Description

Thesis:

I recommend the purchase of shares of Veris Residential (VRE), it the old Mack-Cali that has been radically transformed.  This is primarily a multi-family REIT that is almost done selling its office properties, and which owns apartment buildings mostly in NY and Boston metropolitan areas.

I believe that it is an exceptional opportunity to invest in a very attractive and tax advantaged asset class, with multiple tailwinds, that should benefit substantially from inflation, high mortgage rates and immigration. 

We are creating these Class A buildings in areas with barriers to supply at 50% of replacement cost and 1/3 of NAV. 

I expect the shares to re-rate in the next twelve to eighteen months as a substantial dividend is reinstated and possibly a bid from private real estate funds appears. 

Description of the business

Veris owns Class A properties in NY & Boston metropolitan areas and one property in Washingon DC.  These properties are all established and stabilized with one exception – Haus25 – a 750-unit property in Jersey City, NJ that started leasing on April 6^th of 2022, and was 72% leased as of September 4^th.    

Veris is selling at a 7.5% cap rate based on my 2023 forecasts and 13% levered free cash flow yield to the equity when all the properties will have stabilized, and Covid-19 related discounts have rolled-off.  Meanwhile according to industry participants, Class A properties are selling at 4.5% cap rates in these markets. 

Long term prospects

I am optimistic on rent growth in the markets Veris operates.  These are generally markets with high barriers to construction and very high construction costs.   I think the demand for rentals in their markets will continue to increase ahead of supply, and this will lead to rental increases ahead of inflation. 

In the short-run, higher mortgage rates increase demand for rentals as ownership becomes more expensive.   Higher interest rates also make it more costly to finance new construction. 

In the long-run, resumption of immigration post Covid-19 hiatus, Biden’s free for all on the southern border, Ukraine War (5MM people have fled Ukraine, Russia and Belarus) and resumption of emigration from China (WSJ article from May 14^th 2022 https://www.wsj.com/articles/chinas-covid-lockdowns-drive-middle-class-citizens-to-head-abroad-11652460449?mod=world_major_1_pos1) will significantly increase demand for apartments in the areas that Veris operates.  Given 98%+ occupancy, impact on rents and asset values will be material. 

Management

The management is new, installed by the activists.   The management team seems to be doing fine but they have had the wind at their back.

SG&A is absurdly high at $40MM per annum, should be more like $10-15MM, although SG&A does include one-time costs, I am assuming that the SG&A will get to $10MM by 2023. 

There are two mitigating factors: the activists who kicked out the previous management team are still there, and there is the discipline of take-over market.  There are no controlling shareholders.   

Financials

The company gives an excellent break-down in quarterly reports.

Residential

The multifamily segment (at share) was at a $160MM run rate in Q2 2022, and I expect it to hit $220MM run rate in 2023.  Rents in Q2 2022 were substantially under market, since they were mostly signed in the spring of 2021, and some even earlier, and so were materially below market. 

Commercial and hotels = $9.9MM NOI run-rate, has at least $89MM of debt associated with the segment. 

Other assets including land = $475MM.  Liabilities = $2.675bn (debt + Rockpoint interest).

Office

Other real estate assets: office + hotel - $39.62MM NOI, other assets including land = $614MM;  debt & preferred interest = $468MM. 

Consolidated

Free cash flow to the equity in 2023 - $160MM or roughly $1.60 per share. 

$220MM (normalized residential) + 50MM (office + hotel) - $10MM (SG&A) - $120MM (interest & preferred interest) = $160MM.

Capital structure

Debt + preferred interest = $2.95bn on 06/30/2022

Market cap = $1.25bn on 09/22/2022 ($12.40* 100.353MM assuming all LP units are converted)

Valuation

Assets

a)      Multi-family - $220MM 2023 normalized NOI at 4.5% cap rate = $5bn

b)     Commercial +hotel+ office = $50MM NOI at 8% cap rate = $625MM

c)      Other assets, including land = $1.09bn

Liabilities

a)      Debt + preferred interest = $2.95bn

b)     Corporate SG&A burn = $275MM ($10MM per annum at 4.5% cap rate)

Equity

Net to equity = $3.49bn or $34.77 vs $12.40 per share price. 

Sensitivity analysis:

a)      1% increase in class A cap rate = $1bn or $10 per share

b)     1% increase in office/hotels cap rate = $75MM or $0.75 per share

c)      50% haircut to other assets, including land = $500MM or $5 per share

d)     $10MM increase in corporate SG&A = $225MM or $2.25 per share

Capital allocation

Not clear, I was not a fan of Park Ridge, although presence of activists gives hope that it will not be bad. 

Conclusion

An opportunity to buy a collection of primarily Class A multi family assets in premier apartment markets in the US, at 50% of replacement cost and 1/3 of NAV, with nearly a 13% free cash flow yield to the equity.

Catalyst

Catalyst

Initiation of significant dividends in 2023.

Take-over bid from Blackstone, KKR or another real estate operator.