Monday, December 27, 2021

American Realty Investors: TCI Multi-Family JV Portfolio for Sale

*Disclaimer: This is another closely held, illiquid micro cap*

Last week, Bluerock Residential Growth REIT (BRG) agreed to be acquired by Blackstone (excuse the small victory lap) for a healthy sub-4% cap rate on their multi-family portfolio, surprisingly Blackstone was willing to take BRG's (possibly non-arm's length) lending portfolio which I thought might be an impediment to a deal happening.  We know the multi-family sector is getting crazy (especially in sunbelt markets) when even a REIT with a poor governance structure sells out versus grifting on related party deals to the end of time.  The natural next question, what other poor governance structure multi-family stocks are out there and could something like this deal happen again?  Which brings me to Transcontinental Realty Investors (TCI) and its largest shareholder American Realty Investors (ARL).  I've add this complex to my hairy "hidden" multi-family real estate bucket alongside HMG and BBXIA.

TCI is one of the original REITs (it converted to a c-corp many years ago due to ownership concentration limitations), it goes back several decades and could be described as pioneer in poor governance situations (almost like an RMR REIT before RMR).  Back in 2001, the Wall Street Journal ran a front page story on Gene Phillips, the controlling investor in a series of real estate companies that had (and still have) cross ownership interests and related party transactions: Income Opportunity Realty Investors (IOR), Transcontinental Realty Investors (TCI) and American Realty Investors (ARL).  There's even a Bill Ackman reference in the article, his old fund Gotham Partners, went activist on TCI.  Gene Phillips died in August 2019, the trust for his 7 children are now the controlling shareholders via Realty Advisors, Inc ("RAI" - not publicly traded).

These three companies still exist, their relationship is a bit of Russian nesting doll, RAI owns 90% of ARL, ARL owns 78% of TCI (RAI owns another 7% in TCI directly) and TCI in turn owns 81% of IOR (RAI owns another 2% in IOR directly).  Each step of the way, there is an external manager, Piller Income Investment Management (wholly owned, by you guessed it, RAI), that collects a 0.75% of assets annually, 7.5% of net income and 10% of asset sale capital gains above an 8% hurdle.  None of these entities pay a dividend, they pretty much solely exist as fee revenue streams for the Phillips' heirs at this point.  The accounting is confusing because there are intra-complex loans outstanding and ARL consolidates TCI and TCI consolidates IOR, it's one big mess to untangle.

Most of the assets are at the TCI level (to get even more confusing, technically "Southern Properties Capital" or "SPC" in their filings is the wholly owned subsidiary of TCI that owns most of the assets and secures the Israeli bonds), where it gets interesting today is in 2018, TCI sold the vast majority of their multi-family portfolio (53 buildings in the sunbelt, now 51) into a JV (named Victory Abode Apartments or "VAA") entered into with Macquarie.  On 11/21, the two announced an agreement where they would sell the properties in the JV (with TCI essentially taking back/buying 7 of them) in early 2022.  The JV portfolio is held on TCI's (and ARL's) book using the equity method of accounting, there's also an odd mezzanine loan that is equally owned by the JV partners that should be treated as equity, either way, the carrying value of the portfolio is understated on the balance sheet, likely by a wide margin.  From the latest TCI 10-Q:
To mark-to-market the JV, here's the Q3 operating results:
If we annualize Q3 NOI, I get about a $69MM run-rate, at a 4% cap rate that's an asset value of $1.726B, there's $856MM mortgage, TCI owns 49% (Macquarie has 49%, and then TCI's former CEO strangely still manages the JV and has 2%), for a $426MM pre-tax, pre-fees value to TCI.  Out of that number, TCI owes Macquarie $34MM left on an earnout that the two went to arbitration over (probably a marginally net negative readout, there were 10 properties under construction included in the JV portfolio, guessing to-date these didn't stabilized as expected when the contract was struck, but the environment is different now, even marginal properties are likely performing well).  And then external manager Pillar is going to get a cut of the sale proceeds and there will be taxes to pay since TCI is a c-corp and not a REIT.  But even after all that (I'm honestly not even sure how to estimate it) there still seems to be plenty of margin of safety here given that TCI's market cap is only $337MM (using a $39 share price).  And again, TCI is buying 7 of the properties from the JV, so they're not going to get ~$400MM cash dropped in their lap, it'll be some fraction of that.

On top of the VAA JV, TCI owns real estate directly in three buckets: multi-family, commercial and development land.
Similarly annualizing the Q3 NOI ("Profit from segment" here seems analogous NOI) for the multi-family segment and putting a 4.5% cap rate on it (moving it up a touch for fun/since its not on the market) and I get about $145MM in asset value.  For the commercial side (mostly office, one retail property), using a 7% cap rate, I get about $135MM in asset value.  These feel too conservative as it is a bit below the depreciated book value (if we ex-out the land below) on the balance sheet.

Then I'm always a sucker for development assets and raw land, here TCI acquired a big plot (~2900 acres at the time) of land ("Windmill Farms") outside of Dallas back in 2011 through some convoluted restructuring:
On November 1, 2011, we acquired 100% of the membership interest in Bridgeview Plaza, LLC. On September 21, 2010, we sold our investment in EQK Bridgeview Plaza, Inc. to Warren Road Farm, Inc. (“WRF”), a related party under common control, for a sales price of $8.3 million to be paid via an assumption of debt of $6.2 million and seller-financing of $2.1 million. On October 4, 2010, WRF filed a voluntary petition seeking relief under Chapter 11 of the bankruptcy code. The approved bankruptcy plan was effective November 1, 2011, whereby TCI, for its contribution to the plan, was given 100% equity ownership in the entity. During the period of time that WRF owned the equity interest, it had also acquired 2900 acres of land known as Windmill Farms land located in Kaufman, TX, previously held by ARL, for a sales price of $64.5 million. ARL provided $33.8 million in seller-financing with a five-year note receivable. The note accrues interest at 6.0% and is payable at maturity on September 21, 2015. WRF assumed the existing mortgage of $30.7 million, secured by the property.
The land is located in Kaufman County, TX, which is southeast of Dallas and not the most desirable part of the metroplex, but as Dallas continues to heat up, the sprawl has moved towards TCI's land.  By my math, they're down to 1,420 acres currently, here are the recent sales prices from the last few years:
During the nine months ended September 30, 2021, we sold a total of 134.7 acres of land from our holdings in Windmill Farms for $19.0 million, in aggregate, resulting in gains on sale of $9.2 million.
During the year ended December 31, 2020, we sold a total of 58.8 acres of land from our holdings in Windmill Farms for a total of $12.9 million, resulting in a total gain on sale of $11.1 million.

I don't want to get all HHC/JOE math on people, but the carrying value for all their development land is $42MM, and the average price they've transacted with homebuilders the last two years is $165k/acre, now we don't know how much development capex or time it would take the sell the remaining 1,420 acres, but the value is certainly more than $42MM.

And then there's the 81% stake in IOR, IOR's loan book is full of related party transactions (similar to BRG's loan book) used to fund TCI's apartments and development activity, it was probably intended to be a true mortgage REIT, but now is just a nano cap that is unlevered and houses most of the loan book on TCI/ARL's balance sheet.  Again, no dividend, only exists to generate fees.  But the book value is $107MM, so 81% of that is $87MM (IOR trades for less than half book value, could be interesting on its own if the complex does fold up?).

On the right side of the balance sheet there's $185MM of Israeli bonds (they do report on IFRS there, others have translated the filings to come up with similar findings) and $178MM in direct mortgage debt, for a total of $363MM in long term debt at the TCI level.  There are other assets, cash, loans that aren't in IOR, related party deals, but they're hard to untangle and I'd probably get it wrong, so very high level swag:

  • $350MM for the VAA JV after fees and taxes (some of this is the retained value of the 7 properties)
  • $280MM in owned properties
  • $150MM in land
  • $87MM in IOR
  • ($363MM) of long term debt
Or about $500MM to TCI, or ~$60/share (probably conservative here, there a lot of unknowns), it trades for $39/share with a clear catalyst the JV sale in the first half of 2022.  

Another way to play TCI -- I've reluctantly chose this path -- is via the even more illiquid ARL.  ARL's market capitalization is $187MM, the only significant asset they own is an 80% stake in TCI, so buying via ARL you're effectively buying TCI equity for $230MM (I could be wrong here, there are intracompany loans, hard to tell what's what, but I think they net out (minus some minority interest leakage)?).  Now there are more risks to ARL, you're one step from TCI and are counting on the discount being closed by the whole complex being collapsed (ARL has no reason to exist after all).  

That is unlikely to happen, I'm probably too bulled up on sunbelt apartments, but with the family patriarch gone, the kids don't appear to be closely involved here, craziness in the multi-family sector, maybe the JV sale is the catalyst to just collapse the whole thing or use the cash to take out minority investors via a go-private offer.  The grift is egregious here, but it's really only on the minority shareholders and that's a relatively small piece of the pie (90% of ARL * 78% of TCI = 70% + 7% directly owned = 77% look through ownership of the multi-family portfolio), selling out at the top is probably worth more than stealing from ~23% of outside shareholders throughout the complex.  If a sale or going-private deal doesn't happen, its probably just an okay investment, it'll still trade a huge discount, but should bump up a touch, versus owning TCI probably reacts better in the base case scenario that the JV sells for going markets rates and TCI just reinvests the proceeds to keep the scam going.

Other thoughts:
  • TCI did receive a $44/share buyout offer, but the proposal hasn't gone anywhere and was probably just for publicity anyway.
  • TCI's book value is ~$41/share, given how mis-marked the VAA JV is on the balance sheet, and that GAAP accounting often understates real estate value (historical cost minus depreciation), its rare that a multi-family company would trade at a discount.  Both highlights the undervaluation and the markets skeptical view that it ever gets resolved.  Similarly, ARL book value is $21/price versus a $11.50/share price.
  • Buying back the 7 properties is kind of a "bad fact" to a full sale/liquidation thesis, but with the cash, might end up getting a low-ball going private offer that still results in a satisfactory result.  If that's the case, probably best to own TCI directly (talking myself out of ARL right now).  My best guess is these are some of original development properties that might not be fully stabilized and won't fetch full value in a competitive auction.
  • Macquarie is the adult in the room, will want to maximize value and reduces any related party risks to the actual sale of the JV, but the management grift factor remains elsewhere in the complex.
  • Brad Phillips, Gene's son, is the president of a life insurance firm.  There are 58 people according to LinkedIn that work at Pillar Income Asset Management, it appears they don't manage considerable assets outside of ARL/TCI/IOR.  One article I found lists Gene Phillips' estate at $3.5B, so there might be other assets outside of this mess, presumably they could take out minority shareholders and run this as a family office, not that they will of course.

Disclosure: I own shares of ARL (might add TCI directly too), (and still holding HMG, BBXIA, BRG calls)

7 comments:

  1. Good write-up. One thing that I would add is that you can see IFRS valuations of their properties in the Israeli filings. Figuring that out is a bit of a mess, but, for example, their wholly owned multifamily properties are listed in the 2020 annual on page 19, 20 (https://drive.google.com/file/d/15h2Fk3v4AoZq6MHx5sLdF0OH803v9xQG/view?usp=sharing), total ~180m.

    And their commercial property is also in there. See for example the translated h1 2021 filing here: https://drive.google.com/file/d/15ibIk-_M5uFIUerlfrGhI5lR-GOKpf9s/view?usp=sharing . On page 45 Browning Place is assessed at $97.6m and Stanford at $59.6m. South Post Oak is also valued at $17m according to the April 2021 Isreali presentation. So that's about $350m.

    Also, there is quite a bit of (excess?) cash on the balance sheet, $60m+.

    This could easily be worth $70+ or $80+ per share in an orderly liquidation. But will we ever get one, is the question .. So probably good to be a bit conservative.

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    1. Yeah I'd like another shot at this post, almost need to spend a few weeks on this mess, but yeah hard to know how and where to be conservative on the valuation, just because we assume we're not going to get 100% fair value. My head is still spinning a bit on the related party receivables and which assets are where.

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  2. Few comments/questions/adjustments:
    1. Recent sales (p.21 of the 10-Q) indicate 72-92ะบ price per unit sold which gets us to the value of wholly owned apartments of no more than $137m, probably ~$120m (those sales were made in 2020 though, prices have been on the rise since then). Allensville was strangely sold for just 36k per unit (!) in the midst of the corona panic on March, 30 (needed liquidity?). What do you think of the wide range in value for realized multifamily assets?
    2. Commercial portfolio should probably be valued at a 7.5%-8% cap rate as the occupancy is below average (69%-78% vs 82% average for Dallas-FW (source: https://cdn.nar.realtor/sites/default/files/documents/2021-q2-commercial-real-estate-metro-market-reports-tx-dallas-fort-worth-arlington-08-19-2021.pdf) and 85% for US overall (source: https://www.commercialedge.com/blog/national-office-report/))
    3. The earnout is $39.6m, not $34m (p.14 of the 10-Q)
    4. Why don't you subtract other liabilities and outside partner's capital when valuing the JV assets? Pre-everything value should be $415m in this case (0.49*(1 726m - 1 277m in liabilities) + 121.5m share in mezz loan + 73m share of partners capital). Doesn't really matter, just curious
    5. On the positive side - expenses for wholly owned properties include $3m per quarter in 'Advisory fee to related party' (p.10 of the 10-Q) so the normalized NOI in the eyes of an outside buyer might be $12m higher. Owned properties alone could be worth $487m (using your cap rates and assuming advisory fees are distributed proportionately between commercial and multifamily)
    6. Also on the positive - taxes from JV sales might be minimal as a large chunk of the gains will be transfered to parties via the repayment of the mezzanine loan (I think that was the primary goal of providing the loan)
    7. An elephant in the room is that Pillar is getting paid by a percentage of AUM, the Philipps may be reluctant to sell their cash cow, especially if it's the only cow. Probably the likeliest scenario is that they will just reinvest the proceeds from the JV in other properties, get a slice from asset sales via Pillar fees and keep milking the business (on an expanded asset base). ARL is not the best choice in this case

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    1. Good questions:

      1 - $120MM versus the $145MM I had, seems reasonable, prices have moved a lot in the last 6-9 months, I don't view that as a big difference.
      2 - That's reasonable too, I wouldn't quibble much with 7.5%-8%
      3 - I netted out the payment they made to the earn out, see page p9 of 10-Q
      4 - I should have subtracted the other liabilities, but in the end I just kind of swagged the value because its hard to know what fees and taxes are going to be owed on it. The $73MM of partners capital shouldn't be subtracted, that's Macquarie's/Managers equity right?
      5 - I think that fee is below the NOI line, so it might be already excluded from my back of the envelope math
      6 - Interesting thanks, I figured the mezz loan was for tax reasons but didn't know the details
      7 - This is true, but they're really only getting paid on the ~20% minority interest, they're charging themselves on the rest, essentially nets out. My thought is they might take this opportunity to buyout the minority interest, internalize as a family office, there's no stock options here, they *could* be worse. I have come around to thinking TCI is probably a better play to own it directly, haven't changed my position yet, but might.

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  3. I've sold all my ARL and reinvested in TCI, ARL is up 70+% from my post while TCI is largely flat.

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  4. TCI's VAA JV sold for $2.05B (based on news in Israel, where their bonds are listed), I've got that at about a 3.85% cap rate, better than I was expecting in the current environment. Still awaiting the U.S. press release/8-K but this should be a positive catalyst. Now we await what they're going to do with the cash inside the Southern Properties entity once the deal closes.

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