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Gramercy Capital (GKK) - Deep CRE Value Play

|Includes: Gramercy Property Trust, Inc. (GPT)

    Recently, David Tepper took a 7.5% stake in Gramercy Capital Corp, a Commercial Real Estate REIT.  With commercial real estate touted by many as the next looming crisis, one wonders what he saw in GKK.  Through two quarters this year, GKK has reported losses of over $225M (or $4.52/share).  This from a stock trading around $3 with a market cap around $150M.  Although the 3Q09 report has yet to be released, GKK will likely report another loss.  Beyond GKK's internal problems, the CRE finance model of issuing CDO debt to finance CRE lending appears to be dead.  So what gives David?  Why are you buying up this terrible stock?
     Pouring through the financials, you quickly realize that GKK is a hybrid company consisting of two distinct arms.  One arm is the CRE finance company that SLG original created when it spun off GKK.  This is the arm that currently accounts for all GKK's losses.  The other arm is a traditional operating REIT which focuses on bank branches.  This entity is in essence the former AFR (American Realty Financial) which GKK purchased at discount in 2008.  
     Looking at the numbers, GKK realty quickly stands out as the gem in GKK's hat.  GKK realty currently has about $3.1B in property with $2.4B in associated mortgages.  This is about $9.70/share worth of equity and accounts for $600M of the $875M total equity in GKK.  The properties are 88% leased with average lease term remaining of 10 years.  I'm going to go out on a limb and say the crisis will end before GKK's leases.  In fact, GKK realty is cashflowing about $30M/quarter.  So, if it weren't for GKK finance, GKK realty would be producing a $0.60/quarter dividend.  Of course, there are 2 looming issues with GKK realty.  When GKK acquired AFR, it had a portfolio of buildings leased to BAC known as the Dana Portfolio.  The terms of this portfolio were that BAC pays $10M/quarter through 2011 and starting in 2011, BAC only pays operating expenses.  GKK is attempting to renegotiate the Dana portfolio terms, but assume they are unsuccessful.  Revenue decreases by $10 million/quarter and GKK realty dividend drops to $0.40/quarter.  The second looming issue is GKK has about $800M in mortgage debt from Goldman that will need to be refinanced in 2011.  But given the strong cash flow from the properties, it is highly probable that GKK manages to refinance.  Finally, GKKs biggest tenants are banks - BAC and the former Wachovia.  It is possible that banks do not re-lease when their leases expire.  But, seeing as the bank branches are the source of their deposits, I feel banks will keep as many branches open as they can.  So, in short, GKK realty is worth about $9.70/share and should provide a steady dividend of $0.40/quarter.
     Now, we need to look at GKK finance.  Rather than try to place a value on the finance arm, let's assume its worthless.  Fortunately, this arm is effectively firewalled from the rest of the company since all the debt associated with GKK finance is in the form of non-recourse CDOs.  In the worse case scenario, Gramercy loses all income from the finance arm as it gets diverted to paying off CDO debt.  (I do think the Finance arm is worth something, but that is beyond the scope of this article).
     In short, Tepper has found an excellent investment.  At $3/share, GKK could easily be a 3 bagger paying $1.6/year in dividends.  How would you like to get a 50% annual payout on your investments along with 300% price appreciation?  Well you can if you are willing to wait one to two years.  Investing like this is what has made Tepper so famously rich.  And the great thing is we can piggy back and profit right along with him.

Disclosure: Author is long GKK and GKK-A.