01/09/22 05:05 PM EST

SUNDAY NIGHT REIT READ | 1.9.22

Takeaway: Hope everyone had a great weekend!

First off the NY Giants mercifully ended their season this evening, but not before TWO consecutive designed QB sneak plays inside their own 5 yard line on 2nd and 3rd down. Going down swinging!

CHART OF THE WEEKEND: YTD REIT Subsector Performance

Source: FactSet, Hedgeye

Ticker: PGRE

Subsector: CBD Office

Headline: Review of buyside feedback on new Best Idea Long idea

First and foremost, the feedback was overwhelmingly supportive and in agreement on a number of levels. The stock is cheap and has been for a long time but just in need of a catalyst. Secondarily and as we talked about on the Macro Show recently, it is very rare for a REIT subsector to deliver two consecutive years of top performance (such as Self-Storage and Apartments in 2021). Could it be CBD Office's time to shine in 2022 amidst a general RoC improvement post-COVID, as well as shareholder activism/consolidation? Week one of the year delivered +1,400bps versus the XLRE.
The most frequent and natural question asked was, "what gives you confidence that now is the time for activism?" To that we would say that following our self-embargo on covering office for the first six months at Hedgeye, the commentary from the buyside on PGRE specifically was critical at best, and that is being generous. Investors do not believe that PGRE should be a public company and that a take-out (whether private or public-to-public) is really the only catalyst and outcome here. This sentiment has been echoed by PGRE's own management team at numerous industry conference meetings over the years, including "I/we really hate being public" and "life is much easier being a private company" versus having to deal with public company reporting as well as the public market cost of capital which remains punitive to office. Let's just say that we heard "what do you think are the chances of activism here?" and "are you hearing what we are hearing about activists circling PGRE?" numerous times over the course of fall 2021 with increasing frequency. The 8-Ks filed near year-end raised the rhetoric significantly.
Regarding the potential tie-up with ESRT, to be clear investors think a straight take-private of PGRE is much more probable and we agree. But with each week that ESRT outperforms PGRE (+100bps last week alone) the relative cost of capital moves more in ESRT's favor.
In terms of timing, we already missed the deadline to nominate directors for the May 2022 annual meeting. The deadline to nominate for the 2023 annual meeting is in late-fall 2022. So just thinking through that, IF anything were to happen we would expect an activist to surface over the summer and make their presence known, while in the background engaging with management and the Board and deciding whether (1) to settle for a few Board seats, (2) go away or (3) launch a "fight deck" along with a full campaign to gain greater representation and push for change. The point here is that, if that timeline was to play out, you want to be in the name BEFORE the summer and play it as a smaller long position with asymmetric upside.

Tickers: CUBE, EXR, LSI, NSA, PSA, UHAL

Subsector: Self-Storage

Headline: Tough out of the gate in 2022 for the subsector

Hence the choice of cartoon above! It wasn't a pretty open for self-storage in the first week of 2022. Clearly there was a subsector rotation happening within REITs to start the year. Self-storage (-7.1%) trailed only the Towers (-7.3%) on the week.
To be clear, we still think there is some juice left in the tank in 2022 through the end of 1Q at least, before the RoC really turns against us. On last check CUBE broke TRADE support of $53.13/share on Friday with new TREND closer to $47/share, with our preferred longs remaining UHAL/LSI/CUBE in that order.
We wrote about this on Thursday, but the fact that self-storage DID NOT tank on Thursday following the release of PSA's 4Q21 operating data was a bullish sign in our view. Normally the first sequential decline in move-in rental rate registered in 5 quarters by the bellwether (PSA) would crush a short-duration sector, but self-storage actually hung in there fairly well on the day. Either the market had already discounted it up to that point, or we are moving into a "sweet spot" where ECRI accelerates and becomes the driving force behind growth.
To be clear, we have been and remind mindful of the RoC slowdown likely to occur between 2Q/3Q.

Tickers: OFC, ONL

Subsector: Secondary Office

Headline: Position monitor changes

Adding OFC to Long Bench - potentially interesting setup for a great Quad 4 stock potentially also hitting earnings growth escape velocity.
Adding ONL to Short Bench - more to come on this one, but a potentially interesting short opportunity for this recent spin-off from the O/VER merger.

Figure 1: Updated Position Monitor