Description

With only $150k of daily volume and less than $40 mm of float, Transcontinental Realty Investors (TCI) is only suitable for PAs and small funds.

On Sept 22, Brixton Capital and Shidler Group made public an offer to purchase all shares of TCI for $44.4/share, after being ignored by the TCI board. Both Brixton Capital and Shidler Group (run by prominent Hawaiian businessman Jay Shidler) have been active in multifamily investments, and it is no surprise that they would desire TCI’s multifamily portfolio.

TCI is a real estate company 78% owned by American Realty Investors (NYSE:ARL) and 7% owned by Realty Advisors. Both ARL and Realty Advisors are ultimately owned by May Trust whose beneficiaries are late Texas real estate tycoon Gene Phillips’ children, one of which is Brad Phillips. ARL’s only substantial asset is its 78% ownership of TCI.

One interesting aspect of TCI is that it provides detailed filings to the Tel Aviv Stock Exchange (TASE), because TCI has issued three series of Israeli bonds listed on the TASE. Substantially all TCI assets are owned by its subsidiary Southern Properties Trust (SPC), which is the issuer of the Israeli bonds. Issuing bonds in Israel is a popular financing strategy for US multifamily owners. Borrowers benefit from better credit ratings due to a different local rating scale (more details here: https://www.multifamily.loans/apartment-finance-blog/raising-unsecured-debt-in-israel-competitive-financing-alternative-for-us-multifamily-developers).

TCI wholly owns about 1,600 apartment units, a few office buildings, some mortgage loans, and some land. All these assets are principally in Texas.

TCI’s crown jewel, however, is its 50% interest in the Victory Abode Apartments (VAA) joint venture with Macquarie. VAA owns 10,000 units in 52 MF properties in the Sunbelt (TX, FL, AR, LA, CO). The portfolio is quite young with average age of 10 years, and average monthly rent is about $1,100. Occupancy is currently 95%. In 2018, TCI sold 50% interest to Macquarie, and I estimate the transaction valued the portfolio at $1.3 bn. Currently VAA’s run-rate NOI is $70 mm. Sunbelt MF is red hot right now. Public peers (CPT and MAA) are trading at 4% or below implied cap rates, and assets are transacting at 3.5% cap. At 4% cap (valuing the portfolio at $1.8 bn) and subtracting $860 mm of mortgage debt, TCI’s 50% interest is worth $450 mm or $52/share. Note that the $860 mm figure excludes about $240 mm of mezz notes that TCI and Macquarie each owns half of. In other words, the $52/share includes both TCI’s equity stake and mezz loan.

On a price per unit basis, a 4% cap rate is equivalent to $175k per unit, a far cry from ~$300k per unit implied by MAA and CPT’s current valuation (granted MAA and CPT have higher rents at $1,300 and $1,600 respectively).

The JV performed well during 2020 and YTD. 2020 NOI was $64 mm vs $58 mm in 2019, as disclosed by their IR deck filed with the TASE. Part of the growth was from the stabilization/lease-up of property #41-51. On a same store basis (comparing property #1-40) between the 2 years, NOI was up 2% in 2020. Note the disclosure is very detailed with property level NOI, and TCI also discloses that stabilized NOI would reach $77 mm, a number which buyers in today’s environment will likely use vs my $70 mm. In Q2 2021, NOI was up 18% y/y (no same store comparison was available).

Source: 2021 IR deck; “stabilized NOI” only provided for property #41-51.

Adding other hodgepodge of assets (see valuation exercise below), TCI is worth $80/share. Brixton and Shidler’s offer values other assets at 0.

SOTP:

I’ve circled relevant numbers on TCI’s 2021 TASE deck and interested readers can use Google Translate to figure things out:

2021 deck: https://mayafiles.tase.co.il/rpdf/1365001-1366000/P1365069-00.pdf

2020 deck: https://mayafiles.tase.co.il/rpdf/1299001-1300000/P1299288-00.pdf

Another angle to look at is TCI ended Q2 2021 with $334 mm or $39/share of book value, but the VAA JV is carried on the books at merely $52 mm. TCI’s equity and mezz loan investments are adjusted downwards by $148 mm ($17/share) and this adjustment is amortized over time (and booked as income). And the assets are carried at $1.2 bn (5.3% cap rate), far too high in today’s environment. If they are worth $1.4 bn as asserted by TCI, TCI’s share of value would increase by $12/share. Adding the $17 and $12 to the $39, one could argue that a more realistic book value is $68/share – which values all the other operating real estate at depreciated book value. It is then worth noting that TCI just sold 600 Las Colinas, an 80% occupied office building in Irving, TX for $75 mm, $32 mm higher than book value (albeit $12 mm less than fair value used in the IR deck)

So I’ve established that the stock is cheap. What’s the catalyst (other than that there’s a buyer which the company wants to ignore)? Well, Macquarie and TCI’s JV agreement stipulates that either party can unilaterally IPO or sell VAA after November this year (TASE filing: https://maya.tase.co.il/reports/details/1221902):

The Class A Members and the Class B Member have agreed that prior to November 19, 2020, the Company shall engage a nationally-recognized financial advisor acceptable to both Class A Members (“the IPO Advisor”) to advise the Company with respect to a potential initial public offering (“IPO”) of the Company’s portfolio of assets. Any such IPO shall be acceptable to the unanimous consent of the Class A Members. Notwithstanding the potential for an IPO, either Class A Member, at any time after November 19, 2021, may cause the Company to engage in an IPO without the approval of the other Class A Member. As an alternative to an IPO of the Company’s portfolio of assets, either Class A Member, at any time after November 19, 2021, may cause the Company to offer all of its properties for sale.

Why do I think it’s likely that Macquarie would initiate a sale of VAA post Nov 2021? (1) First, now is a terrific time to sell given the cap rate compression in Sunbelt multifamily and how much investor demand is out there. EQR which focuses on coastal markets just “re-entered” Atlanta and Austin by buying at <=4% cap. (2) VAA also hasn’t been expanding the platform – it owned 53 properties at formation and currently owns 52. (3) The dynamic around former CEO (since 2010)/Director/3.4% owner Daniel Moos is also interesting. In August 2020, almost exactly one year after the death Gene Phillips, Brad Phillips removed Daniel Moos from all his positions at TCI, ARL and SPC, but Moos remains the manager of the VAA JV. He’s also the JV’s Class B member (quoted in the excerpt above) with 2% profit participation interest. It is likely that Macquarie wanted Daniel Moos to see through the JV’s monetization, and it helps that Moos’ interest is aligned with that outcome (nuance discussed in the bottom).

I think a sale is more likely than an IPO because 10k units are still quite subscale for an independent for a public company.

With the November deadline rapidly approaching and an offer on the table, I believe the next few months will be eventful for TCI. As discussed above, I think $44.4/share is far too low and TCI is unlikely to engage unless the offer is substantially improved. In the current transaction environment, I believe a sale of VAA will generate proceeds too large to ignore vs the current stock price, despite TCI being a controlled entity with questionable governance. The monetization of VAA could generate enough proceeds to buy out the minority shareholders at TCI and ARL – at current prices, TCI has less than $40 mm of float and ARL has $20 mm of float. It is possible that both TCI and ARL would go private – there’s no liquidity, no Wall Street coverage and not much asset left if VAA is sold; there’s no reason for them to stay public. The current price is still low enough for TCI to offer minority shareholders something much better than $40 and keep the upside for May Trust/Gene’s children. The Brixton/Shidler bid has put the company under spotlight and the ball in management’s court.

Risks/Concerns

1.       Related party receivables: Historically TCI has made advances to ARL. Currently TCI has $157 mm of receivables from related parties on the balance sheet, most of which are advances to ARL. The SOTP exercise above valued these receivables at 0. TCI could “loan” VAA proceeds to related parties, and all minority shareholders get is a bigger related party receivables line on the balance sheet.

2.       TCI’s auditor is FARMER, FUQUA & HUFF, PC. A search of SEC filings shows that the firm only audits a couple other nano caps with no real operating business. The fact that Macquarie invested somewhat alleviates this concern.

3.       When the VAA JV was formed, TCI contributed 10 development properties whose values would be remeasured after stabilization. If the values (determined by a formula not disclosed or buried in Hebrew filings that I didn’t find) are lower than expected, TCI would pay Macquarie a clawback. Initially, TCI recorded a liability of $10 million but Macquarie didn’t agree. The matter went to arbitration which sided with Macquarie and required TCI to pay $39.6 mm (July 2021 8K: https://www.bamsec.com/filing/101054921000146/1?cik=733590). The development properties all look like they have healthy occupancy (except Terra Lago). It’s unclear to me how the development properties can be worth less than 2018 expectations, or maybe the formula doesn’t use a dynamic cap rate. Nevertheless, the fact that TCI would pay Macquarie a clawback (instead of Macquarie paying TCI an earn-out) isn’t a positive read.

4.       After Daniel Moos was forced out, no replacement CEO was appointed, and no search was initiated. The board doesn’t have anyone with substantial real estate experience. In fact, Brad seems to be the most credentialed director. Other than Brad, TCI’s directors include a territory manager at a retired guy, a dermatology products company, an investment advisor, and CFO of a nursery. I can only speculate that all of them are family friends.

5.       If Dan Moos is no longer manager of VAA, the Class A members have the right to call his 2% interest at a price as if all properties are sold, and this price is to be determined by an appraiser appointed by TCI and Macquarie. I assume if the properties are in fact sold, this appraisal becomes moot. And if the properties are not sold, TCI and Macquarie wouldn’t want to come up with the cash to pay Dan Moos. However, it is possible that TCI and Macquarie find a cooperating appraiser and buy out Dan Moos at a discounted price without monetizing their own stakes.

Catalyst

Sale of VAA 

Privatization or improved bid