Description

Under very reasonable valuation metrics, CTO Realty Growth Inc. is worth ~$80 per share by the end of 2022 vs. the current trading price of $57, representing a relatively low risk 40% upside in a little over one year.  CTO was last written up on VIC in May 2014 – it was a great write up which provides background on what the story looked like at that time.  A lot of the thesis has played out which is a testament to the leadership under John Albright, the CEO who was put into place in 2011 due to activism by Wintergreen Advisors.  Generally speaking, the investment pitch was CTO would sell off non-income producing assets, reinvest proceeds into income producing real estate investments and convert to a REIT.  CTO is at the final leg of that transition – they only have $9.0mm of remaining non-income producing assets to sell vs. a total asset base of $690mm and they have already converted into a REIT.  At this point, there are five buckets of value (1) value of income producing assets in place (2) value of income producing assets to be acquired with cash on hand and proceeds from the sale of remaining non-income producing assets (3) ownership of their Mitigation Bank JV (4) the market value of Alpine Income Property Trust (ticker PINE) owned by CTO and (5) the value of CTO’s management agreement with PINE.  CTO takes a lot of guesswork out of the valuation – specifically, we point readers to their most recent investor presentation – and more specifically, slides 12 and 13 of that presentation.  A SOTP table is provided at the end of this write-up.  

Value of Income Producing Assets

As stated on slide 12 of CTO’s most recent presentation, as of 9/30/2021, CTO had $37mm of in-place NOI and they are collecting 100% of contractual base rent.  CTO’s portfolio is 91% occupied and in high-growth, business friendly markets (a lot of Florida and Texas).  The composition is as follows:

On slide 13 of their presentation, CTO states that putting the $75mm of cash on their balance sheet to work will add another $4.7mm of NOI, which puts in place NOI at $41.7mm.  No heavy lifting here – in this rate environment and where REITs have been trading, a 6.50% cap rate is quite reasonable which equates to $642mm of value.

Value of Assets to be Acquired with Proceeds from Assets Sales

In recent years, CTO has been opportunistically selling off their non-income generating assets and using proceeds to purchase income generating real estate.  CTO is part owner in a JV which owns 1,600 acres of land in and around Daytona Beach.  In June 2021, they announced they had entered into a binding contract with an affiliate of Timberline Real Estate Partners for the sale of this land for $67mm.  CTO will receive $25.6mm.  Book value of CTO’s portion was held at $42mm, therefore we should not see a tax liability from this sale which is expected to close by year end.  CTO also has $9.0mm (company guidance) of other assets including subsurface mineral interests, wholly owned excess land, loans and other assets.  This is outlined on slide 12 of their most recent presentation and is calculated by taking the $32mm of other assets and subtracting out their $23mm ownership of the Mitigation Bank JV (further explained below).  Assuming CTO uses proceeds of $9.0 + $25.6 = $34.6mm to acquire $98.9mm of assets at a 65% LTV, they will have another $7.9mm of NOI from income producing assets.  At a 6.50% cap rate, this is worth another $122mm.  A sanity check to these numbers is provided on slide 13 of their presentation.  Specifically, they state investing the cash on their balance sheet and non-income producing assets in real estate and adding leverage will add another $12.4mm of NOI which equates to $49.4 of PF NOI, in line with our SOTP model below.

Value of Mitigation Bank JV

CTO’s Mitigation Bank JV engages in the creation of wetland mitigation credits and sells those credits to third parties.  Mitigation credits are used by developers to offset ecological losses that occur when developing new land.  In 2018, CTO sold a 70% interest in this JV to BlackRock for $15.3mm.  Without going into a ton of detail, the agreement required CTO to sell a certain number of mitigation credits per year and BlackRock had a put right to put a certain number of credits to CTO each quarter at 60% of the then fair market value of the credits.  On September 30th, CTO repurchased BlackRock’s 70% interest for $16.1mm, implying the whole pie is worth $23mm.  This is the same valuation that CTO held their 30% interest on their own books.

Value of PINE Shares Owned by CTO

CTO owns 2.04mm shares of Alpine Income Property Trust (ticker PINE) which owns and operates a portfolio of single-tenant commercial properties.  PINE trades at a price of $17.97 vs. a consensus sell-side target of $22.29 which is still a big discount to peers.  At the current trading price of PINE, CTO’s ownership is worth another $36.7mm.

Value of PINE Management Agreement

Pursuant to CTO’s management agreement with PINE, CTO earns a base management fee equal to 0.375% per quarter (1.50% annually) on PINE’s total equity.  They also earn an incentive fee equal to 15% of returns above an 8.0% hurdle.  In 2020, CTO earned management fees of $2.5mm and they are currently earning an annualized amount of $2.7mm.  In CTO’s most recent presentation, they valued this management fee stream at just $8.6mm – which was “calculated using the trailing 24-month average management fee paid to CTO by PINE as of September 30, 2021, annualized by multiplying by twelve, and then multiplied by three to account for a termination fee multiple.”

SOTP Summary including 1 year of Dividends:

Why Does this Opportunity Exist?

The most obvious explanation is that with a market cap of just $340mm, CTO is far too small for most REIT investors to know about or even care.  We’ve learned that REIT investors are very finicky.  Unless a REIT follows a very strict list of portfolio composition rules, most REIT investors will stand clear.  This includes owning non-core or non-income producing assets.  As CTO transitions away from non-income producing assets into a full REIT portfolio, more REIT investors might care.  But if REIT investors ever start to care, this will trade a lot better than a 6.5% cap rate.  If REIT investors never care, CTO will still attract value investors and a 6.5% cap rate is probably in the right ballpark.  Although the full business transition won’t be complete until the later part of 2022, investors still pick up a 7.0% (and growing) dividend yield while we wait.

Catalyst

Sale of non-income producing assets in 2022 and purchase of income producing assets with proceeds from those sales and cash on hand