in excess of $ 5 billion and with a diverse track record in managing capital and assets related to medical office, shopping centers, and net lease funds.

As announced by Schorch,

This was an extraordinary execution. We succeeded in completing our IPO in the midst of a substantial economic correction and a series of natural disasters which affected New York City. This is a strong testament to both our team and the quality of the offering. In a period of historically low interest rates, and substantial market volatility, strong real estate locations leased to investment grade tenants should enable our shareholders to preserve capital, as well as pay and cover our 7% distribution.

Historically, the free-standing REIT sector is one of the safest and most reliable sectors in commercial real estate investing. Typically a net lease asset will be leased to a credit rated tenant, under a long term lease, with escalations in the rent.

At first glance I was excited to see a new REIT IPO with investor-aligned “margin of safety” attributes; however, I became noticeably concerned when I examined the product offering. Of the 63 assets in the initial portfolio, 60 are leased to a super regional bank, 2 are vacant bank branches, and 1 is leased to Home Depot (NYSE:HD). The 60 bank branches are all leased to Citizens Financial Group with a weighted lease average of 6.9 years. Citizens operates in around 12 northeastern states with combined bank assets of around $129.7 billion. The bank is a subsidiary of Royal Bank of Scotland (NYSE:RBS) and the bank’s US retail and consumer group lost around $740 million in 2009 and $930 million in 2008. The bank does appear to be on sounder footing as it managed to squeeze out an $11 million profit in 2010.

The biggest issue that I have with the IPO is that the assets are highly concentrated with just two tenants, and one of the two tenants is a troubled bank with minimum lease term remaining. Furthermore, like many banks, branches are being reduced in size and, as a result, the “brick and mortar” model is becoming less important (to the banking model).

As explained in Citizens 2010 Annual Report:

We are investing in marketing and technology innovation…enabling mobile smart phone apps to manage cash banking, transactions, wire transfers, payments, and check balances…

The bank also announced that the “non bank” model will increase ATMs by another 1,100 in 2010.

So clearly the bank branch model is becoming less of a factor in banking transactions and consequently, leased bank branches will be less likely to renew. And with a weighted lease average of 6.9 years (for the ARCP portfolio), I do not see values improving beyond the initial stock price of $12.50 per share. I consider the IPO offering pricing of $12.50 per share to be around 30% - 40% over realistic NAV pricing.

Also, I am concerned that the bank branch supported revenue stream will not be able to support the 7% dividend if some of the bank branches do not renew in 6.9 years. In my opinion, a REIT should acquire and invest in assets that are as close to the organic creation as possible, not in older facilities with questionable business models (i.e. Blockbuster, Circuit City, etc…).

In the case of the new IPO, management appears to be solely focused on paying off (or bailing out) its previously arranged secured debt and not on providing a diverse, long-term triple net lease portfolio for investors.

Although I would not recommend ARCP, there are many durably safe equity REITs, including National Retail Properties (NYSE:NNN), Realty Income (NYSE:O) and Excel Trust (NYSE:EXL). I consider these REITs “sleep well at night” investments with experienced management and diverse revenue drivers. National Retail is currently paying a 6.2% dividend, Realty Income is currently paying a 5.2% dividend and Excel Trust (EXL) is paying a 5.8% dividend.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.