01/03/22 07:53 AM EST

REITS DAILY BRIEF | 1.3.22 | (POSITION MONITOR UPDATE, PGRE)

Takeaway: Happy New Year, everyone!

Ticker: PGRE

Subsector: CBD Office

Headline: Moving to Best Idea Long List - Is it finally time in 2022?

This one may be surprising to folks given how bearish we are on CBD office over a TAIL duration, but as we like to say at Hedgeye "we play both ways," so this morning we are adding CBD office REIT Paramount Group, Inc. (PGRE) to the Best Idea Long list for 2022. The catalyst is simple, a rising probability of shareholder activist agitation and a potential take-private or other transaction. We see upside to the $12-14/share range for +40-70%+ appreciation, with potential downside to ~$6/share under extreme circumstances offering a risk/reward of 1.5-2.5x. We are going to follow up with a more detailed note and wanted to get this on the list this morning, but here are the key points in a nutshell:

There is broad consensus that PGRE should not be a public company and is "cheap," but requires a catalyst.
Over the last ~3 months we have detected a VERY MEANINGFUL level of dissatisfaction from shareholders on stock price performance, public/private discount, governance, leverage, the captive fund business which should not exist, lack of scale, Otto family control/influence and the management team. The shareholder list would likely be very supportive of any activist involvement, a private market bid and/or an effort to refresh the Board and effectuate change.
Investors will recall the Company rejected Bow Street bid at $9.50-$10/share in late-2020, so there is precedent for activist dissatisfaction and involvement. Everyone in the market knows the issues here and that PGRE should not be public.
There could be an emerging bid for high-quality CBD office assets vis-a-vis CXP, OMW among others.
There is no longer an embedded "sting tax" liability to contend with as of late-2019.
CEO Albert Behler had his employment agreement extended for 3 years to 12/31/24. Shareholders were not happy about this and discussions make it clear that there is broad agreement by the base that new leadership is needed.
Long-time PGRE employee and Head of Acquisitions, David Zobel, who was a top-4 officer at the company, just resigned effective 1/20/22. Employee turnover is astronomical judging by the investor presentations viewed over time.
It is our understanding that Rob Simone's replacement (full disclosure he worked at PGRE) as Head of Business Development left after just 5-6 months at the company to go to DRE.
To be clear, this is a wait-and-see long idea but priced interestingly with limited downside and asymmetric upside. The deadline to nominate Director nominees is in the fall, so any agitation if it were to occur would likely begin over the summer.
More to come...
Separately, we moved IRM to the Long Bias list on a less favorable risk/reward. We added as a Best Idea Long at ~$42/share and saw upside to the low-$50/range into year-end, and that scenario largely played out for a +25% gain before dividends so we are booking gains.

CHARTS OF THE WEEKEND: Select Slides from Friday's Macro Show

A few key takeaways: (1) REITs have had very few consecutive down years over the past decade and a half (with the 2007-2008 GFC period being the exception), (2) shorter-duration subsectors dramatically outperformed in 2021, and perhaps most importantly (3) it is VERY rare for a subsector to be a top performer in two consecutive years. Industrial/Warehouse tends to consistently gravitate towards the top of the ranking along with Data Centers and Towers, with Office and Retail being serial underperformers. Probabilistically this demands that we remain nimble in our positioning as we begin 2022.