Friday, January 22, 2021

CIM Commercial Trust: Proxy Fight, Possible Liquidation or Sale

CIM Commercial Trust (CMCT) is another small illiquid idea (~$240MM market cap), CMCT owns about ten office properties in LA, Oakland and Austin, plus the Sheraton Grand Hotel in Sacramento.  When thinking about asset types and locations where covid has been the most impactful -- office, CBD hotel, Bay Area migration, LA lockdown -- CMCT checks a lot of those problem boxes.  CMCT is an externally managed REIT, the manager is CIM Group, a fairly large and well respected real estate firm based out of Los Angeles.  The shares trade at a discount to the company's own estimated NAV (which is very stale, pre-covid), two different activists have put forward a slate of new directors  (here and here) with the intention to liquidate the portfolio.  I believe there's a decent chance management caves here and either commences a liquidation on their own or kicks off a strategic alternatives process aimed at selling the company to one of the other west coast focused office REITs.  The upside is a bit unclear to me (open to hearing from people with a stronger view), so possibly this is more of a watchlist idea, but I opened up a starter position at just under $14/share.  It popped unexpectedly today, apologies that this is not as timely or actionable, it could give it all back, but just for context purposes my cost basis is a bit lower than where it is trading today.

CMCT has a strange origin story for a public REIT, it began life in 2005 as a private equity real estate fund diversified across office, multi-family and hotel.  In 2014, as the fund's maturity was coming up, it was reverse merged into a small mREIT ("PMC Commercial Trust") that made SBA loans (CMCT oddly still makes SBA loans in this legacy segment), with the PE fund owning well over 90% of the proforma entity, but only the non-PE investor shares traded publicly creating this odd stub.  Cynically, CIM took a limited life fee stream and turned it into a permanent one at the detriment of their investors as the shares have failed to trade close to NAV since the reverse merger.  In the meantime, CIM has sold the majority of assets within CMCT in a few different slugs and then returned capital to investors either through a buyback or a big special dividend that was issued in 2019.  Notably, those asset sales were done near their published NAVs at the time.  So here we are now, a subscale externally managed REIT with long suffering shareholders that has limited options to raise capital to grow, sort of stuck in no man's land heading into a post-covid world.

Here are the real estate assets today:

Again, the portfolio is heavy on Oakland and LA.  In Oakland, they own the Ordway Building (1 Kaiser Plaza) which is primarily leased by Kaiser (30% of CMCT's overall rent roll).  Kaiser previously announced they would build a new headquarters in Oakland and consolidate their real estate foot print (presumably exiting CMCT's asset) but recently they cancelled those plans in light of the pandemic, so potentially Kaiser could extend their lease.  If not, market rents pre-pandemic were a decent bit higher than in place rents, we'll see how things shake out in the Bay Area, but Oakland could cool off significantly as San Francisco office becomes cheaper and reduces the spill over into the more affordable Oakland market.  Additionally, they do own a parking lot next door, which they've been marketing as a build-to-suit, but presumably new office development is off the table for several years, my guess is it remains a surface lot for the foreseeable future.

The other chunky asset of concern is the Sheraton Grand Hotel in downtown Sacramento.  CIM acquired the hotel in 2009, it sits next to the convention center in Sacramento which is finishing up a renovation and expansion project, the convention center is scheduled to open in February.  Pre-covid, CMCT was planning to invest $26MM to renovate the hotel, but those plans have been put on hold.  CMCT also owns another parking lot across the street that they suggest is an additional development site for either a hotel or multi-family tower.  Located in a state capital and positioned next to the convention center, I can see a path where this hotel fully recovers.  Downtown Sacramento has seen a considerable amount of development recently and there are a number of hotels that are in the pipeline, one is even considering breaking ground soon, signaling demand or at least the expectation of a recovery in the market.  The hotel is still cash flow negative, in October (last data point) it only averaged a 29% occupancy rate, and isn't expected to cross the break even line during the first half of 2021.

In LA they own several clusters of assets, LA is CIM Group's backyard.  I don't have much to add here, the one asset that is only 21% occupied was previously earmarked for a significant repositioning, but that's been put on hold as well.  The below slide management puts out also shows all of the properties CIM has exited over the years, clearly you can see that they're one of the major players in the LA market providing some comfort around this piece of the portfolio.

The other assets include an office complex in Austin that was just leased up and a small loft style office property in San Francisco.  And as mentioned earlier, they oddly still operate the SBA lender business which is a legacy from the reverse merger.  Making SBA 7(a) loans is a fairly good business, a portion of the loan is guaranteed by the government, SBA loan originators are able to sell that guaranteed portion into the secondary market and since it is guaranteed by the U.S. government, originators are able to sell those portions at a premium.  They're then left with servicing rights and the unguaranteed portion of the loan, which most lenders retain.  The one red flag with CMCT's SBA business, the portfolio is basically a pure player lender to franchisees of economy and midscale franchised hotels (think brands under the WH or CHH flags).  They also have PPP loans they've extended to their borrowers that will likely be fully forgiven and paid by the SBA to CMCT.  I tend to think the economy hotels make it through covid, but its worth flagging that there is risk in this asset. 

So those are the assets, the capital structure is a bit odd here, it's heavy on preferred shares, which about half of which are continuously offered through their RIA channel and are not publicly traded.  I took the 2019 proforma NOI from the Lionbridge letter and backed into what cap rate the market is putting on their assets, approximately 6.7% which feels high to me.

CIM Group does put out an annual NAV estimate, the current one is stale from pre-covid, year-end 2019.  The NAV is a little disingenuous as it also uses the old capital structure, the company has issued additional preferred stock since YE 2019.

We'll probably find out in the next month or two what the new NAV estimate is, it will certainly be lower, my back of the envelope guess is somewhere in the $20-22 range, which would be a 6.0-6.2% cap rate on 2019 NOI.

Will CIM Group cave to activist pressure? 

CIM Group was co-founded by Richard Ressler (Chairman of CMCT, also Chairman and former CEO of JCOM), Avi Shemesh and Shaul Kuba in 1994.  Today they manage just under $30B in assets, about $1B of which is CMCT (at their stale valuation) and they also have a significant non-publicly traded REIT business after their purchase of Cole Capital in 2018.  I bring that up because they recently merged a few of their private REITs, potentially in preparation to list them publicly, might be stretch but that vehicle is much larger than CMCT and they wouldn't want to damage their reputation and limit that REIT's growth in future (assuming CIM agrees that CMCT failed in becoming a growth platform).

The management agreement at CMCT is a bit non-standard for an external REIT, it was rolled over from the original PE fund and wasn't revised in the merger:

  • The management fee is tiered with breaks as CMCT gets larger, but instead of getting bigger, it has only gotten smaller as a public entity, and more problematically the fee is based off of the asset value in the NAV calculation.  The stock has never traded anywhere near NAV and clearly NAV is subjective and manipulatable in their favor.  Additionally they have typical expense reimbursement provisions, read through the activist letters for more detail. 
  • It is a perpetual term contract, "and shall remain in full force and effect until the Partnership is dissolved, this Agreement is required to be (or is automatically) terminated pursuant to the terms of the Partnership Agreement or the Partnership and the Adviser otherwise mutually agree" -- I'm guessing this is the angle of the activists, take over the board and then "dissolve" the partnership entity through a liquidation. But not entirely sure a proxy win for the activists is needed here.
  • One benefit of rolling over the original management contract, it doesn't appear to have a termination fee which most externally managed REITs include, making it more attractive for activists to get in here and attempt to remove the manager.
CMCT is a Maryland corporation which does make it difficult to unseat an external manager, CIM insiders own roughly 20% of the company, so it's an uphill battle.  But again, this is a small piece of CIM, why ruin your reputation over a relatively small management fee stream?  And most importantly, CIM has relented to shareholder pressure before, here Lionbridge describes the events leading up to previous asset sales:

What transpired over the next few years bore little resemblance to CIM’s originally stated growth objectives for CMCT. In 2017, CMCT sold over $1 billion in assets and repurchased a similar amount of CMCT stock owned by the private fund. In its public communications, CMCT depicted these corporate actions as the result of a regular evaluation of its business and prudent management. Based on our firsthand discussions with CIM Urban REIT investors, however, we believe these sales were the result of extreme pressure from its fund investors, who were voicing displeasure for the public vehicle. In other words, only when it was clear that the REIT strategy had flopped, and under intense pressure from its pension-fund clients, did CMCT begin selling property and returning capital to investors.


Rather than rightfully completing the sale of its portfolio once and for all and returning the remaining value to its investors in cash dividends, CIM dug in its heels. In 2018, the company announced a "Program to Unlock Embedded Value in Our Portfolio and Improve Trading Liquidity in our Common Stock.” At the time, CMCT was trading at a nearly 40% discount to NAV. This program contemplated another $1 billion in asset sales, or roughly half of the remaining portfolio at the time. The net proceeds were distributed to shareholders, but again, instead of completing a cash liquidation, the private comingled fund was dissolved via a distribution of CMCT shares to its partners. The result was a more structurally flawed company with even less scale. Upon the distribution of CMCT shares, the partners would own over 95% of this deeply flawed and obscure REIT’s shares.

In its public messaging CMCT portrays its asset-sale programs as discretionary capital allocation moves made in response to strong markets and emblematic of CIM’s willingness to return capital to shareholders. Again, based on firsthand accounts from CIM’s partners, we believe that assertion is misleading. We understand the asset sales and return of capital were being demanded by the partners, according to some accounts, under threat of litigation and were not what CIM Group was otherwise inclined to do.

Contrary to what CIM representatives portrayed to prospective investors, what awaited the market after executing the plan to “unlock value” and “increase liquidity” was an ownership base comprising almost entirely legacy fund investors whose moods we understand generally ranged from frustrated to incensed at CIM’s refusal to completely liquidate the company for cash. In the aftermath of the distribution, the shares were soon trading at a nearly 50% discount to published NAV, wider than when the “Program to Unlock Embedded Value” was announced. They would remain in that vicinity for months before they further collapsed in the COVID-related market sell-off.

CIM Group has caved twice to CMCT investors, starkly clear this isn't a growth vehicle for them, my thesis is they'll do the right thing and either liquidate or sell the company, keep their public reputation in place for where there is actual growth (like their private net lease REIT) and brush this entity under the rug.

Another interesting way to play this idea is the Series L preferred shares (CMCTP), I tried for a couple weeks to buy shares but didn't have any luck, it is very illiquid but strangely the class has a liquidation preference of $28.37 versus the usual $25, and its redeemable next year at shareholders option, the company has the option to play stock or cash, but either way it seems like a pretty attractive high teens, low twenties IRR if you're able to get shares at $22-$23.

Disclosure: I own shares of CMCT