02/18/24 09:11 AM EST

SUNDAY NIGHT REIT READ | NEED ABR "K" + WE GIVE UP ON HR | 2.18.24 | (ABR, DLR, HR)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: That ABR call was "interesting," but we need the 10-K. Where is it, btw?

Hedgeye Cartoon of the Weekend: Inflation Redux

Hedgeye REITs Chart of the Weekend: 2Yr Breaking Out

Source: Hedgeye Macro Team

Presentation Library:

Black Book: Active Short St. Joe - Replay LINK

Black Book: Active Short Digital Realty (DLR) - Replay LINK

Active Short MPW REIT Status Deck - LINK

Active Short MPW Prospect Rent Deferrals - LINK *WE TOLD YOU OVER THE TARGET*

Black Book: Active Short Digital Realty (DLR) - Replay LINK

Overview of Priory Relationship (MPW) - Replay LINK

Prospect Restructuring Agreement Deck (MPW) - LINK *BOMBS AWAY!*

Actual Prospect Restructuring Agreement Document (MPW) - LINK

Black Book: Active Short Prospect Capital Corp. (PSEC) - Replay LINK

MPW RCF Covenant Work (MPW) - LINK

Ticker: ABR

Company Name: Active Short Arbor Realty

Subsector: Commercial mREITs

Headline: Unfortunately, need to wait for the 10-K filing... too much is unclear at this point. Btw, where is the K?

A few observations/questions:

That was painful! Again, the advantage they have is that they control this thing end-to-end. Any short needs to be small in size, as it is opaque and expensive. But under the surface there are very clearly issues + the math does not make sense + the 4Q23 earnings call raised more questions.
First, we do not believe it is possible to fully analyze Active Short ABR without the 10-K filing. And on a related note, the 10-K filing is late - as far as we can tell, this is only the third time in twenty years that ABR did not file its 10-K report on the same day as earnings. Why?
For example, last quarter on 10.27.23 ABR finally disclosed in the 3Q23 10-Q report a large (for them) ~70.5 million loan default that actually occurred back in 2Q23. This default occurred at the same time ABR was addressing the >220 million Applesway default, but opted not to discreetly disclose the smaller ~70.5 million default for ~4-5 months while it was sitting in the NPL bucket. The point is, we do not know what to fully make of the quarter until we read the 10-K.
Why did the average current pay rate for the on-balance sheet structured portfolio drop in the quarter, while the total UPB also fell? The weighted average current pay rate fell ~40bps from 8.8% in 3Q23 to ~8.42% in 4Q23. Total UPB excl. loan loss reserves dropped to ~12.62 from ~13.13 billion (~500 million, or -3.8%, q/q) amidst ~550 million of net runoff and a ~17.3 million provision for loan losses. We would assume the 4Q23 runoff occurred at lower yields given the vintage, meaning the average current pay rate should go UP not down, all else the same. For example, in 3Q23 ABR issued at an average ~10.1% blended rate while loans paid down carried ~9.45%. Does this mean ABR cut the cost of the existing UPB by some amount in the quarter to grant relief? This would be akin to PSEC lowering the spreads on the NPRC TLs, or a company like MPW granting rent relief to a problem tenant. Again, we will wait for the 10-K as we need to better understand these movements.
We can unequivocally state that ABR's earnings power is declining. The loan book is shrinking, pay rates and average servicing fees are down, provisions are up, the company is originating more mezz/pref equity (we think as part of workouts under the surface) and originations are declining from a RoC perspective + remain a tiny fraction of 2021/2022 levels while those vintage loans are running off. The company also remains a net issuer of stock. Despite these facts, ABR trades at ~1.1x TBV.
We want to see how many shares ABR issued in the quarter and the sources & uses of funds, but estimate perhaps ~1.5-2 million shares issued via the ATM. The buyback remains a smokescreen, in our view.
Call Notes:

Let's just be honest here - there were likely "friendlies" on the call. Some may disagree, but that is our view. And we have good reason to hold that view because we worked for Fortress briefly on New Senior Investment Trust (SNR) way back when, and saw something similar happen on those earnings calls as well. If so = red flag. We generally don't care about "shout outs" or "congratulating" management teams. That is "Ministry of Truth" stuff. How about some critical and constructive questions?
This was an actual quote from a follow-up "observation" to end the call: "Thank you. I would just observe, Ivan, that welcome to the world of short sellers. The 64 million shares short, and these guys are smart and they play a very vicious game. They put out information at times it's false, you got to deal with it. Now, I'm reminded of an expression, when the going gets tough, the tough gets going, and you're very tough guy. And I don't think that they realize who they're dealing with. I wish you good luck and you could be very active.
Got it. A great use of everyone's time trying to "bully the shorts." And nothing unusual or concerning there at all...

Ticker: DLR

Company Name: Active Short Digital Realty

Subsector: Data Centers

Headline: A few additional notes after re-reading the call and ahead of the 10-Q filing

First, a little nuance from the quarter that we missed initially - unless we are misreading this, absent executing the development JVs DLR's total expected capex would have been an estimated ~3.5 billion (now lower at DLR's share), which is higher than we would have expected if they kept 100%. We think it could be driven perhaps by now having the freedom/flexibility to start more development given third-party capital, but it is also possible that costs are up / additional capex would have been needed to preserve DLR's existing NOI streams. Which again, appear to be declining given the consistent declines in occupancy rates and now fall-off in realized rents per kW despite rising underlying power rates. We continue to be of the view that investors are massively underestimating the capital intensity of this business model. Granted, it has not mattered over the last year and may not matter going forward...
We continue to question "strongest cash releasing spreads" + high retention rates, against a fall in realized cash rents. Those two fact patterns are internally inconsistent, in our view.
Strengthening the balance sheet - this is true, DLR did in fact do that. We would just highlight that DLR sold an estimated ~2.2 billion of equity in FY23, or ~5% of the current equity market cap, + raised an estimated ~2.6 billion of sale proceeds yet net leverage declined just ~0.8x turns on our numbers and also ticked up slightly q/q in 4Q23. We still think there is a balance sheet and capital intensity issue here, albeit less severe. We need the cash flow statement but estimate pro forma leverage is closer to ~6-6.5x in 1Q24, and ~0.5x turns higher when including the preferred. If you do not buy into the ~10% development yields, and we do not, it will be costly to bring leverage down further. But to be fair to DLR, they are trying.
Sitting here right now we expect FY24 to be another negative FCF year, as management appeared to indicate on the call. We originally thought that the 4Q23 cash balance would have been higher given that (1) the company raised ~1.1-1.2 billion of equity in the quarter, which we did not have, (2) DLR brought in the Realty Income proceeds and (3) the 4Q23 ~390 million dividend gets paid after quarter-close in January. The capex spend of ~1 billion was consistent with our model. But in doing a like-for-like, we get to roughly ~1.6 billion of cash when adjusting our model coming into the print, which is what DLR had for ending cash in FY23. We want to see the CF statement when it comes out, but seems to check out for now.

Ticker: HR

Company Name: Healthcare Realty

Subsector: Healthcare / MOBs

Headline: We're done, uncle! Moving to DMZ

We are not spending any more time on this thing until if and when an activist steps in and fixes things. We will use it only for comp purposes, such as with AHR upcoming that has a sizeable MOB portfolio.
It is "dead money" at best for the foreseeable future given the last two years, but even under the best case it should U/P under higher-for-longer and as the macro accelerates in 2H24.
Shares declined -28% on TSR and underperformed the XLRE by -2,600bps since we added to the Active Long list.

Figure 1: Hedgeye REITs Position Monitor