RNY Property Trust Probably Winding-Up: A Sad Story Comes To An End

Summary

• The trust lost money for years and recent asset sales made RNY unsustainably unprofitable going-forward.
• 19.9% holder Aurora requested a meeting and proposed to take RAML's position as manager of the trust.
• External manager RAML proposal would lead to winding-up RNY with 24% upside in base case.

RNY Property Trust (Grey Market: OTC:RYPTF) is a special situation investment. Keeping things as is would burn the remaining cash and lead to bankruptcy. At the shareholder meeting on September 12, 2017 unitholders will probably approve the proposal to liquidate RNY. Liquidation would provide undiscounted 24% upside in management's base case. Despite meaning business failure, liquidation corresponds with investment success at the right price. A market uncorrelated 24% compares favorably to 10-year government bond yields of 2.2% and 2.7% for the USA and Australia respectively. In case unitholders choose to liquidate, most of the proceeds could possibly be distributed in about one year.

Background on the trust

RNY is an Australian listed property trust with office properties in the New York Tri State area. Since listing in 2015 at A$1.00 per unit on the Australian Securities Exchange the unit price has fallen to about 1.2 cent now. Despite seven distributions, totaling 20.1 cents per unit, an investment into the trust has been a disaster for the mainly Australian investors.

The trust had an initial portfolio of a 75% indirect interest in 25 office properties located in the New York Tri-State area. With the benefit of hindsight suburban office was a bad choice. Management sees the "lack of office-using job creation in the suburbs, and in turn modest demand for suburban office space" since 2009 as one reason for the bad performance. In the NYC area most new jobs were in the technology, advertising, media, and information technology industries, which prefer urban areas. Secondly, the boom in development in areas close to Manhattan (Brooklyn, Queens and the New Jersey water-front) has soaked up demand. Management sees those "structural shifts" as responsible for the underwhelming performance despite "operating the Portfolio to the best of our abilities". Obviously, going leveraged into the global financial crisis has not helped either.

In January, 2009 the trust changed its name to RNY Property Trust from Reckson New York Property Trust. On the same date the responsible entity also changed its name to RNY Australia Management Limited from Reckson Australia Management Limited. At the time of changing names performance was abysmal already (see chart).

Portfolio occupancy averaged 90% from 2006-2009, before falling to below 80% for 2010-2016.

The six initial directors of the external manager "RNY Australia Management Limited" (RAML) remain overseeing the value destruction (see charts) until today with the exception of one non-executive director, who resigned in August, 2017 "for personal reasons". To be fair in 2008 the three executive directors of RAML purchased 51.3M units of RNY (19.5%), making them the largest unitholders of RNY.

RNY owns 100% of RNY Australia LPT Corp. (US REIT), which in turn has a 75% interest in RNY Australia Operating Company LLC (US LLC). The owner of the remaining 25% interest is an affiliate of RXR Realty, a private enterprise founded by the three executive directors of the trust Rechler, Maturo and Barnett. In effect, New York based RXR Realty owns 20% of RNY and an additional 25% of the underlying assets (the US LCC). RAML is an affiliate of RXR. In addition to RAML RNY also has an external manager for the indirect investments in the US LLC.

The fact, that the trust is externally managed, is important for the cost structure and also because the manager's interest may not have been aligned with the unithloders. A manager can often times still extract value via fees and contracts, while the controlled entity loses money. The annual report 2016 shows the management fees as purchases from related parties.

In comparison to RNY's market capitalization based on 263,413,889 outstanding and a unit price of AUD$0.012 of AUD$3.2MM the management fees of AUD$1.5MM are very material.

19.9% shareholder Aurora claims RXR to have received significant amounts of fees compared to the current market cap:

RXR Realty has received $21.7m in management fees, $7.2m in sponsor fees and incurred $9.8m in administration costs since listing. In addition to direct charges, RXR received indirect fees for leasing and managing RNY's properties that are estimated to be $46.0m* (total fees of $84.7m). Indirect charges do not appear to have been disclosed in RNY's financial reports.

A look at the income statement shows, RNY's underlying US operations (US LCC) have been profitable and RNY without the management fees would have been profitable, too. Large losses from fair value adjustments lead to catastrophic headline figures. The cost structure with external management and a public listing in Australia while operations are in the USA, lead to cash burn. Unitholders now are deprived of the chance to wait for a potential recovery in the suburban office market. A sale of the US LCC would have served them better.

Portfolio

As of 30 June, 2017 the portfolio comprised of 7 office properties, down from 18 as of December, 2016 and 25 at the listing in 2005. On August, 3 the 710 Bridgeport Avenue property was sold for the carrying value, bringing the current number of properties to 6.

Due to the significantly downsized portfolio normalized net income from the US LCC will be lower going forward compared to my estimates of normalized figures above. This makes a restructuring or fast liquidation all the more urgent to preserve any value for the unitholders. The 492 River Rd property is encumbered by loans and there is no equity value remaining. The lenders are expected to take possession or allow US LCC to manage the sale for a fee. The other 5 properties are encumbered under the defaulted upon ACORE debt. There is also no equity value at the current property prices.

Since the global financial crisis liquidity for RNY's real estate in the suburbs dried up. A lack of comparable asset sales made the valuation of RNY's portfolio more subjective. For the past few years the entire Portfolio was valued every 6 months by the board with the help of third-party valuers, who performed appraisals and provided cap-rate data. If a property was under contract to be sold, the property's value was the contracted sales price. This resulted in downward fair value adjustment after downward fair value adjustment. Now the cap and discount rates used per the H1 2017 report are surprisingly high. Now there is only the optionality of receiving higher bids, left.

Unitholder meeting

In July, 2017 Aurora fund management (Aurora) has requested a meeting. Aurora has proposes to remove RAML as manager and to appoint Aurora in its place. Probably to counter RAML proposes a cash distribution strategy.

The unitholder meeting is scheduled for September 12, 2017. The decision is important. It's funny how RNY omitted the proxy from its investor relations page.

You can find the proxy on the ASX page for RNY. Basically, the unitholders have two choices (see below).

Wind-up plan by RAML

RAML's plan is to wind-up the trust distribute any remaining cash to unitholders.

"With a current cash balance of approximately US$10.3m available to the US LLC prior to reserves for settlement of lender claims, other reserves/expenses and capital required to operate the Trust and affiliated entities during the wind-up, it is estimated that the amount of cash available for distribution to Unitholders is between A$0.015 to A$0.019 cents per unit, with a downside projection of A$0.000 per unit."

Source: Investor presentation

As you can see in the slide above RAML expects US$2MM to be necessary for settlement. This is very material with the base case distributable cash balance of US$3.1MM.

Per the reports the ACORE debt was always labeled non-recourse. Now in the 1H 2017 report management writes:

5 ACORE assets were marketed, and bid prices in total were approximately US$1.8m less than the debt after accounting for closing costs and the release of outstanding reserve balances; as a result of the low bids the lender asserted various legal claims; management disagrees with the lender's claims; the loan remains in default and lender has the right to start foreclosure proceedings; management is in discussions with the lender and has an agreement in principle to resolve such claims (such agreement is contingent on unitholder vote scheduled for 12 September 2017).

In an update on August 23, management tries to justify paying extra for the non-recourse loan (RE= responsible entity):

contrary to Aurora's claims, the ACORE loan is non-recourse, and the US LLC believes that the lender's legal claims are overreaching and excessive; but, instead of waging a lengthy and expensive legal battle to fight these claims, which could take years and the cost of which could exceed all of the US LLC's remaining cash, the US LLC has negotiated a proposed settlement to cap the liability of such claims at US$2 million; although, such settlement is contingent on RAML remaining RE; if RAML is replaced as RE the lender may re-institute their legal claims for US$6.6 million,

There is no exchange rate risk, as long as the cash is held in USD. The properties are located in the USA. The functional currency of the US REIT and US LLC is USD. Over the last year the exchange rate fluctuated by about 10% from looking at the chart. Hedging the currency could be an idea, when the cash is distributed to the Australian parent company. Ultimately, any remaining cash would be converted to AUD and distributed to unitholders. The amount and timing of any distribution is unknown today.

Aurora alternative proposal

There are poison pills in place. If Aurora wins the proxy fight, RAML could choose to liquidate the properties. Also the lenders could foreclose on the properties. In addition an RXR affiliate would waive US$659K deferred asset management fees and on a going-forward basis charge only direct cost as asset management fee if Aurora is unsuccessful in replacing RAML. We do not know how much Aurora would charge as manager.

Aurora has no precise plan, yet:

Unitholders now have the choice. Do they want to wind-up the trust and realize their losses or try another manager with high uncertainty regarding the outcome. The saga will probably soon come to an end. I do not see how Aurora could make RNY profitable with the current structure. Only if money could be clawed back from the RXR entities, it would make sense to me to switch the operator. But Aurora did not mention this possibility. RXR has enough leverage to make the job for Aurora unlikely to be successful. The Aurora alternative is too imprecise, compared to getting 1.5 cent in the base case with the RAML proposal. I think unitholders will vote for liquidation.

Conclusion

With all the properties currently under water no trust in the book value is required. Even including the projected settlement of US$2MM with ACORE for "non-recourse" debt, management's base-case of AUD 1.5 cent provides 24% upside. But the value destructive past of management gives me some pause.

The possibility of Aurora winning the proxy fight adds uncertainty. I am waiting for RAML to win the vote and hope for lower unit prices. Although at the current price the risk/reward in a diversified portfolio already looks good, with the possible liquidation adding a market uncorrelated return. Buying RNY in the past even with a considerable discount from the value of the underlying assets lead most of the times to looses (except with lucky timing). Liquidation is now the way for new investors to realize profits.

Sources and recommended reading

RNY Investor relations

RNY Australian Securities Exchange

Forager Funds on RNY

Dedicated website from Aurora

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.