07/10/22 04:59 PM EDT

SUNDAY NIGHT REIT READ | 7.10.22 | (HR, HTA, INVH)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Hope everyone enjoyed the weekend!

Cartoon of the Weekend: Pixie Dust

It is 7.10.22, and Active Short MPW is overvalued by approximately ~$15.59/share.

Tickers: HR, HTA

Subsector: Healthcare

Headline: Active Long HR provides update on asset sales / JVs to fund $4.82/share special dividend

Transaction consideration includes a 1:1 exchange ratio in HR shares paid to HTA plus a $4.82/share special dividend or ~$1.1 billion, funded through a series of asset sales + JV transactions blending to a ~4.8% cap rate.
Currently there are 27 properties worth ~$807 million under contract with five counterparties (~$673 million of which have secured buyer IC approval and are closing within 10 days of the merger), and another ~$295 million of assets under LOI and expected to close by mid-August. Proceeds will be used to pay down the ~$1.1 billion "bridge" term loan facility being used to fund the special dividend to HTA holders.
There are also ongoing discussions at various stages with additional counterparties to sell another ~$600 million of assets at similar cap rates, which if closed would help further delever the combined company post-close and increase the % of on-campus MOBs which was one of the main criticisms of the deal from a cap rate/quality dilution perspective.
The special meeting will be held on Friday, 7.15.22 with 66.67% of HR's holders required to vote in the affirmative in order for the deal to close. Both ISS and Glass Lewis recommend holders vote "FOR" the deal, which significantly raises the probability of the transaction closing. If approved the merger will close on or around 7.20.22.

Ticker: INVH

Subsector: Single-Family Rentals (SFR)

Headline: Some additional thoughts on last week's objections to the MTD by two CA cities

We wanted to follow up with some additional thoughts on Active Short Invitation Homes (INVH) following client feedback from last week.
First and foremost, we understand that the two cities did not technically "intervene" from a legal perspective. They state that clearly at the end of the signature pages. At no point did we state HERE in last week's note that either city had intervened. Just to clear up any confusion.
However with that being said, we are going to stick with the view that it is next to impossible to make an argument that this is not one of (if not the) most important news items for INVH since the qui tam case first became widely known earlier this year. Emphasis on widely, as it is our understanding that INVH was more than sufficiently concerned about this lawsuit internally as early as October/November 2021.

As we have said previously, we think this is a situation where the judge is unlikely to dismiss the case and more likely to move ASAP into discovery. At the same time, we have strong reason to believe that discovery could potentially be exceptionally damaging for INVH. All else the same, these two objections increase the probability the case is not dismissed. Combine these statements together, and there is an increased probability of a very unfavorable outcome for INVH. Just handicapping outcomes here.
We all need to be honest here - the narratives on why this lawsuit does not matter being circulated since February were something along the lines of "the cities opted not to participate," "the cities seem to think this plaintiff and case are not credible," and "everyone on the ground in California knows that Neel Senturia is just a local political actor with an agenda, no DA would ever view it as credible." We have heard those arguments multiple times over the last few months while trying to refute or find additional instances of non-permitting across the Sunbelt, up to and including various clients telling us on multiple occasions that INVH themselves had said those things both in group and 1-on-1 meetings. So here is the key question: "Does last week's news torpedo those narratives?" We would argue "Yes." We were very clear in our note last week that the most significant impact was on management credibility. If we were shareholders we would be asking "why did you guys repeatedly tell both us and the sell-side these things?" And then we would ask the sell-side, "Why did you guys just repeat it, including in published research notes?"
We would further argue that between now and oral arguments on 7.25, it is highly likely that additional cities oppose the MTD on similar grounds, further raising the probability that the judge does not dismiss the case. This is critical for a few reasons. Again, the cities never permanently declined to intervene in the case, rather maintained a legal "holding pattern" to see (A) if perhaps another larger jurisdiction took up the case first, but also (B) to maintain their optionality to potentially intervene when more information came to light and it was more politically palatable to do so. It takes some "gaming out" of the situation, but directionally it seems to be heading that way, and that is significant. Stepping back, no city is going to just throw away a free option for a piece of a potentially large judgment that someone else can fight and win on their behalf.
To the specificity argument, we would just say that it is highly likely that there is significant data underlying and sitting behind the 15 examples presented in the original complaint. Our understanding is that defendants ALWAYS argue lack of specificity as its a basic fallback argument for qui tam cases, and if all the data were included in the complaint it probably would have been ~10,000 pages long. So there is a practicality and efficiency angle to filing these complaints, and any skilled plaintiff's attorney would present the minimum to have the case advance and then hammer the defendants in discovery for a larger settlement/judgment. Finally on the 15 examples, we are not quite sure what the lawyer from the other expert legal call was looking at, but we are very sure that we saw filled in pools, additions and renovations to homes, combined with an absence of requisite permitting. See figures 1, 2 & 3 below. Pretty obvious to us on that one. Maybe they are hoping the judge is blind? We shall see. Because that is essentially the argument being made here: that we all can't see what is actually on the page. We would also note that, while outside of the scope of this case, there are for sure FAR worse examples of similar business practice in other states that we have seen with our own eyes. Hence our concern over discovery.
And then finally, and it takes more game theory here, but what happens IF and WHEN the case is not dismissed and IF the scope is not limited. Do the cities then intervene? Probably, and they have maintained the optionality to do so. And then, most importantly, what does the stock price discount?