02/05/23 02:57 PM EST

SUNDAY NIGHT REIT READ | WHO BLINKS FIRST? WE THINK SELLERS AS WELL | 2.5.23 | (CPT, EPR, MPW)

Rob Simone, CFA

Takeaway: CPT thinks that sellers blink first, and an MPW debt bull just called the MPW equity essentially un-investable

Hedgeye Cartoon of the Day: Lit Fuse

WEEKLY VALUATION HANDBOOK PDF LINK

Ticker: CPT

Company Name: Active Short Camden Property Trust

Subsector: Apartments / Multifamily

Headline: Sellers to "blink first" in multifamily? If so, bearish values...

Highlighting one key point from the CPT 4Q23 call on Friday.
CEO Rick Campo described a holding pattern environment where the bid-ask spread between buyers and sellers of multifamily assets is as wide as he can recall. While sellers point to 10-15% declines in asset valuations, buyers point to a very different macro backdrop versus a year ago and argue that values should be even lower. CPT thinks that sellers will be the first to "blink." We agree.
What this really means, in our view, is that while cap rates may have adjusted higher to account for a higher cost of capital, forward growth expectations now need to be revised lower. This translates into lower MF values from here. Cap rates STILL may have room to adjust to the upside.
As a result CPT adjusted its required unlevered IRR hurdles up by at least ~100bps to the ~7% range. For distressed deals CPT is thinking in terms of "price per pound / unit" to achieve as low a basis as possible.
We were early but remain bearish Sunbelt MF, and continue to like CPT and NXRT as Active Short ideas here into 2Q23. The space remains over-owned and we think several long-only funds might be trapped in what was thought to be a "TINA" trade. There are alternatives...

Ticker: EPR

Company Name: Active Short EPR Properties

Subsector: Triple-Nets (NNNs)

Headline: VICI (not covered by us) debt investments provide informational value for EPR

We were looking for relatively recent comparable transactions applicable to Active Short EPR, given the unique nature of its portfolio, etc.
VICI Properties (VICI - not covered by us) last year in 3Q22 originated two mezzanine loans to Great Wolf Resorts, which to our understanding carried a yield in the ~8% range. The total VICI loan book carries a blended ~7.5-8% yield.
Thinking through that, if we were to extrapolate that ~8% to EPR (btw, we think movie theaters would be higher...), that would largely validate our blended ~10% cost of capital assumption for all of EPR given its financing mix. For the cost of equity we assume the dividend yield + growth of dividends framework, or 8% + 3-4% = ~12%. EPR is financed roughly 50/50 w/ debt and common equity, with a small 9% preferred sliver in the middle.
Big Point: A ~10% cost of capital = a 9.5-10x cash EBITDA multiple given EPR's lease economics (as we wrote about initially), and applying that multiple results in a mid-$20/share stock price for ~33% downside from here including the dividend carry.
Now we wait for the credit event, and then hopefully get paid...

Ticker: MPW

Company Name: Active Short Medical Properties (Dis)Trust

Subsector: Triple-Net Hospitals (Maybe? Possibly? We think?)

Headline: Again, believe us yet on the equity?

This is a fun one! Parties in the market are now either coming around to the idea or inadvertently agreeing MPW's equity is essentially worthless.
JPM credit research last week on 1.31.23 (perhaps taking a line from MPW's management, which is wild to think about), essentially called MPW a subprime hospital CLO. That is nothing short of hilarious. Also, we're kind of mad at ourselves for not thinking of this idea first, because it makes total sense! That's exactly what it is! A dumpster filled with bad credit and pooled together to pretend to function like a publicly-traded NNN REIT.
Quote: The bears don't "...really understand the essence of the triple net lease arb (pooling weaker, often single B tenants, where the whole is more credit worthy than the sum of the parts and allows for more efficient capital to be raised at the REIT level)." Say what?
First, that's actually not how NNN arb works, especially not for a publicly-traded REIT. For there to be any hope of an arbitrage, you need to have above single B credits in the portfolio as well to "absorb" the credit risk of the weaker tenants. Look at MPW's tenant roster, and note Prime exposure is lower after the call option exercised in 3Q22. Then look at NNN, O, ADC, NTST, etc. If you carve up a portfolio of ~B (or lower in this case) credits, the upper tranches of (Dis)Trust (the bank debt) MIGHT have an above-B credit rating, but the lowest tranches (the equity) would mathematically be C-rated or lower. Perhaps even D. And the point here isn't that it needs to go "D," rather that the credit should be underwritten appropriately. We would posit that a ~6.1% net effective cash cap rate implied by MPW's share price, with essentially no spread to the BBB yield in the market, is not doing that. Building a subprime hospital CLO REIT impairs the entity's ability to raise capital rather than enhances it, resulting in the "REIT box," an inefficient public market structure and a gradual "bleeding out." Tenant credit events, should they occur, just accelerate the death. And that's exactly where we are right now with MPW.
Second, it is not pure triple-net, as north of >10% of MPW's balance sheet consists of loans / equity investments to the operator credits supporting triple-net lease payments.
Third, even if there was an arbitrage, MPW levered it up ~8.5-9x cash EBITDA, thereby magnifying the risk to the lower levels of the stack (the equity).
Fourth, MPW's cost of capital in the market is completely shot, and liquidity is being drained in a Quad 4. Under what macro regime do subprime securitizations blow up?
And lastly, because we can't help ourselves, we linked this video to the appropriate time. Enjoy.
Maybe one more point - we remain of the view that you cannot invest alongside this management team, for all of the reasons we described last year. But if this concept (the triple-net lease arb comment above) came from (Dis)Trust's management, that should outright terrify the equity holders. A bulge-bracket credit research analyst just published a note essentially calling the lower tranches (including MPW's equity) un-investible.
Note: We have no published view on MPW's bonds.