02/22/23 07:16 AM EST

REITS DAILY BRIEF | PSA 4Q22 + INVH CASE + OFFICE LOANS | 2.22.23 (PSA, INVH, OFFICE)

Rob Simone, CFA

Takeaway: New filing from INVH in the qui tam case + MPW / Tenet litigation updates + other matters

Hedgeye Cartoon of the Day: Volatility Incoming...

It is 2.22.23, and Active Short MPW is overvalued by approximately... whatever the current share price is.

Ticker: INVH

Company Name: Active Short Invitation Homes

Subsector: Single-Family Rentals (SFR)

Headline: Late-night filing in whistleblower qui tam case

Last night (2.21.23) Active Short INVH filed its answers to Plaintiff and asserted defenses in the Southern District of CA.
Some highlights of note, in our view, from the preliminary statement:

"Invitation Homes cares deeply about its residents and the homes they live in, and it endeavors to provide a high quality rental experience to those residents." Yet, if the Plaintiff is to be believed / is correct, the company has and continues to allow residents to occupy out-of-code homes.
INVH continues to attempt to throw it's contractors under the bus, and to our read of the response implicitly disclaims any responsibility to make sure appropriate permitting was obtained and asserts (again) that all fault lies with the GCs:

"... Invitation Homes engages and works with a dedicated group of licensed contractors and subcontractors, upon whose construction experience and expertise Invitation Homes appropriately relies."
"Invitation Homes enters into contractual relationships... require those contractors to obtain all necessary permits and to otherwise comply with applicable state and local building code provisions. As provided in their agreements with Invitation Homes, the contractors themselves retain ultimate responsibility for obtaining all required permits."

The key questions here, in our view, are: (1) is it reasonable for the landlord to allow, knowingly or unknowingly, for tenants to reside in out-of-code homes regardless of who had the initial responsibility to obtain permits, and (2) did INVH in its contracts explicitly waive all reciprocal responsibility to "monitor," i.e. make sure that its GCs had properly obtained necessary permitting required for certain work?

Very logically INVH proceeds to deny all of Plaintiff's allegations in the pages following the preliminary statement and asserts 17 defenses.
INVH concluded by demanding trial by jury.

Tickers: BXP, DEI, ESRT, HPP, JBGS, KRC, PGRE, SLG, VNO

Company Names: Various, but includes Active Shorts Paramount, SL Green & Vornado

Subsector: Gateway and Secondary Office

Headline: Credit stress rising in office

Following a string of recent high-profile CBD office loan defaults, the WSJ wrote yesterday that more and more market participants believe that WFH and hybrid arrangements may have permanently impaired the office market. Subs will recall that, following our time at PGRE, we spoke about the "long-tailed bleed-out" of office as leases roll, face rates remain flat and concessions rise dramatically. And then related to that, what could happen in 3-5 years when the buildings you thought were levered ~50% turn out to be levered 70%+ or higher on lower values upon loan maturity? We are starting to scrape the 3-year mark...

According to data from Trepp, the delinquency rate for office loans rose +25bps in January which was the largest increase since January 2021.
"The growing number of distressed office buildings reflects a recognition by owners and lenders that the robust return to the office they had hoped for isn’t likely ever to materialize. The number of employees returning to the office rate has plateaued at around half the level it was before the pandemic, reflecting the popularity of remote and hybrid work policies."
"Loan officers are steering away from new mortgages backed by office buildings unless they are fully leased for long periods of time by creditworthy tenants."
"The stress on the office sector will likely take years to resolve. Lenders have numerous financial disincentives to foreclose on properties. Such transactions mean writing down the value of the loans and, in many cases, require the lender to pay transfer taxes."
WFC said in January that non-accrual loans backed by office assets increased +8% q/q to ~$186 million.

Along a similar thread, Bloomberg reported yesterday that the ~$1.2 billion mortgage on 555 California (JV between VNO & the Trump Organization) landed on a lender watchlist. The loan, of which VNO's share is ~$840 million, carries 5 1-year extensions and is capped at 2.26% (originally L + 193bp).
PGRE, SLG & VNO remain on our Active Short list, with BXP, HPP, ESRT, CUZ & HIW all on the Short Bench.

Ticker: PSA, EXR

Company Name: Public Storage

Subsector: Self-Storage

Headline: Really good Q, but disappointing FY23 outlook likely to weigh on subsector

We have no recommended position on PSA, but the stock is obviously the bellwether for the subsector and we think the 4Q print / FY23 guide is a bearish read-across for all of storage. The guide disappointed relative to our and Street expectations, and the revenue growth trends are both concerning and indicate a poor and worsening RoC profile. We think it is possible / likely that, again, Short Bench EXR was the first to see trends worsening at an accelerated rate and "took their medicine" first late in FY22.
FY23 Guidance:

Core FFO: $16.10 to $16.80/share ($16.45/share at the midpoint), vs. ~$16.85/share for Hedgeye ( - ) and FactSet $16.72/share ( - )
SSRev: +2.5% to +5.5% vs. Hedgeye at +4.6% ( - ) <-- we are most concerned here and think investors will focus on this number; 4Q is a seasonally weak quarter for storage broadly, but the "roll down" at -21.4% driven by $16.71psf rents to new customers is the largest negative spread to move-out rates since 2Q20 (!!!). Combined with occupancy rates falling ~250bps y/y, PSA is BOTH losing occupancy at an accelerated rate AND unable to push rate at this point in the cycle.
Direct SSExp: Hedgeye at +4.1%
Total SSExp: +4.75% to +6.75% vs. Hedgeye at +4.1% ( - )
SSNOI: +1.2% to +5.1% vs. Hedgeye at +4.8% ( - )
The upside / advantage to owning PSA, in addition to its style factors, continues to be the non-same store pool which is stuffed with recently acquired value-add assets and is important for understanding PSA's overall growth profile given the company's unique same store reporting. We think the guidance for incremental NOI growth of $80 million in 2024+ is still likely conservative.