August 11, 2008

Value Idea: NorthStar Realty

I have talked a lot about Commercial Real Estate (CRE) debt market in the past, see here, here, and here , and how pricing really do not reflect its economic reality. Mainstream media superficial analysis and reporting and fear from a repeat of the housing collapse have put downward pressure on all things real estate and CRE was not spared. I have also noted that CMBS debt have took a steep hair cut along with residential debt and now their pricing are attractive given their risk/ reward profile, see chart for spread over 10 year Treasuries. To be clear, I do not think this distress debt thesis will yield as a good of a result, if any, as in the previous crashes of CRE in early 1990s and 2000 downturn. There are just too many funds chasing these securities and crowding the market, keeping prices up. But still the returns can be worth while. I want to take advantage of this opportunity and place my bet, but what eluded me is how?

Then, I found NorthStar Realty Finance (NRF), the idea came thanks to NRF is ...

... an internally managed real estate finance company that focuses primarily on
originating and acquiring commercial real estate debt, commercial real estate
securities and net lease properties. The Company conducts its operations so as
to qualify as a real estate investment trust (REIT) for federal income tax

I bought into NRF at $8.6 on August 11 and it comes with a dividend yield of 16%, lets hope that I can see some of this yield this year!

Investment rationale:

  1. CRE Economics are OK: CMBS underlying market have relatively good fundamentals but they are priced for disaster defaults, which I do not think will happen. I have made this case before in various posts.
  2. Growth potential: I see several trends and reasons for increased business pipeline for NRF:
  • The tight credit environment offer opportunity to NRF to extend and originate loans and/ or buy discounted assets and debt. The CMBS market along with structured debt have evaporated overnight with the credit crises. It may be resurrected in the future but it won't be in the near term. Banks and traditional lenders are grasping for capital and as a result have tightened lending so much. However, there has to be a credit provider alternative for businesses and CRE and even individuals. There has to be some entity to fill the void for the market to function smoothly, albeit maybe at a higher interest rates, equity like rates of return maybe. I think private equity and companies like NRF will fill that void. It won't be cheap but I think they will price risk better than the banks did over the last 5 years. I think the growth potential here for NRF is absolutely terrific.
  • As Banks try to deleverge their balance sheets by selling loan portfolios. NRF will buy at steep discounts such portfolios and can earn high return on equity invested.
  • Another area of growth opened for NRF is sale-and-leaseback transactions, where corporations that own their offices sell them to raise capital and then lease them back from the new owners. Banks are engaging in these transaction at feverish pace; Citi bank, BofA, and many others are doing these transactions more and more. NRF has already done a number of them to Fortune 1000 corporations and will do more as corporate America tries to raise capital.
  • Mezzanine loans to owners is another growth area for NRF. Those loans provide equity like returns to originators and the dislocation in the credit markets makes the returns more attractive. Private equity outfits like KKR and Blackstone have been raising funds to take advantage of this segment, see story here. Distressed debt funds raised 38% more capital globally, raking in a total $33 billion in the first half of this year according to Private Equity Intelligence Ltd. The global pool of mezzanine capital doubled to $20 billion. The top three U.S. funds raised so far this year are: the $15 billion Warburg Pincus Private Equity X; Goldman Sachs Private Equity Group's $13 billion GS Mezzanine Partners V; and Oaktree Capital Management's $10.9 billion distressed vehicle, OCM Opportunities Fund VIIB. All this capital raising validate the thesis for NRF business model right now.
  • Liquidity is king: NRF has about $295 M in cash to deploy and in a time where liquidity is in short supply, those funds will earn excess returns. As I said above they can deploy these funds into areas of opportunities with high return on equity.
  • Experienced Management: good quality and accomplished management in the real estate and investment world. Moreover they own about 10% of outstanding shares and have been buying recently, always a good sign. NRF is internally managed that means that no asset manager is hired to mange the fund and carry the mandate. It is set up as a corporation that have employees and they make the investment decision rather an externally hired asset manager and in this case they have skin in the game through their ownership.

In the next post i will detail risks and valuation.

1 comment:

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