Whitestone REIT: Buyer Beware

| About: Whitestone REIT (WSR)

Summary

WSR recently sold 7 million shares to help fund a $204 million acquisition.

REITs often need to issue shares for a large purchase, and this is a big one for WSR.

A look at the math - will this purchase benefit shareholders, and how long might it take?

Whitestone REIT (NYSEMKT:WSR) has seen its share price plummet today due to a large issuance of shares. Often in the world of REITdom, this type of issuance is a fantastic opportunity to get a discount and the share price will bounce back relatively quickly.

So when WSR went on sale, I took a quick look and did some back-of-the-envelope math. Should I buy the dip? In this case, my answer is a resounding "NO." There are a few red flags, and the math does not add up.

The Location:

The purchases are located in McKinney, TX, a suburb of Dallas and Houston. Both are areas that have experienced solid growth and are areas that WSR specializes in. WSR does not have a lot of geographic diversity, instead focusing on high-quality Texas localities and Phoenix, AZ.

For me, that is not a negative. I routinely invest in REITs that specialize in localities. There are a lot of benefits in an acquisition team that is intimately familiar with the nuances of their market.

The Properties:

El Dorado Plaza in McKinney is a Class A mixed use development. It has 221,577 SF of gross leasable area. According to the press release, WSR intends to build an additional building with 24,000 SF. For a total of 245,577 SF.

Likewise, BLVD Place is a Class A mixed use development. It currently has 216,944 SF of gross leasable area and WSR intends to build an additional 137,000 SF of retail and office space, for a total of 353,944 SF.

Both are highly attractive properties for those who believe that mixed use developments can beat the downward trend in retail.

The Cost:

Here is where I have an issue. This is a big bite for WSR. With their current dividend of $1.14, their 7 million new shares will cost $7.98 million per year in dividends. That is before you consider the property level debt that WSR is taking on.

When you do the math, that works out to be $18.24 per square foot. By the time you add in property level debt, the use of the revolver and overhead costs, this is a significant expense for a company that might not be able to afford it.

Brad Thomas has already stated his concerns over WSR's debt levels, here, and I agree. This deal will exacerbate it. Furthermore, the expansion plans for BLVD call for $45 million of additional investment, it is unclear how WSR plans to fund that.

The Potential:

Again, referring to the press release, WSR is projecting an unlevered internal rate of return in the "mid-teens" over 8 years. That number is assuming the development goes as planned, that it maintains its occupancy levels and an exit at a 6% cap rate (currently the average cap is 6.9% in Houston per Colliers.

So IF everything goes perfectly and property prices appreciate 8 years from now, the return is in the mid-teens. But that is unlevered; by the time you subtract the high costs of financing, the deal appears far less attractive.

With the current leaseable area, and assuming a 7% cap rate (the company has not disclosed the cap rate of the sale), the properties should produce approximately $14 million NOI. That leaves only $6 million give or take to pay for the increased debt and overhead. They financed at least $80 million, which at a 4% interest rate means interest only payments around $3.2 million.

It is apparent that any profit from the current operations is going to be minimal. Clearly, WSR is banking on their development. With a balance sheet that is already questionable and their stock at such high yields, this move sets off my red flags.

Conclusion:

I am not saying that it is impossible that this move works. My look at the properties was very cursory due to time constraints, and the properties do look like solid properties.

However, investors should be very careful assuming this deal will be accretive. The back of the envelope math shows it being really close and this is from a REIT that claimed it was going to try to reduce debt, now suddenly taking on $80 million+ and planning on additional expansion. It is far from apparent how WSR is going to be able to leverage their balance sheet profitably.

This deal does not pass the initial smell test for me, so while an 8% drop for a secondary is always tempting with a REIT, I am going to pass for now. The impact to the balance sheet could keep things going down for awhile and give potential investors time to determine how WSR is going to handle it.

Sources: WSR filings and press release, Colliers, BLVDplace.com

Disclosure: I/we 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.

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