Boston Apartment Portfolio at Half Off (Or More)?

New England Realty (NEN) is a limited partnership that owns approximately 2,300 apartments in the Boston metro area.  Through JVs, the company owns about 2,600 (includes NEN's share, not entire JV portfolio).  In addition, the firm owns 114,000 sq ft of commercial real estate in the Boston area.

The firm is managed by Harold Brown who is a 50-year veteran of the Boston markets.  In addition to his investment in NEN, Mr. Brown, either directly or indirectly, owns another 2,500 apartments (approximately) in the Boston area. 

Valuation:

The Class A units trade on the AMEX.  The General Partnership units and the Class B Units are owned in their entirety by Harold Brown and his brother Ronald.  At $67 per class A unit, the firm has a market cap of aproximately $106 MM (includes GP and Class Bs) and an enterprise value of approximately $248 MM.  Trailing 12 Month FFO ~ $8.1 MM and EBITDA is ~ $16.3 MM.   Below is a comparison of valutation metrics versus national apartment REITs:

	NEN		AVB	EQR	ESS	PPS	Average
P/FFO	13.10		30.01	27.19	22.75	32.2	29.8
EV/EBITDA	15.20		27.91	23.39	26.71	31.03	27.26

If one were to value NEN at 22x EV/EBITDA, EV = $358 MM minus the existing $142 MM in debt to give a market cap of $216 MM or > 2x the current market cap of the equity units.  

Ownership:

There are approximately 1.8 MM equity units outstanding (including GP and Class Bs).  Only about 538,000 are not owned by insiders or as treasury stock.  At $67 per Class A unit, this ~ $36 MM of float.  The company has been an aggressive purchaser of Class A units over the last 3 years.  From August 2007 through December 2010, the company has bought back ~ 400,000 equity units or almost 1/4 of issued equity.  Much of this was done as the firm refinanced much of their portfolio and took out cash.  We expect this to continue as one of the firm's most valuable properties, Boylston Downtown, has a maturity date of 2013 on its debt.  The debt totals $19.5 MM and Harold Brown has stated that he's been offered $60 MM for the property (http://www.bostonmagazine.com/articles/the_comeback_kid/).  If refinanced at 50% LTV as the other properties have been, NEN can take $10 MM out and buy back about 28% of the Class A float.

Boston Apartment Market:

The Boston market has a history of tight supply.  Currently the vacancy rate for the metro area is approximately 6% versus 6.2% nationwide.  The NEN portfolio had a vacancy rate of 3.5% as of February 2011.

In their earnings conference call yesterday, AVB stated that June re-leasing rates are up 9.0-9.5% for New England ("Renewal rates are continuing to escalate as well, with offers for renewal increases averaging around 7% per May lease expirations and over 8% for June expirations, up from around 5% April. For June, in Northern California, New York, New Jersey, and New England, the range is around 9 to 9.5%."  from Calculated Risk).

Dividend:

NEN currently pays $2.80 annually or about a 4.1% dividend.  The amount of total cash that the company has dedicated to dividend payments has dropped over the last few years from $4.8 MM in 2006 to $3.7 MM in 2010 (all due to lower outstanding shares).  If the company paid out the same dollars currently, the dividend yield would be in the neighborhood of 5.3%. 

Debt:
 
As stated above, management refinanced much of the current portfolio.  This action was taken at the end of 2007 and resulted in a large portion of the assets financed at 5.5% with 15-year interest only debt.  Any future increases in revenues will be leveraged against fixed rate debt that doesn't mature until 2023. 

Negatives:

One drawback is that the investment is a limited partnership and requires the filing of K-1 statements with tax authorities.  This corporate structure limits the attractiveness of the opportunity for institutional investors in particular.  Management has resisted converting to a REIT.  Don't expect this to change.

Another drawback is liquidity.  There are many days where the units don't trade at all.  Any further repurchases of equity by the company would exacerbate this.

Summary:

NEN offers the opportunity to own a portfolio of Boston area apartments at valuation that is well below where other national portfolios trade.  One can argue that the Boston market has better metrics for apartment ownership (tighter supply, colleges, favorable industry composition) than other markets.  Recently, the New England market has seen favorable rental increases per AVB.  This is expected to continue.  The company, as well as management, continues to buy the outstanding shares.  We think there's a good chance that a major refinance in 2013 could lead to another large repurchase of outstanding equity.  At that point, management could also boost the dividend sharply.  All-in, this is a well-managed, inexpensive apartment portfolio in one of the most desired markets in the country.  Sooner or later, the value in this portfolio will be unlocked.  For investors looking for exposure to the apartment sector with downside protection, one could do worse than NEN.

Disclosure: I am long NEN.