Thursday, March 4, 2021

INDUS Realty Trust: GPT 2.0

I'm about a year late on this post, thank you to Sterling Capital (@jay_21_) -- one of the best follows on Twitter -- for pointing me back to the idea.  Also deserves a belated hat tip for collaborating on the ACR idea.  

One of my early successes was Gramercy Property Trust (GPT), originally a busted up commercial mREIT (favorite theme of mine) which following the financial crisis transformed itself into an industrial triple net lease REIT before eventually selling itself to Blackstone in 2018.  The architect of that transformation and value creation story was Gordon DuGan, one of the few CEOs I've kept a Google alert to keep tabs on where they go next.  Last March, DuGan popped back up as the new Chairman of Griffin Industrial Realty (GRIF is the old symbol), Griffin was an accidental real estate company, a 1997 spinoff from an operating company, Griffin spent the following two plus decades operating in the relative shadows slowly building out an industrial portfolio -- first in Hartford on historical land holdings and later expanding to PA, Charlotte and Orlando.  Bringing in DuGan signaled a transition for the company, late last year Griffin announced they would be rebranding as INDUS Realty Trust (INDT) and converting to a REIT.  On the investor day last fall, DuGan admitted to have never heard of the company prior to meeting the CEO at a REIT conference, but today I think the company is interesting (more of longer term value investment than event-driven) because:

  • This is a jockey play, Gordon DuGan is a proven capital allocator, he did this once before, I have confidence he can do it again.  This is a somewhat similar playbook to GPT, take a small-cap industrial REIT (~$450MM) that is small enough to do one-off deals, institutionalize it, in the process the valuation re-rates up to the more liquid large-cap peers.
  • Industrial REITs are richly valued, they trade for ~4-5% cap rates and have been major covid beneficiaries as ecommerce "last-mile" logistics and inventory management have become more critical.  INDT's growth is not in acquiring assets, but rather acting as a developer, industrial/logistics buildings are relatively cheap and quick to build, the arbitrage between yield on development costs and market cap rates is wide at this time.
  • INDT raised a significant amount of equity this week in a secondary offering at $60, possibly weighting on the trading dynamics in the short term and creating a buying opportunity.  The equity raise is accretive to the long term value as that capital is put to work into new projects at attractive yields and it also helps improve the liquidity of the shares.

The current industrial portfolio is heavily skewed to the Hartford market where INDT had much of its undeveloped land, purchased long ago and some of that land is still held on its balance sheet at historical cost.  The company's strategy to diversify away from Hartford, instead focusing on their other markets of Lehigh Valley (PA), Charlotte and Orlando.

They point to the age and size of their assets as a differentiator, their buildings are newer and focused on the mid-sized market which provides them a lot of flexibility in the types of tenants they can attract while still being economical from a cost perspective.  I don't have a lot to add to their current portfolio, seems reasonably high quality with a diverse tenant mix.

Why INDT is unique is their ability to grow through development versus needing to rely on making sizable portfolio acquisitions to move the needle.  I'm generally a sucker for real estate development companies, my view is the market has a hard time valuing development assets correctly as they're non cash generating and thus not great for the REIT structure or investor base.  The problem with development companies is typically the long construction cycle, if for instance you're HHC, its 2018 and makes perfect sense to build a beautiful high rise office building on the Chicago River, by the time its complete in 2020, there's a pandemic and people are questioning if they'll ever go back into the office again.  A lot can happen in those two years before construction is complete and even longer to bring it to stabilization.  With industrial warehouse type properties, the construction is pretty quick and simple, 9-12 months, the product type is pretty homogeneous, you don't need a fancy architect to attract top tenants.  The timeframe from shovels in the ground to stabilization is shorter and the certainty of projected cash yield is firmer on construction costs.  This is a less risky form of development with much of the same upside.

INDT has historically been able to earn 7.7%-8.1% cash yields on their development costs, their current projects are estimated more in the 6.0%-6.5% range (guessing the difference is land cost, historical cost versus current market in their new developments), but with stabilized assets trading in the 4%-5.5% range, there's a lot of margin available to INDT's development platform to create shareholder value.

This week, the company issued equity at $60 per share giving them ample capital to pursue additional development opportunities later this year.  To illustrate what I think the company could be worth once this capital is put to work, I created the below back of envelope math.

The company still has a fair amount of non-core assets to be sold, so I assume those are sold at the price they're currently contracted at or book value which might be conservative, especially for the land holdings.  As part of their recent REIT conversion, they'll have a purging dividend that will be paid in part cash and part shares.  Then I also assume they'll sell the additional greenshoe shares, but maybe that's not a guarantee if the market's slide continues.  But then all that cash, plus incremental debt gets pushed into development projects at a 6.5% yield on cost, revalued by the market at a 5% cap rate.  The end result is roughly $82 per share, think of that as a target price a year out.  Probably a few mistakes in there, feel free to point them out.  One thing I am ignoring for now is the warrants that were issued last year as part of a private placement, those have a strike price of $60 which would raise additional capital as well.

My estimate is highly dependent on the market cap rate for industrial properties and their yield on cost for development, I ran a quick scenario analysis that shows what the math looks like at various assumptions.  Across the top is the development yield and down the left side is the market cap rate.

As you can see, the market is roughly valuing INDT at a 6% cap rate with little value being given to their development pipeline.  The math could really go in INDT's favor if they're able to issues shares closer to NAV or even above (many industrial REITs trade at a premium to NAV) creating that virtuous cycle that all REITs strive to get.  In summary, you have a proven capital allocator in a subsegment of the real estate market that should have continued tailwinds post-covid with a decently long but safe development pipeline to create significant value. 

Disclosure: I own shares of INDT

11 comments:

  1. I like the idea but a couple of concerns:
    1) I don't really understand what competitive advantage they have developing properties. It seems like something that could quickly attract competition if it really is so profitable
    2) If they are willing to do an equity raise at current levels (below your hypothetical NAV), what is stopping them from doing it again (and again)?

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    1. 1) The competitive advantage is in the management team, sourcing deals, buying into a market and building it out. It's a jockey play. The advantage is also that INDT is small, each new development matters, versus say Blackrock's mega-REIT, they can't waste their time doing a lot of development, doesn't move the needle.

      2) If this was an externally managed REIT, I would agree with you, but here the incentives are pretty well aligned, DuGan bought stock in the open market when he joined. I think they did this current raise to get the growth engine going, might not have been an ideal transaction, but sets it up for better raises down the line if they can execute and show growth.

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  2. What is the timeframe for your stabilized NOI from which you base your Cap Rate? Thanks for the good work

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    1. It's Q3 NOI annualized per their supplemental

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  3. https://finance.yahoo.com/news/indus-announces-fiscal-2021-first-011500057.html

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  4. Hi thanks for the article. Dumb question - how are you calculating Incremental Debt?

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    1. I'm just taking the total capital available for development and leveraging it up so that the capital structure is 35% debt.

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  5. What is the significance of the latest updates? Good news, bad news?

    https://finance.yahoo.com/news/indus-announces-fiscal-2021-second-204500370.html

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    1. Sort of neither, just their communication style to update at the end of each quarter, most of these updates were already known.

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    2. They do make a statement regarding expected stabilized NOI specifically from their development pipeline of 5.8-6.3% which is on the low end of what I would hope for in house construction. They indicate inflationary pressures as the culprit: "impact of recent market price increases for raw materials..."

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  6. Few days late with this, but looks like they're just bringing the entire Gramercy team over. A true second coming of Gramercy

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