Purchase #2: RNY Property Trust

Purchase #2: RNY Property Trust

Note: The original version of this post contained some serious calculation errors and the post has been substantially edited since then.

First, thanks to reader Daniel for pointing out that my calculations were inaccurate. Due to sloppy spreadsheeting on my part, I was basing my worst/best case calculations on the expected equity to be received, not on the property valuations.

I applied my ‘worst case scenario’ discounts to the $25 million in equity RNY is expecting to receive, not to the value of their properties. If you have property of $100m, owe debt of $75 million, and can only sell the property for a 30% discount, you don’t discount the $25 million equity you were expecting to receive, you discount the property value (i.e., $100m becomes $70m) – in which case you are underwater.

Apart from ‘oh no’, the first thing I thought upon discovering my error…

Now, while I aim to keep my mistakes on display for all to see, I have specifically gone through and deleted the erroneous calculations for best and worse case scenarios for my RNY investment. Not only are they wrong (garbage in, garbage out) but they are dangerous illusions in that they suggest a certainty to the investment that does not exist. I also note that RNY shares jumped 10% today – and I am receiving an unusual amount of traffic to my site, which is not indexed by search engines – so I am being cautious. I am required by my own rules to hold RNY shares for at least 1 calendar month after I bought them (07.04.2017) and I will be holding them until at least that date.

(My disclaimer has recently been updated so if you have not read it yet, please take the time to do so:  http://www.10footinvestor.com/disclaimer/ )

Now the real concern here is – the original thesis is broken. Is there a second thesis? Peter Lynch once described investing in stocks as similar to playing a 70-card hand of stud poker. With this new card I have been dealt, should I hold ’em or fold ’em? I haven’t decided yet.

Fortunately I still have my actual property valuation estimates to draw upon. I’m currently meditating on those and will aim to post a complete decision in the next few days.

The property dilemma:

The crux of the issue is that there are 9 properties (7 in ACORE) being sold and 3 are already contracted for sale (2 in ACORE), providing a small degree of certainty. The ACORE pool is the main one I’m interested in as this is where 90% of the potential $$ is.

(Company presentation in February 2017)

Two of the 5 uncontracted properties (6900 Jericho and Charles Lindbergh) appear to have a good shot at achieving their book value, with minimal tenant expiries and good WALEs. Charles Lindbergh actually grew in value over TTM and Lockheed recently re-signed and expanded its lease at this site (subsequent to report date), so if anything I expect this property is worth more than its estimates. The most recent valuation downgrade for these properties at 31 December 2016 was quite minor, although properties sold in the last year were done so with an average discount of 14% (I think).

The remaining 3 ACORE properties are the issue, with around ~30%-40% of tenants renewing in the next two years. In the 2 months to the latest update in February, RNY has already got enough renewals + new leases to cover a chunk of the possible departures in sq ft terms, and a cumulative total of up to 40% with ‘prospective’ leases.

Is there a good enough chance of these properties achieving a valuation that would make me money to justify making the investment? I am not sure yet. I figure for this type of investment I’d want to make about 50% in a year given the risks. My original target was +~70% over ~2 years, but I thought risks were lower.

But an acceptable risk reward tradeoff doesn’t always make a good investment in my opinion. Theoretically if you have a 1% chance of making 1000 times your money, you should take that bet every time. For a small portfolio however, say ~10-20 stocks over 5 years, I really think you need higher certainty than that, because you will not have enough iterations to justify that probability, and also your upside is capped by the time frame. Being right 5 to 6 times out of 10 is my target.

Daniel’s comment

Now, just to answer Daniel’s comment below about the sale fees on property and the outstanding management fees of $0.5m; to my way of thinking they are (sort-of) not relevant to the thesis. If the investment is a success or mostly so, the sale and mgmt fees won’t be hugely material given the market capitalisation ($9m) and expected equity to come out (A$29m before ~$3m fees on the ACORE properties – plenty to go around). If the investment is a failure and properties are worth less than the debt, well, that’s the end of that, again fees aren’t important. The middle ground is where they become an issue, say if equity from sales is $15m, and $4m of that goes to fees, leaving $11m. For a ~$8.7m mcap at the time I bought, that’s a poor return. However, and I was not explicit enough on this in the original post, my goal with the investment is to be right enough that the misc. fees don’t matter. If, in the original case, I thought that I would only make 20% on RNY, I would not have bought it. Should that seem the likely return going forwards, I will sell. It’s not that I’m ignoring fees per se, it’s just that I thought they were not important (and I’m trying to keep post size down).

Either way, what seemed a relatively straightforward investment has become a ’10-foot’ hurdle.

More to come.

I have kept most of the original post below for posterity, sans valuation estimates.

Now, The Rules say that I won’t copy other people’s research, but that taking a tip (e.g., a name) is OK. I did all my own research on this, but fair shake of the sauce bottle to Forager Funds, if they hadn’t written about it so much over the years, I would not have recognised the name RNY Property Trust (ASX: RNY) and been curious enough to look at its report when it showed up in my list of 52-week lows. This one goes on the books as a tip.

I will quietly admit though that after I did all my research – I was dead set on making sure this was my own work – I went and read everything Forager has written about RNY in the past 2 years just to double check. Ultimately it wasn’t very useful as much has changed in terms of asset values etc in that time.

But based on the current share price and publicly available information, I still think RNY is an opportunity.

The what:

Mediocre properties with plunging values that are nevertheless worth substantially more than the current share price. There is no turnaround coming in this particular property market, and after many years of struggle, management is going to try to sell each of RNY’s remaining 15 properties, pay down debt, and return the proceeds to unitholders.

source: RNY website

I spent about 5 hours with Excel plotting out each property’s value, the change in values over the past couple of years, looking at Weighted Average Lease Expiry (WALE) and occupancy levels, and figuring out how much further each property might have to be discounted to be sold.

In short, there are 3 property pools, ST/TL, ACORE, and ISB that RNY owns, and each have debt secured against them that are non-recourse to RNY (loans are secured against the buildings only). RNY will sell down each of the property pools, use the proceeds to pay off debt, and return any leftover proceeds to shareholders.

The ST/TL properties, once sold, will not generate any excess returns (all money will go to pay the debts).

The ACORE and ISB loans are expected to generate A$29 million in funds over and above the size of the loan repayments. For a company with a market capitalisation of A$8.7 million, you can see why I’m interested.

Note: Previously here was a list of possible outcome scenarios. The data they were based on was incorrect (the wrong cell in excel) making them dangerously illusory because they suggested greater likelihood of investment success than is the actual case. I have removed the original prognostications for this reason.

The risks:

Primarily that, despite my best efforts, I do not have a complete grasp of the legal and banking implications surrounding the sales and being in default.

There are all sorts of issues, for example around the debt, if the lenders refuse to allow the properties to be sold or if there are disputes. I am not a lawyer but I imagine that a lender (E.g. ST/TL lender) might try to sue RNY to get money back or similar, .  Property values could also plunge faster than I expected,  there could be a fire or natural disaster, or any number of other (mostly bad) occurrences. RNY is currently in breach of one of its lending covenants and has 60 days to rectify this, which it hopes to do through property sales – that could have all sorts of negative outcomes.

There is an added hurdle in that I have no idea what the property market is like – I am relying on book values and the company’s asset sales as being a fair measure of their value. There could be errors either to the upside or the downside here (at a guess I’d say mostly downside). In this case because they’ve sold so many properties recently, and because the properties have been revalued so many times, I believe there is a good chance of this being accurate information.

None of the above events would be ideal and I’d have to assess any of these situations on a case-by-case basis.

The bottom line

I bought RNY figuring that the company will be able to sell its properties and distribute more to shareholders than the shares are currently worth.

Based on my research and the depressed market for these properties, I am hypothesising that lenders’ best chance of getting their money back is by management selling the properties to repay the loans, and the recent haircut that one lender took on its debt suggests that at least one creditor also thinks this is the case.

Maybe I am an idiot but time will tell. Bearing in mind all of these things, I bought a 5% position in RNY for my portfolio. Like Thorn it could prove another respectable ‘single’ or possibly a ‘double’ (cricket terms) for my portfolio.

On 07/04/2017, I bought 15,500 RNY shares (units, actually) at $0.033 plus $14.95 brokerage, for a total cost of $526.45, or $0.0339 per unit.

Disclosure: I (obviously) hold shares in RNY Property Trust.

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