01/16/23 10:32 AM EST

MONDAY NIGHT REIT READ | MULTIFAMILY UNDERWRITING + EPR + PIPELINE | 1.16.23 (EPR, APARTMENTS, MPW)

Rob Simone, CFA

Takeaway: Also enhancing Position Monitor transparency around relative performance

Hedgeye Cartoon of the Day: Pour Me Another

It is 1.16.23, and Active Short MPW is overvalued by... whatever the current share price is. Again, until the relationships with Steward & Prospect are restructured and more transparent, our view is that there is no price you should be willing to pay for the equity. That is the genesis of "the equity is worthless" and "it is overvalued by x" comments, which are obviously different than the question "what will the stock do?"

HERE is our running "cheat sheet" of MPW issues.

WEEKLY VALUATION HANDBOOK PDF LINK

Tickers: All

Headline: Updating Position Monitor format w/ relative performance tracking

To enhance transparency and after receiving client feedback, we added relative performance for our long / short ideas on a total return basis versus the XLRE benchmark from the time they were added to the present (see Figure 2 below).
Our hope is that it provides more context into what has worked and what has not, and to timestamp the track record as Hedgeye likes to do with RTAs, etc.
As expected in Quad 4, it has been relatively easier to find winners on the short side.

Ticker: EPR

Company Name: Active Short EPR Properties

Subsector: Triple-Nets

Headline: Additional sub feedback items on the short idea

Broad agreement that this cannot be a TAIL duration long until the AMC situation is resolved.
Subs, both long-only as well as long / shorts, believe that most of the negotiating leverage lies on the tenant side of the equation. Our takeaway is that it could be the classic case of "if a ~1% tenant runs into trouble it's the tenant's problem, but if a >10% tenant runs into trouble (with few immediate replacement options) it's the landlord's problem."
Subs continue to think about the likelihood of a credit downgrade at EPR itself, and the implications for EPR's stock price. Our read of the tea leaves is that most subs DO NOT believe a rating reduction is priced in, and that such an event would be traumatic for the share price.
With all of that said and on the positive side, investors appear to like the relatively high earnings quality which we tried to demonstrate, the quality of current management, prudent capital allocation (perhaps minus the dividend) in the form of pulling back on incremental investments, and perhaps the idea as a derivative play on some recovery in domestic box office. The last point is probably where there is most disagreement. The theater tenant restructurings need to be completed first, however. Subs generally do not believe they are being appropriately compensated for risk at current levels.

Tickers: AVB, AIRC, AIV, BRT, CPT, CSR, EQR, ESS, IRT, MAA, NXRT, UDR, VRE

Company Names: Various

Subsector: Multifamily / Apartments

Headline: CBRE 4Q22 underwriting report shows going in cap rate expansion for Class A

CBRE reported that the average going-in cap rate for Class A multifamily assets increased by +36bps sequentially to ~4.49% on average in 4Q22, or up +113bps on average over the last 9 months.
Comparable going-in cap rates averaged ~4.16% in 4Q19 pre-pandemic.
Meanwhile investors are projecting +3.1% compounded annual rent growth over the next 3 years, including +3.3% on average for gateway markets.
IRR targets rose +33bps to ~6.73% on average.

Figure 1: CBRE Summary of Buyer Underwriting for Class A Multifamily Assets

Source: CBRE Research, https://www.cbre.com/insights/briefs/underwriting-assumptions-exceed-pre-pandemic-levels-for-prime-multifamily-assets

Ticker: MPW

Company Name: Active Short Medical Properties (Dis)Trust

Subsector: Triple-Net Hospitals

Headline: Like clockwork + Wadley update + questions we would ask RDLT (if we had a chance to, that is...)

This past Friday around noon ET we wrote HERE following our read of the updated Pipeline Health reorganization plan. At the end of the note under "Our Take" we wrote: "... More of the same theme that we have seen over and over again with Shasta, Adeptus, Watsonville, Prospect, Steward, etc. - MPW overpays for the real estate, the operator gets into financial trouble, MPW funds additional dollars to the operator in the form of negative NPV "capex" and/or operator loans that are really for working capital, rent is deferred and/or there is a default, and somehow MPW treats the end result as a "win" despite write-down of loan principal at the very least..."
Well, like clockwork, later that day we got the classic "post-Friday close ahead of the long weekend" press release from the company. Items conveniently left out of the press release text:

The bankruptcy auction for the 4 CA OpCos failed and was pulled in December after no qualifying bids received, presumably because no bidder would underwrite/assume an ~$18 million annual rent burden which leaves the portfolio completely under water. We take this outcome as a "Plan B" that is more onerous to MPW than "Plan A."
MPW will be funding an additional ~$17 million of capital to Pipeline, over and above the ~$6 million included in the original master lease. So again, funding more money to an insolvent operator. Thinking through that, the incremental ~$17 million represents almost one full year of rent after adding it to the lease base and assuming an ~8% return.
This also means that MPW is funding incremental capital at a return roughly in-line to slightly-below its current market-derived cost of debt, which by definition means it is below MPW's unlevered cost of capital. In our view this is being done purely as an attempt to preserve an unsustainable rent stream. We have said from the beginning that the capital allocation history from MPW's management team is AWFUL. This is another example of that.
The ~$23 million of total capital to be funded by MPW is equivalent to roughly ~33% of the current value of the OpCo, as determined by the debtors' advisors. Again, think about that.
MPW waived covenants under the original lease, agreeing to negotiate covenants based on Pipeline's pro forma business plan.
The consolidated FCCR test (EBITDA less unfinanced capex / fixed charges) was set at 0.7x through December 2024. MPW is funding additional capital into that situation.
It appears from the updated advisor projections that Pipeline is only cash flow positive in the early years via the capital injections from MPW.
Our favorite part is the CEO quote from the MPW press release. If your definition of "well-underwritten hospital estate" is "operator bankruptcy within a year" combined with "needing to inject additional funding below your cost of capital, just to 'earn' an uncertain rent deferral," well then we will not invest with you.
The pushback will likely be that "Pipeline is small, so who cares, etc." Our contention is that this is just MPW in a microcosm.

On the (potentially) positive side, Steward broke ground (again) on Wadley Texarkana, more than a year after the first ground breaking after which we think MPW "floated" Steward ~$50 million in liquidity. The new expected opening for the hospital is 2025. Our guess is that Steward is now able to move forward/contractors are willing to sign post-ABL extension and possibly with additional liquidity support from MPW. Watch "Texas" in the "investment balances" section in the supplemental for changes along with 4Q22 results.
Finally, a little birdy told us that MPW/Steward are rolling out RDLT this week for investors, clearly as part of a broader media blitz. Here are some of the Qs we would ask, if given the opportunity:

What is the current balance outstanding on Steward's ABL? What is the borrowing availability?
What was Steward's cash balance pre-ABL extension, what was it at the end of 2022, and what is it now?
Why did you effectively "factor" Steward receivables via the CMAX deal?
Why has Steward had two auditors / three audit partners over a span of three years?
Did Steward have "going concern" language in its 2019 audited financial statements?
Why does Steward repeatedly experience delays in completing its audited financials?
Why does Steward have so many unpaid vendor bills, mechanics liens and lawsuits related to non-payment of vendors?
What is Steward's total annual cash rent burden, due to all of its landlords?
How do you bridge / justify a nearly ~3x increase in 2023 EBITDAR over 2022, as implied by the guidance provided by MPW?
Should the Utah portfolio be sold, please lay out the anticipated use of proceeds as well as the pro-forma cash rent, EBITDAR and cash burn for "NewCo" Steward.
What is CREF? Who owns CREF? Why does CREF share employees and office space with Steward? Why does Steward appear to be CREF's only customer? Why has CREF been removing advertised customer relationships? What is CREF's role in Wadley Texarkana?
What was Steward's liquidity position in 1Q21, before Steward declared the ~$111 million distribution out of the structure?
What is Steward's current accounts payable balance and aging?