New England Realty is a publicly traded limited partnership that owns apartment buildings in greater Boston. Note: In addition to the small market cap, this is very illiquid as over 40% of the stock is held by insiders (who never sell and periodically add to their holdings): The average daily volume is about 500 shares so it is really most suitable for personal accounts. It has been written up on VIC 5 times in the last decade, so for those of you interested there is plenty of background and, consequently, this analysis will be short and to the point.
Simply put, NEN trades at 50-60% of its intrinsic value, which I believe will grow nicely going forward. Furthermore, Harold Brown, the General Partner and largest owner has a long track record of value creation and shrewd capital allocation. Though Mr. Brown is 86, he is still totally absorbed in the business. Additionally, Carl Valeri, who is not an officer of NEN but is the President of Hamilton Realty, a private company which is closely affiliated, is very knowledgeable and highly motivated, owning over $4MM in stock. Valeri is in his late 40’s; he should be an excellent leader of the company at some point in the future.
The Boston Apartment Market:
NEN’s focus on this market is important for several reasons. First, management has scale (over 7000 apartments between NEN and Hamilton) and immense local knowledge. Second, Boston has unique characteristics: A large student population and health care/scientific community who are great tenants for the middle-income apartments that are the company’s bread and butter. The area is land constrained and permitting is difficult in many of the municipalities. A Marcus & Millichap survey ranked Boston as the #3 rental market in the country keyed to strong employment growth:
Management notes that the market really started to firm in late 2010.
Here are a few different ways of looking at the underlying value of the partnership:
I: NOI in 2010 was $16.61MM. I conservatively project $17MM in 2011. At a 6% cap rate, which I also think is conservative, the enterprise value is $283MM. Total debt is $142MM. Note that almost all of this is long-term mortgage debt on the underlying properties without cross-collateralization. So the equity value is $141MM, or $107/share on a base of 1.315MM shares. In addition, however, NEN is a JV with Hamilton Company in 7 apartment complexes totaling 799 units. Over half of the value in this group is in Dexter Park, which is a 409 unit complex in Brookline. For those of you not familiar with Boston, it is in a fantastic location--very near BU and the medical corridor on Longwood Avenue. NEN (40% interest) teamed with Hamilton Company to buy Dexter Park for $129.5MM in late 2009. I think the current value is a little higher than that and that this asset should appreciate handsomely over the long term. In all, I estimate the equity value net to NEN of its unconsolidated holdings is $35MM, or $27/share. Hence, my appraisal of the overall equity value is $134/share.
Another way of looking at this is to back out the unconsolidated holdings. On that basis, NEN trades at a current cap rate of 8.6%.
II: NEN owns 2288 units outright and a proportional share totaling 358 units in the JVs. On the current enterprise value of the company, that is $88K/apartment. This is ridiculously low for a portfolio of good quality apartments in metropolitan Boston. Over the last 3 years, in fact, NEN has sold three of its less attractive holdings at prices ranging between $96K/unit and $133K/unit.
III: After backing out interest and projected capital outlays for 2011, NEN should generate about $7MM in free cash flow, or $5.32/share. This represents a 7.7% return on the current stock price forgetting about the value of the unconsolidated holdings. Backing those out as above raises the cash on cash return to 12.7%.
NEN has distributed $2.80/share for several years. I believe that this is unlikely to change going forward unless the partnership (and hence shareholders as tax treatment is passed through to them) generates a lot of taxable income, which has not been the case. Management is more interested in opportunistic real estate purchases and share buybacks than increasing the distribution for its own sake. Between late 2007 and the end of 2010, the company bought back almost 30% of its stock outstanding at an average price just under $74/share.
I think the biggest risk is spike in interest rates over the next couple of years. NEN has attractively priced, long-term mortgage debt in place today, but faces a refinancing challenge in 2-3 years. Management is acutely aware of this fact. Mark Twain once said, “History doesn’t repeat itself--at best it sometimes rhymes.” If rates move as they did in the 1970’s, there should be an opportunity for NEN to refinance most or all of its debt coming due even if the company does not hit the absolute bottom in rates and/or has to pay a price in prepayment penalties.