Description

Overview

INDUS Realty Trust (INDT) offers an opportunity to participate in Gordon Dugan's public investment in the warehouse space.  We believe this is a cheap option on Gramercy Property Trust 2.0 with 3-5 bagger potential in the next few years. Gordon Dugan is famous for growing Gramercy from $243mm market cap in 2013 and selling it to Blackstone in 2018 for $7.6 billion.  The return to shareholders over 5 years has been amazing as Blackstone paid $27.50 for a stock that traded at $4.06 in straw1023's write up in Aug 2013 for a 6.8x plus dividends along the way.  Gordon Dugan joined the board of INDT as chairman about a year ago and moved quickly to revamp INDT's investor relationship outreach.  INDUS underwent a REIT conversion and a rebranding from its nursery roots, Griffin Industrial Realty.  Since then, INDT has raised $27mm in equity capital at $50/share from Conversant Capital in 2020 and recently closed a $105mm equity raise at $60/share with a roster of bulge bracket investment banks.  The roster includes Morgan Stanley and Citigroup as co-lead joint book-running managers, Baird acting as bookrunner and BTIG, JMP Securities and J.P. Morgan acting as co-managers for the offering.  INDT's story is quickly transforming from a subscale warehouse company being exploited by the controlling family to a potential compounder leveraged to growth in e-commerce with an all-star chairman.  We believe that the combination of Gordon Dugan and Michael Gamzon (CEO) is a perfect match to participate in Gramercy Property Trust 2.0.

Link to Investor Presentation - https://indusrt.com/wp-content/uploads/2019/06/Q4-Supplemental-2.18.21-vFINAL-1.pdf

Asset Summary

INDT owns 4.2mm sqft of warehouse in Hartford CT, LeHigh Valley, Charlotte, NC, and Orlando FL that generates $25mm of NOI. The company also owns $19mm of land under contract to sell and another $30mm present value of land parcels from its legacy as a tobacco grower in CT.  In addition, the company owns an office portfolio worth about $14.5mm and $11mm worth of warehouses under construction.  Most of the warehouses is developed internally without accessing the public capital markets.    

Key Value Proposition

Gordon Dugan is the capital market wizard who can help INDT gain access to low cost of equity capital.  We have been surprised by how much the buyside loves him.  The reaction has been "why is he involved in this micro cap?  Let me take a look.”  In turn, Michael Gamzon can deploy the capital into smart development deals and one-off "value add" opportunities in the warehouse space.  We believe that the development deals and value add can generate 6.0-7.0% un-levered cash returns.  The public comps such like Prologis, EastGroup, First Industrial, etc trades in the 3s to low 4s cap rate.  Private market cap rates for most markets are in the fours with certain markets in the 5s.  If INDT put $100mm to work (which they are currently doing) and achieve a 6.5% unlevered cash yield, the value creation is about 44% if the market will value the stabilized NOI at 4.5% cap rate.  At 4.0%, the value creation is 62%.  At 5.0%, the value creation is 30%.  If the company uses a modest 30% LTV of debt, then the value creation is 42%, 63%, and 89% for 5.0%, 4.5%, and 4.0% cap rates respectively.  There is also the reflexivity of accessing public market capital with WACC at 3.7% assuming 3.0% cost of debt and 4% cost of equity on 30% LTV.  VIC members are smart, I do not think I need to explain further how this is accretive and create a lot of value.        

Let's address the key question why would Gordon Dugan put his name on a micro cap warehouse company?  We think it is because INDT has a great track record in ground up development of 100-400k square last mile Class A warehouses.  Michael Gamzon, the current CEO, astutely pivoted the company away from its legacy nursery business, office, and land holdings north of Hartford CT into a 4 mm sqft warehouse portfolio in four different submarkets.  The decision to buy and build in the Lehigh Value in the early 2010s has been a homerun decision.  We estimate that the equity IRR is in the high 20s.  INDT acquired and built 6 warehouses totaling 1.3mm sqft for $87mm.  This portfolio is likely worth $185mm today at $140/sqft.  INDT also did it without access to capital markets.  INDT would build one warehouse with construction loan and then use mortgage it and pull the cash equity out.  The process was rinsed and repeated multiple times.  We estimate that the return on equity is about 6x plus cashflow received while the company employed on average $21mm of equity in the projects.

There are a lot of example of astute capital allocation by Michael Gamzon such as acquiring a warehouse in Charlotte, NC via a 1031 exchange that was 76% occupied and quickly leased up to 100% within months.  Recently, they announced a 15 year deal with Amazon for a build-to-suit that will yield in the 6% range in Charlotte, NC.  They can probably sell a building like this in the sub 4% range.  They also did a build-to-suit for Ford Motors to distribute parts to dealers in the NE region for 12 years.  With no access to the public capital markets, the CEO has built an enviable portfolio that will stabilize to about $25mm of NOI.  By utilizing $160mm of non-recourse mortgages, we believe the value creation has been north of $200mm plus cashflow in the last 10 years.  This $200mm of value creation is impressive when we consider that the company utilized a rinse and repeat strategy that only utilized a maximum of $20-30mm of cash equity on development or value add projects at any given time.      

After following the company for 4 years, we have come to appreciate Michael Gamzon's abilities.  We think he has two key skills which are rare.  Warehouse developers tends to be either good at the forest or the trees.  They are rarely good at both the big picture and the detail.  From our conversation with Gordon, he admits that he was more of a bigger picture and capital markets guy.  He played a good public/private arbitrage game from 2013 to 2018.  INDT's CEO is good at picking the right markets.  So far, their entry into LeHigh Valley, Charlotte, and Orlando have proven to be astute.  The company has identified 10 markets that they view as favorable due to land constraint, demand growth, and favorable long-term demographics.  They believe that they can develop to greater than a 6% cap rate and still enjoy 2-4% rent increases in the long run due to these unique dynamics in the local market.  Remember that pivot from Hartford into LeHigh 10 years ago?  The CEO has been studying these 10 markets for years now.  INDT has no intention of entering a market like Dallas where one can always build bigger boxes a little further out.  To understand the opportunity, one must understand that warehouses like self-storage has a NIMBY dynamic where neighbors do not want them close to residential areas.  Due to INDT’s smaller scale, we believe they can effectively deploy capital in a sharpshooter manner to pick off unique opportunities in those 10 markets.     

On the micro level, we have been impressed with how the CEO consistently surprise us with development and leasing of projects.  Out of the blue, the company will announce a build-to-suit with credit tenants with 10, 12, 15 year leases on a 200-250k box.  We have personally visited warehouses in Hartford, CT, LeHigh Valley, PA, and Charlotte, NC.  I know I am weird.  I just have to go see these assets myself.  It is a disease of mine.  I can assure you that they are 1) New Class A buildings 2) have all the proper ceiling height, construction quality, floor smoothness, parking spaces, and dockings, etc. 3) well located within striking distance for last mile delivery or centrally located in strategic areas for regional distribution.  We believe that the CEO is as good as anyone at Blackstone or Prologis when it comes to designing the right features for a warehouse with regards to all the factors that I listed above.  

Valuation       

The attached NAV calculation is a good framework to think about the current value.  Due to the recent fund raising and the development pipeline, we must grmake some modifications.  We need to add $98mm of net cash proceeds from recent equity raise.  The $7.3mm of NBV of remaining undeveloped land should be adjusted to about $30mm of present value.  This assumes about $15/sqft for the entitled industrial land which translates to about $15mm.  The commercial/mixed use land has traditionally been sold for about $100k/acre. This would translate into $23.5mm.  The CT nursery farm allows the tenant to buy it for $7 to $9.5mm.  These three assets bring us to $45 to $47mm.  The other parcels will be considered extras.  By applying a one third haircut, we get to a ballpark of $30mm.  This is not exact, but I feel that we are in the right ballpark.  Frankly, if you use $20 or $40m, it does not matter much at this point. 

$25mm of stabilized NOI @ 5% cap rate = $500mm

Land under contract = $17.6mm

Office/Flex = $14.5mm

Construction in progress = $10.7mm

Excess land = $30mm

Cash and other assets = $28.5mm + $23.1mm + $98mm = $149mm

Total liabilities = $207mm

Equity Value = $721mm asset value less $207mm total liabilities = $514mm

NAV Per Share = $514mm/7.4mm shares = $69.45

Near Term Opportunity – The company has announced $112mm of developments that will yield between 6.1-6.6%.  This is an incremental $101mm of capital as $11mm has been spent.  Upon lease up, this will add $6.8 to $7.4mm of NOI to the company.  At 5% cap rate, this will translate into $136mm to $148mm of warehouse value thus creating an additional $24mm to $36mm of value.  This translates to $3.24 to $4.86 in per share value creation.  This will cause NAV to reach $73 to $74 per share.  However, if you believe that a 4.0% cap rate is appropriate for the portfolio, then the NAV will be $91 per share.      

Compounder Potential

Is it worth it to pay $60 for something that is worth $70 today and possibly $91 in 1-2 years?  On paper it seems not that attractive.  However, we have to recognize that INDT has the potential to become Gramercy 2.0.  If Gordon Dugan and Michael Gamzon can get the shares to trade at a premium to NAV which would imply something in the 4.0% cap rate range.  Then reflexivity kicks in and the value creation from issuing equity to develop to a 6.0% to 6.5% cap rate is 50% to 62% on an unlevered basis.  You guys are smart enough to understand this. 

Why Does This Opportunity Exist? The Brisket Stall Phase

Fund managers will compare investing to all sorts of endeavor like endurance sports and cage fighting.  They even use all sorts of fancy words like variant viewpoints and draw up pictures like flywheels etc.  I will try to convince you that investing is really like smoking a brisket.  You see the brisket is a rough cut of meat that contains a ton of tough connective tissue, water, and fat along with muscle.  Turning those connective tissue into juicy succulent bits of heaven is a craft and requires a bit of patience.    

A brisket stall is a phenomenon that occurs when, after a brisket has been put on to roasting on a barbecue or smoker, the temperature of the meat suddenly stops rising. This stall in temperature can last for four or more hours, sometimes even dropping a few degrees in temperature instead. The stall usually happens at around 150°F, nowhere near the ideal temperature of 203°F for a tender, succulent brisket.

There are many theories on why this happens.  One theory is that the collagens are being transformed into gelatin which results in delicious and succulent brisket.  Another theory is simple evaporation of water inside the brisket.  Whatever it is, this is a necessary step in cooking a succulent brisket and you must stay the course and keep at it.     

In the past 6 months, INDT share price has stalled around $60 which is the same price as the recent $105mm secondary offering.  We believe that INDT is currently experiencing its own version of Brisket Stall in its share price performance.  We specialize in investing in smaller and subscale real estate companies trading a discount to private market valuation.  As such, we have become accustomed to the various pain points of elevating a small cap real estate company into an institutionally owned REIT.  In INDT's case, INDT has completed many of the heavy lifting.  They have converted into a warehouse REIT.  They have rebranded themselves and bought on a credible chairman to advocate for the company.  They have already raised $130mm of equity capital.  It is currently in the process of converting the existing shareholder base from retail and hedge funds into long only mutual funds and indexes.  In addition, the story is not quite a pure play on warehouses now.  Wall Street love pure plays!  It takes additional work to adjust for land and office in Hartford which no public market investors want exposure to.  There is also the dynamic that INDT is subscale.  At $25mm of warehouse NOI and $8mm of G&A and $7mm of cash interest, there is only $15mm of FFO.  It does not screen well.  The trading liquidity could be better.  There is $112mm of development that will add $6.8 to $7.4mm of NOI which will largely fall to the FFO bringing it above $20mm.  There is also a larger concentration of the NOI in Hartford CT now.  If INDT is a brisket, these pesky factors are the touch connective tissues that we must cook through to get to the promise land of that succulent bite of smoked heavenliness.   

I think we will get there in the next 12-18 months.  The existing warehouse portfolio is 99% leased now and hence the $25mm NOI has been achieved.  The latest delivery date for the $112mm of development pipeline is Q2 2022.  Half of the expected NOI in the pipeline is pre-leased including the 15-year deal with Amazon which accounts for about 1/3 of the pipeline.  The company also has $19mm of land under contract for sale which they will 1031 into development deals.  We believe the company will likely sell the office portfolio and reinvest into warehouses soon.         

Due to the Brisket Stall dynamic, shareholders can participate at an attractive entry price on a potential long-term compounder.

Downside Analysis and Hedging

With the recent equity raise, INDT has significantly reduced Debt to EBITDA metrics.  We are buying the current warehouse portoflio at about 6.3% cap rate.  This is a good price for a portfolio of young Class A warehouses.  We estimate that a portfolio like this in the private market will trade at high 4s to low 5s cap rate.  We can also use a $/sqft analysis.  Most portfolio transaction of this size has been done in the $110-130 range lately.  INDT trades at about $96 for the warehouse portfolio after netting out other assets.  Public comps typically trade at high 3 to low 4s cap rate.    

If you are worried about interest rate, cap rate, or overall forthiness of the warehouse market, you can hedge out the risk by buying puts in Prologis.  Due to Prologis' $85bn market cap, the puts 20-30% out of the money are fairly cheap.  I think an investor can compound at >20% by being long INDT while hedging out tail risk and taking a 2-3% annual drag on performance by buying out of the money tail risk puts in Prologis.  I would not recommend buying Terreno or Rexford as they have exposure to unique coastal markets.   

Summary            

Investors can buy INDT at 15% discount to NAV today with the optionality of the NAV going to over $90 in the next 12-18 months.  Most importantly, this is an opportunity to bet on 2 excellent jockeys with a long runway for growth.  INDT smaller size coupled with Gordon’s sponsorship is an unique advantage.  It is much easier to move the needle with $100-300mm annual clip of developments and value add deals.  The public comparable companies need at least $1bn a year in development or deals to move the needle.  This is a cheap option on Gramercy Property Trust 2.0 with 3-5 bagger potential in the next few years.       

Footnote

Please note that we wrote up INDT in its previous form as Griffin Industrial Realty in 2018.  We believe the investment case is completely different today and warrants a new write up and should be considered as a complete new idea.  

Catalyst

Development of $112m pipeline adding $6.8 to $7.4mm of NOI 

Selling of land under contract and selling of office and redeploy capital into warehouses via 1031 Exchanges 

More investor relationship outreach to switch out retail and HF shareholders to long only institutions and indexes