Description

Clipper Realty Investment Thesis:

Clipper Realty is an owner-operated REIT focused on New York City that is trading at a large discount to its NAV. It has a $440mm market cap, but a float of only $145mm as the rest is owned by insiders. It trades at a discount for a multitude of reasons, many of which we expect to dissipate over the next 12-24 months. We see the current price of $9.75 per share as an attractive entry point for a REIT with desirable properties, a competent and incentivized management team, growing free cash flow, and debt financing that is locked in for 10 years at a 3.75% cost. We project YE 2020 NAV of $23 per share (138% upside from here) and expect that NAV to continue to grow at attractive rates from there. We use year end 2020 as our NAV point because Clipper has locked in NOI growth from two properties (Livingston office assets) and a lease up of a new development (Clover House) that will drive NOI from ~$60mm to annualizing at almost $80mm by YE 2020.

With the backdrop of 1.82% ten year Treasuries, we would note that cap rates for high quality NYC properties are quite low. We feel comfortable that the cap rates we are underwriting to (4% multifamily, 5% office) are appropriate and conservative relative to the current private market (and to other publicly traded REITS). It is easy to hedge the broader cap rates for multifamily or interest rates more broadly.

We note further down in this writeup the various positive catalysts over the next 12-24 months but would like to note that FCF story here as well. We have Clipper trading at a 9.2% FCF yield on 2021 numbers after the lease up on Clover House and contractual rent bumps on the Livingston assets. From there we would expect CLPR to grow FCF at 15%+ organically as 5% NOI growth flows down a fixed capital structure. As non-earning assets continue to turn into income generating assets, we would hope they can do better than that. As the stock transitions from simply an asset value story to a cash flow story, we expect the market to rerate the stock materially.

As a public company, CLPR has, to date, been perceived by investors to be illiquid and an amalgamation of assets in a challenged area of the market (NY) that doesn’t generate much free cash flow. We expect as free cash flow growth improves, management works to simplify the portfolio, and NY (which is a relatively high barrier to entry & attractive market) eventually turns, that investors will eventually see this as the best way to play that turn. Over time, with a skilled and incentivized management team, we don’t see why this shouldn’t trade at or near NAV. We would note that there are numerous REITs that trade at NAV with significantly worse assets, incentives, and management teams. While it is hard to know when that shift will occur as companies and markets are hated until they are not, there is a very large opportunity for change in shareholder perception to close the NAV gap (and NAV should continue to grow nicely while we wait). This value dislocation is why we like to invest in small caps.

Background:

Clipper is a relatively recent IPO that has not worked. It went public in February of 2017 at $13.50 per share, after having originally sold shares to investors in an FBR sponsored 144a deal in the summer of 2015. As various investors from the 144a deal sold down shares, it traded poorly throughout 2017 and has continued to trade at a large discount ever since. The IPO was poorly timed with a weak time in the market for NY real estate. Its liquidity has remained very low throughout this time, averaging $270k per day.

The entity Clipper Realty was formed in 2015, but it is a combination of various entities that have been run by the Bistricer family for years. The Bistricer family has been a local sharpshooter in NYC for decades, with numerous examples of attractive purchases & developments. Based on our conversations with the bankers on the FBR deal (who had access to all of the past deals), the Bistricer family had a history of generating very attractive IRR’s on deals over time (this is supported by their wealth creation from real estate investing).

Clipper Realty is run by David Bistricer (CEO & Co-Chairman) and Sam Levinson (Co-Chairman). David Bistricer is the son of Moric Bistricer who started Clipper Realty in the 1950s. Based on our conversations, David has a very good track record of investing in the NY market. He owns approximately $150mm of stock and has been a buyer of the stock around these levels post-IPO. Sam Levinson is the CIO of Glick Family Investments and served as a Director at Canary Wharf, where he was instrumental in turning the business around. He has been a Partner of the Bistricers for more than a decade and owns ~$100mm of stock. David is less focused on the public markets and how his actions will be perceived by the Street with his primary goal to drive long term property level return. Sam is more cognizant to how cost of capital and public market perception can improve shareholder return over time. We have had the opportunity to get to know both of them and believe they will be good stewards of capital over the long run.

Portfolio Overview:

We don’t have much to add here beyond what the company has presented in its June NAREIT presentation. Broadly, we would say the following about their portfolio. They are opportunistic across different locations/types of buildings in NYC. They focus their energy on assets where there is no natural owner; as an example, a building that is currently leased but where there is optionality on a condo conversion is something they like. They like assets that look expensive on a cap rate basis but have a growth story that allows them to create the asset 3 to 4 years out at a really attractive price. I think there is good disclosure in their filing about all of these assets, but happy to go into more detail in the messages if there are buildings people have questions about.

[1]

Valuation/NAV/Projected Returns:

We primarily value Clipper on an asset by asset basis (shown below). We have applied a 4% cap rate on multifamily properties, which is consistent with what we are seeing in the private market. It triangulates with what we are seeing in the public markets for relatively supply constrained, attractive markets. Putting those cap rates into levered IRR based on current debt costs and using the recent Clover development as a proxy, we see a 4% cap rate financed with 3.5% debt at 60% LTV, translating to a 5% FCF yield growing at 10% per year (on a 5% NOI growth). So, 4% cap rate approximately equals a 15% forward levered return for a new investment. We have applied a 5% cap rate to the office buildings (Livingston). We think that is appropriate given the long-term contractual nature of the contracts with the city, but tempered by lower growth than we expect on the multifamily side.

We have spoken to local operators and feel comfortable that the cap rates we are using are relatively conservative for the specific assets.

Among the larger assets, we would note that Tribeca has the potential upside of a condo conversion down the road. We don’t incorporate this into our valuation because the market isn’t in a place right now where a conversion makes sense, but you are creating the building for ~$1,000 a square foot in a market where condo prices are double that (obviously costs along the way to execute it). LimitedDownside wrote CLPR up in 2017 and was more focused on this issue.

We do incorporate the upside of the redevelopment of Flatbush gardens in our valuation. We assume $60mm of value, which seems conservative given the amount of square footage they are proposing to add. The process is moving along, and we expect to have a lot more clarity on the upside (which could be significantly higher than what we have included) in 2020.

Returns: We underwrite to CLPR rerating to ~75% of in-place NAV and a 6% forward free cash flow yield by the end of 2021. While we think it should happen faster than that (and again see no reason for this to trade below NAV), this seems like a reasonably conservative case to underwrite to.  That generates a $16 stock price two years out which along with dividends gets you a ~31% IRR. We hope to do better than this if market perception around the capital allocators/the market changes. 

Why does this opportunity exist:

·         Liquidity

o   Trades $270k a day. Hard to own for institutional investors.

·         NYC market softness/investor disdain

o   NYC has been weak on supply issues for a few years now. More recently the market has firmed up.

o   We continue to believe NYC will be a very attractive multi-family market over the longer term.

·         Confusing asset mix

o   While Clipper has a focus on NYC, its mix of mostly multifamily with some office makes it difficult to invest in for “REIT Mafia” types-where often you have different analysts covering office and residential.

• We don’t believe this will be the asset makeup in the longer term.

·         Lack of free cash flow

o   CLPR historically hasn’t generated significant free cash flow as they plowed capital into renovation and developed Clover House.

• This will change starting 2021.

·         Recent development missteps

o   Recent acquisitions and developments have been subpar compared to their historical deals.

• 10 West 65th was priced for an eventual development but is expensive on current income. Because of the environment, they are waiting on the development.
• Clover House had cost/timing overruns; while we don’t think they lost money here (have created a very attractive asset in an A+ location), there was a lot of work to not create much if any excess value.

o   We don’t believe two mediocre developments (in a relatively tough environment) in a long history of good investments changes the investment thesis; but it has detracted some of the excitement from the investment thesis.

·         NY Rent control

o   In June of 2019, NY passed new rent control laws, which surprised a lot of people given the lobbying power of RE owners locally.

• This NYTimes articles summarize the law pretty well: https://www.nytimes.com/2019/06/12/nyregion/rent-regulation-laws-new-york.html

o   While the laws are worse than Clipper mgmt would have expected and definitely caused CLPR to trade down, the impact on CLPR is not huge and is fully reflected in my valuation above.

• The law impacts Aspen and Flatbush (1/3 of NAV).

o   On that 1/3 of NAV, the laws don’t lead to decline in NOI-just a slowdown.

o   Here are the laws’ main impacts and how they relate to CLPR.

•   Law limits ability to transition from regulated to free market rents above a certain price point. This has no impact on CLPR-they are already not doing this.
•   Law limits rate increases landlords can pass on per year when below the legal limit on rent-this has a small impact but not huge. Maybe a couple of percent a year. Can still catch up when tenants move out.
• Law limits ability to upgrade units and raise rents-this is a frustrating part and will slow Capex and Growth. They have been utilizing this ability.

o   Net-net, it does have an impact most importantly at Flatbush. It takes a 7% NOI grower down to maybe 4% in the near term, but that 4% should be very steady. Impact on Aspen will be a bit less.

·         Leverage

o   Some investors believe the leverage is too high, but we believe longer term it is attractive. They use similar leverage to most private owners of apartments buildings in NY and have a 3.75% cost of debt on locked in money.

Catalysts:

·         Livingston NOI bumps (2020):

o   250 Livingston is leased to the city and will have a $5mm annual NOI bump in 2020.

o   141 Livingston is also leased to the city and will have a 25% rent bump ($2.1mm) at the end of 2020.

o   Clipper should generate 12% NOI growth across the whole portfolio as these rent bumps flow through the numbers.

·         Flatbush redevelopment approval (2020)

o   Progressing on Uniform Land Use Review; expect to have resolution in 6-9 months.

o   Can potentially increase the floor area ratio materially, allowing them to meaningfully expand-will drive a lot of value to the property if they can achieve it.

• Discussions so far have been positive with the government.
• Could get up to 1mm incremental square footage-we have marked at $50mm in our NAV, if they get 1mm square feet-should be worth more than that.

·         Transformative free cash flow (2021)

o   We have CLPR trading at a 9.2% FCF yield on 2021 numbers; as Clover House comes online, and the rent bumps roll through, we are projecting a vehicle that can grow cash flows sustainably and quickly.

• Locking in cap structure for a decade helps in this regard.

·         NYC market (TBD)

o   We are starting to see a firmer market on the leasing side (not for condos).

o   If this continues, we expect it to have an impact on the operations and on the sentiment regarding the stock.

[1] Clipper Realty Investor Presentation, June 2019

Catalyst

2020 NOI growth, asset simplification, Flatbush redevelopment, transformation to cash flow story