Description

TLDR: Nanocap stock ($72mil market cap) trading at 63% of NAV consisting of newly originated commercial real estate (CRE) debt and cash. For PAs and small funds.

Sunrise Realty Trust, Inc. (SUNS), a CRE-focused REIT, was spun out of AFC Gamma, Inc. (AFCG), a cannabis REIT, on July 9, 2024. The divergent strategies, disparate investor base for the assets, and nanocap size create a classic spin-off dynamic. SUNS has $115mil in net assets consisting of 3 CRE debt investments originated since January 2024 and the remainder in cash. At $10.45 per share and a market cap of $72mil, the stock is trading at 63% of NAV. This seems cheap, even if there may be reasons for some discount to NAV.

Background on SUNS

AFCG is a microcap mortgage REIT focused on the cannabis industry. It’s struggled since going public in 2021 as the entire cannabis sector has been in a multiyear selloff (See the chart for the cannabis sector ETF MSOS since 2021: https://www.google.com/finance/quote/MSOS:NYSEARCA?hl=en&window=5Y). Because of the extended downturn in the cannabis sector, AFCG began a pivot towards the commercial real estate sector and subsequently decided to spin out its CRE investment strategy into a separate company.

By now everyone is aware of the stresses in the CRE market as a result of the rapid rise in interest rates over the last couple years. The dislocation has created opportunities for new capital providers to deploy investments into this sector that is experiencing reduced liquidity and increased distress.

SUNS focuses on originating debt investments collateralized by CRE assets and providing capital to high-quality borrowers and sponsors with transitional business plans. SUNS is seeking to create a diversified investment portfolio, targeting investments in senior mortgage loans, mezzanine loans, whole loans, B-notes, CMBS and debt-like preferred equity securities across CRE asset classes. They are targeting a mix to include high quality multi-family, condominium, retail, office, hospitality, industrial, mixed use and specialty-use real estate. The geographic focus is in the Southern U.S. markets, which have seen favorable demographic trends, particularly since 2020.

SUNS has an investor presentation deck providing disclosure about its strategy and its 3 assets as of the spinoff date on July 9, 2024:

https://ir.sunriserealtytrust.com/static-files/dfddf5df-b7da-4fbb-9c7d-d6034a169399

Investment Merits

1. Favorable macro environment to be investing in CRE, not hampered by troubled legacy investment. Here are excerpts from the company’s Form 10 filings describing the opportunity:

   1. “The CRE debt markets today present a significant opportunity to capitalize on market dislocations precipitated by the rapid increase in interest rates since March 2022, declining liquidity and a retrenchment of banks from CRE lending. SUNS believes this declining liquidity presents a once-in-a-decade opportunity for alternative CRE lenders to generate higher returns at reduced leverage levels. Since 2020, COVID-19 has accelerated pre-existing migration patterns and increased CRE demand in the Southern U.S., leading to a supply-demand imbalance which SUNS believes will persist for the foreseeable future.”

   2. This chart from the company’s investor presentation (see link above) provides a visualization of the opportunity (essentially higher pricing at lower leverage levels):

3. There is relief in sight for the CRE industry over the next 2 years. The rates markets are projecting 3 Fed cuts in 2024 and 4 in 2025. CRE loans are floating and benchmarked off of SOFR rates, which track the Fed funds rate. The decrease in interest rates will eventually improve liquidity conditions and help to reduce borrower distress.

2. Margin of safety

   1. At 63% of NAV consisting of 3 CRE debt investments originated since January 2024 and the rest cash on the balance sheet, SUNS offers investors a sizable margin of safety.

   2. The company’s investor presentation from July 9, 2024 (see link above) provides disclosure about these 3 assets. These loans are well collateralized, have reasonable LTV/LTC, and have attractive yields. Below is a snapshot of the 3 loans:

3. Significant Insider ownership. The founder and Executive Chairman of SUNS, Leonard (“Len”) Tannenbaum, owns 1,294,755 shares of SUNS Common Stock, or approximately 18.8% of SUNS Common Stock.

4. Recent insider purchases. Multiple insiders have made a number of sizable insider stock purchases since the spinoff.

   1. See the recent Form 4 purchase filings here: https://www.sec.gov/edgar/search/#/ciks=0002012706&entityName=Sunrise%2520Realty%2520Trust%252C%2520Inc.%2520(SUNS%252C%2520SUNSV)%2520(CIK%25200002012706)

5. Experienced CEO Brian Sedrish. Brian has 25+ years commercial real estate experience and was former portfolio manager at Related Fund Management, former Head of Real Estate Acquisitions Special Situations at Deutsche Bank, and previously employed at Fortress, Goldman Sachs and Lazard Freres & Co.

Reasons for the Discount to NAV

1. Spinoff dynamic. SUNS is a CRE focused REIT spun off from a cannabis focused REIT. While there may be some overlap in the investor base seeking yield, these are different markets and generally appeal to different types of investors.

2. Nanocap size. The current market cap is only $72mil. Even though the market cap is small, the trading volume has been $1mil to $5mil per day since the spinoff. The volume appears to be gradually tapering off over time. Most of the investor base is retail investors. The Form 10 disclosure lists only 1 investor other than the founder with more than 5% ownership (6.9% ownership by Blackrock, which may own it as part of a passive investment strategy or in its wealth management division). 

3. External management of the company. Externally managed REITs generally trade at a discount to internally managed REITs. Externally managed REITs are more likely to trade at a discount NAV. The external manager is passing through expenses and charging a base fee plus incentive fees, which will eat into returns but is not atypical for the industry.

4. Undersized asset base resulting in oversized fees and expenses. Because of the small asset base, the pass-through management expenses and overhead costs are going to be relatively high initially but should decline over time as the business scales up.

5. No analyst coverage. Given the nanocap size and the lack of institutional ownership of the stock at this point, it will take some time to attract sell-side analyst coverage.

6. No current dividends. Retail investors own REITs for the dividend. The company does not currently pay a dividend, and there's uncertainty as to what the dividend amount will be. There will be more interest from investors once the company starts paying dividends, and SUNS starts showing up on dividend stock screens.

7. Concerns about management.

   1. The founder and CEO of AFCG and Executive Chairman of SUNS, Len Tannenbaum, has a negative history on Wall Street. The controversy at his prior company, Fifth Street, is chronicled here in a prior post on VIC from 2014:  https://www.valueinvestorsclub.com/idea/FIFTH_STREET_ASSET_MGMT_INC/5408438137#description.

   2. Potential governance and conflicts of interest issues. 

      1. Len Tannenbaum and Brian Sedrish also manage a private REIT called Southern Realty Trust (SRT) with an overlapping investment mandate. More information about this REIT can be found in the link here: https://thesrtgroup.com/wp-content/uploads/2023/12/C102023_NewDebtPlatform.pdf. While this presents a potential conflict of interest, it’s not uncommon at large investment management companies that manage multiple funds to have overlapping strategies and to have allocations to the same investment in multiple funds. SRT has investments in the same 3 assets owned by SUNS.

      2. Len’s wife Robyn Tannebaum is the President of SUNS and AFCG. Robyn and Len have been working together since the Fifth Street days. It’s not unheard of for founder-led / family-run businesses to have family members working in the business (e.g. Meta, Google, etc.), so it’s not a deal killer but worth noting.

   3. AFCG hasn’t exactly been a stellar investment since going public in March 2021. With Len also involved in SUNS, there may be concerns that SUNS will suffer a similar fate. While AFCG was an opportunistic venture launched by Len with no prior cannabis industry experience, SUNS is run by a CEO who has 25+ years of relevant commercial real estate investment experience. Moreover, the downturn in the cannabis industry has been tough on all players in the industry, with the cannabis ETF MSOS down 84% and the much larger cannabis REIT IIPR down 34% since March 2021. In comparison, AFCG is down 41% during the same period, so on a relative basis, it's roughly inline with or better than these comps.

   4. Overall, while Len’s involvement is a negative factor for the stock, he owns nearly 19% of SUNS and likely wants this stock to do well in the market so that he can raise additional capital to grow the asset base and generate more fees. This is not one of those situations where the management team owns no stock and is incentivized solely to issue equity without concern for the stock price in order to grow the company’s asset base.

Conclusion

On balance, while there are some reasons for the stock to trade at a discount to NAV, at the current price, the stock has an attractive risk/reward profile with a sizable margin of safety.

So what is a reasonable target price? A near term target price of $13.35, which is a 20% discount to NAV of $16.69 per share, seems reasonable. In addition to 28% upside from the current trading price, investors can expect at least a high single digit dividend (potentially a low double digit dividend by adding some leverage to the capital structure) once the payout normalizes in the coming quarters.

Since the spinoff date, the stock has been trading in a very volatile range between a low of $8.10 on the first day of trading to a high of $14.85 a few days later. With the market prices swinging wildly day to day, there may be opportunities to purchase at prices below the current trading price.

If the Fed cuts interest rates over the next 2 years, the distress in the CRE market should improve and drive up pricing for these assets. In that case, the underlying NAV will increase and push the stock price up further even if the 20% discount to NAV persists.

Risks

• Recession

• Interest rate risk

• Management

Legal Disclaimer: This report expresses my research opinions, which I have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purposes only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author and/or his employer has a position in this stock and may trade this stock.

Catalyst

• Spinoff dynamic dissipates over time

• Analyst coverage

• Improvements in the CRE sector

• Dividends