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C4K: Vision Capital Corporation – Investment Thesis for Pure Multi-Family REIT LP

C4K Monthly Manager Insight: Vision Capital Corporation – A Pure Opportunity in a Multi-Family REIT, May 4, 2017

A Pure Opportunity

  • Seeks to identify unique opportunities to buy high-quality real estate through the stock market at a discount to what one would pay in the private market
  • Pure Multi-Family REIT LP exemplifies this market inefficiency
  • Pure is a Canadian publicly-traded REIT that invests in US multi-family rental apartments located in key Sunbelt markets including Dallas (55% of asset value) as well as San Antonio, Houston, Austin, and Phoenix
  • Completed its IPO in the summer of 2012 with two properties; listed in Canada as it was too small to list in the US and the REIT had an external management arrangement (a feature US capital market generally view negatively)
  • Today, Pure owns 17 properties with ~5,800 apartment units
  • Despite demonstrating a track record of adding value, it has only hit the radar screens of institutional investors and generated increased quality research coverage recently
    • Additionally, Canadian investors are less familiar with the favorable supply and demand dynamics of Pure’s markets and tend to focus on Canadian names
  • Premise for Vision’s significant position is fourfold:
    • Favorable supply and demand fundamentals of multi-family sector in the Sunbelt region
    • High quality and newly constructed nature of Pure’s assets
    • Compelling valuation
    • Catalysts and opportunities for this value to be realized

The Sunny Outlook

  • Fundamentals for US Sunbelt apartments are strong, benefitting from a combination of a secular trend of a new “renter nation” post-financial crisis, as well as new supply relative to historic norms as construction lending has become much more disciplined
  • Texas has been the second fastest growing state in the US according to CBRE
  • Due to its pro-business tax policies and its deep labor resources, Texas has experienced an influx of recent national head office relocations including FedEx, Toyota, Liberty Mutual, JP Morgan, and State Farm and is now the home to 54 Fortune 500 headquarters
  • US experienced a significant decline in the home ownership rate as individuals increasingly prefer a renter’s lifestyle and criteria by mortgage lenders have become stricter
  • US millennial cohort with a population of ~80 million is the primary cohort to form new households and has a 60-70% propensity to rent
  • Number of US owner-occupied households has been falling since its peak of 76.7 million in 2006 (in stark contrast, 9 million new rental households have formed since 2006)
  • Median age at first marriage of women has increased from 21 years of age in 1970 to 27 years old in 2014; young adults are also living at home for longer
  • All of these factors have led to significant demand for new and affordable rental housing

Portfolio Quality

  • Concentrated on Class A mid- to high-rise buildings and garden-style communities in fast-growing sub-markets with affordable rental levels
  • Since 2014, the REIT has sold 6 properties in Dallas with an average year of construction of 1991 and reinvested the proceeds into newly-built Class A apartment communities
  • This asset recycling program has shifted the average year of construction for the portfolio from 1993 to 2005 today
  • Achieved this transformation while taking advantage of the investment demand for Class B apartments and effectively upgraded its portfolio with a minimal yield spread of 30-40 bps
  • Not only do newly-built apartment properties provide higher rents, they also require less ongoing maintenance and capital investment
  • Inherently increased the REIT’s operating margins, reduced the maintenance and total capex required to support cash flow growth and narrowed the gap between FFO and adjusted FFO per unit – enabling higher distributions at any given FFO level

Growth At An Attractive Value

  • The core premise for Vision’s significant position is the same as the core focus of Vision Funds in general: ability to access quality real estate more cheaply through the stock market than one can in the property market
  • With the REIT trading at significant discount to NAV, continues to be a significant spread between the high-5% cap rate implied by its unit price as compared to the market cap rates that comparable properties are transacting at in the private market
  • REIT’s two most recent asset sales which were older assets constructed in 1991 and 1998 were valued on the REIT’s balance sheet most recently at 5.5% and 5.25% respectively and were sold at estimated 5% cap rates
  • Current average IFRS cap rate utilized by Pure is 5.4%, investment property valuations have proven to be conservative as the sale price of the six assets sold by the REIT represented a 5% to 20% premium to their previously disclosed IFRS valuations

What “The Street” is Missing

  • While research analysts that cover Pure are unanimously positive on this REIT with buy recommendations and published targets representing substantial expected total returns that generate a total return of 15-20%, they are conservative
  • Consensus NAV per unit of $6.85, utilizes an average assumed cap rate of 5.6%
  • Vision would note that this disconnect is likely due to the fact that the analyst’s NAVs and targets are already implying 15%+ 12-month returns – they may prefer to keep their estimates low and gradually increase as REIT’s units outperform
  • Also do not believe that analysts have sufficiently recognized or included in their assessments both the absolute and relative merits of the growth in Pure’s markets, its superior Class A portfolio and its lower future capex relative to other comparable REITs

Where Do We Go From Here?

  • Recent meetings with REIT management leave Vision confident that Pure will execute compelling portfolio acquisitions in the next quarter and effectively employ the proceeds of its most recent C$92 million equity offering which Vision believes is currently serving as a stock market overhang
  • In the process of listing its units on the TSE, upgrading from the junior Venture Exchange, which would increase the accessibility of its units to a broader base of investors and increase the liquidity of its units therein
  • Savvy, risk-averse and growth-oriented investors continue to actively seek acquisitions of apartment portfolios in Pure’s Sunbelt markets – as such, should the REITs stock price continue to trade at a discount to its private market value, it is ripe as a takeover target
  • Pure provides investors with a unique opportunity to access amongst the highest quality apartment portfolios in North America with exposure to the right growth markets at an attractive valuation
  • Valuation based on recent trading price of its common stock, implies a greater than 25% discount to the true NAV

Vision Capital Corporation is the manager of the Vision Opportunity Funds, private equity funds focused on investments in publicly-traded securities in the real estate sector.

Image Source: Pure Multi-Family REIT
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