- Alpine has a solid triple net property portfolio.
- It is trading at an attractive valuation.
- A couple of growing pains are present which are keeping me neutral for now. This is a great stock for the watchlist.
- This idea was discussed in more depth with members of my private investing community, Portfolio Income Solutions. Learn More »
Alpine Income Property Trust (NYSE:PINE) is a great stock to have on the watchlist. It presently has some attractive investment characteristics including discounted valuation, high yield and reliable cash flows. However, in the near- and medium-term, these strengths are going to be challenged by a sub-scale market cap and the overhang of an upcoming internalization expense.
This article will discuss both the bull and bear arguments as well as when I believe will be an opportunistic time to get in.
The bull case for PINE stock
A triple net lease REIT is expected to do 4 things:
- Provide a strong dividend yield
- Steady revenues through long-duration cash flows
- A healthy tenant roster to reduce chance of disruption
- Grow FFO/share and dividend over time with accretive acquisitions
Alpine does each of these fairly well.
With a dividend freshly raised to $0.27 per quarter, it now has a yield of 6%. This yield is protected by a reasonably healthy payout ratio at 73% of forward FFO. The revenues are long duration in nature with minimal lease expiration through 2025 at which point lease expirations are nicely laddered thereafter.
Any time a company has long leases, tenant credit becomes an important issue. In this regard, PINE has a similar tenant credit profile as other triple net REITs with 44% of tenants investment grade.
Tenant concentration is a bit higher than normal with Wells Fargo and Hilton paying 10% and 6% of overall rent, respectively.
Somewhat high tenant concentration is to be expected given the small size of Alpine. It is harder to be fully diversified with 89 assets as compared to some other triple nets that have thousands.
Leverage is slightly on the high end at 44% debt to TEV and 6.9X debt to EBITDA.
Many institutional investors prefer to see debt to EBITDA in the 5X range, but I view appropriate leverage levels differently depending on sector.
A REIT in a volatile sector like hotels or malls should probably stick to lower leverage because high leverage could cause financial stress as the cycles hit their bottom. In contrast, triple net revenues are steady state making the leverage much less of a risk. I actually prefer when triple nets operate at somewhat high leverage because it improves the cash flow to shareholders.
Growth has been strong so far with FFO/share expected to rise to $1.50 in 2021 and $1.48 in 2022 from $1.23 in 2020.
Source: SNL Financial
In companies this small, the growth tends to be quite lumpy where the FFO figure for a given year will vary drastically based on the timing of closing on an acquisition as compared to the timing of issuing the shares to pay for it.
So rather than just looking at the analyst numbers which should reflect this lumpiness, I would rather get a sense for the run rate based on acquisition volumes and cap rates.
For a company with a market cap of $200 million, that is a massive acquisition volume. Going forward, I would anticipate cap rates to be in the mid 6% range. At that level, I believe acquisitions are mildly accretive against PINE’s cost of capital.
As such, I would anticipate PINE to grow at a slow to moderate pace that is typical of most triple net REITs.
So far, we have basically just shown that PINE checks all the normal boxes of a triple net REIT. The aspect that makes it compelling as an investment is its valuation.
Valuation always matters. It is a core concept of investment and is front and center in my investment philosophy.
It can be difficult to measure valuation in growthier asset classes where so much of the profitability is unknown, but it is plain as day in triple net where cash flows are highly visible up to a decade out.
In a triple net REIT, a cheaper valuation is so much better. All else equal, a lower P/FFO multiple does the following for a triple net REIT:
- Higher dividend yield at same payout ratio
- More cash flow to reinvest into acquisitions
- Reduced risk
- Higher expected return
Perhaps to a greater extent than in any other sector, value is the way to go in triple net and this is where Alpine shines.
With forward FFO/share of about $1.48, it is trading at just over 12X. With its NNN retail focus, its closest peers would be Realty Income (O), National Retail (NNN), Agree Realty (ADC) and Spirit Realty (SRC).
Price/FFO (next 12 month est.)
Data from SNL Financial
That is a rather steep discount in both FFO multiple and P/NAV. NAV is, of course, calculated using a cap rate, so I like to check to see that the cap rate is appropriate.
Source: SNL Financial
Most retail triple net properties trade at cap rates of 6.8% or lower, so I think it is entirely realistic that the portfolio of properties is worth at least $20.93 per share.
A discount to NAV means every dollar invested in Alpine buys the investor significantly more property as compared to that same dollar invested in a peer triple net REIT. More property means more cash flows and that is how PINE gets the investor a much bigger dividend yield.
Normally, a discount this compelling would be enough to get me to buy in, but there are a couple of challenges ahead that have kept me on the sidelines.
The bear case for PINE stock
It is challenging being a small-cap REIT in general, but there are 2 aspects unique to PINE that make it even more difficult.
- Geographic spread
- Encumbered by an expensive management agreement
Diversifying by geography is usually a good thing, but it requires a certain amount of scale in each market to be efficient. Below is Alpine’s property portfolio.
Source: SNL Financial
That is far too many submarkets for a total of 89 properties and that makes it financially inefficient to manage.
When properties are grouped in a submarket, a single property manager can handle them all quite efficiently, but when you have a single asset in Wisconsin and a single asset in Michigan along with a single asset in New Mexico, the necessary G&A cost of maintaining the properties and tenant relationships is going to be rather high relative to the revenues.
There are 2 ways to deal with this:
- Hire a high ratio of property managers to properties
So far, PINE has gone with the outsourcing method being externally managed by CTO Realty Growth (CTO) which is formerly known as Consolidated Tomoka. By combining forces with another REIT, it gives them the necessary scale to manage the assets efficiently, but it comes at the cost of an encumberment.
Below are the terms of the external management agreement.
As far as external management contracts go, these terms are reasonably good. 1.5% of equity per year is a rather normal cost and roughly equivalent to what G&A would cost if PINE were internally managed.
With external management, however, it is rarely the expense of it that REIT investors fear. There is an inherent conflict of interest in that with the management fee being based on the size of the company, there is incentive to grow at all costs whereas shareholders might want to hold off on growth at times when it is not accretive.
This relationship is further complicated by the fact that much of PINE’s acquisition pipeline is expected to be purchased from CTO. I’m sure there are processes in place to make these transactions pass legal muster to be considered fair to both parties, but in real estate, there is a broad range of prices that could be considered fair.
As such, it is really hard to tell if CTO or PINE is getting the good deal when the companies transact with each other.
PINE has publicly stated that internalization is on the horizon. This is both a good and bad thing. Good in that it will remove the perceived conflict of interest and bad in that internalization events are usually quite costly as the external manager gets a substantial breakup fee.
Putting it together
Alpine is trading at a highly attractive valuation and has a strong asset portfolio. These strengths are weighed down in the near term by the challenges of being sub-scale and the complexities of the external manager relationship.
The success or failure of PINE as an investment will depend on how well they can manage their way through the next few quarters. If done well, they can accretively reach efficient scale and internalize at a reasonable cost. However, if cap rates move too low too quickly, there may not be a way to get to scale without substantially diluting FFO/share.
This is a great name to keep on the watchlist. As time goes on, it will become increasingly clear which direction they are headed and I would not be surprised to see this become a highly opportunistic investment down the road.
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This article was written by
Dane Bowler is the Chief Investment Officer and a registered investment adviser at the 2nd Market Capital Advisory Corporation. He has over a decade of experience running a proprietary portfolio with a specialization in REITs. On-site property tours and critical analysis of REIT management help inform his selection process.
Dane leads the investing group Portfolio Income Solutions along with Simon and Ross Bowler. Features of the service include: a diversified high-yield REIT portfolio, data tables on every REIT, tax guidance, macro analysis, fair value estimates, and quick updates via chat on breaking news. Learn More.
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