Description

Inflation got you down?  Starting to think all those guys who preach about real assets might be right?  How about buying some single family homes?  Too time consuming to buy?  Too time consuming to manage?  Getting outbid every time?  Boy, I couldn't agree more.  Let's have someone else do it for us. 

I'm recommending a purchase of Bluerock Residential Growth.  Bluerock's multi-family assets are being acquired by Blackstone for $24.25 per share.  Shareholder approval has been obtained and the purchase looks on track for a Q2 anticipated close.  In addition to the $24.25 per share, shareholders will receive Bluerock's single family holdings via a spin-off called Bluerock Home Trust ("BHOM").  I'll caveat by saying that I like this idea best for non-taxable accounts, as the spin-off is taxable.  That said, I believe the investment is interesting to both taxable and non-taxable accounts and will present below primarily assuming a taxable account unless otherwise noted.  When the Company announced the acquisition, management estimated BHOM's NAV at $5.60 per share with an opinion provide by Duff & Phelps. 

OK, so you buy BRG for $26.24 per share.  In pretty short order you get $24.25 per share, meaning you are paying $1.99 for BHOM.  Don't jump up and down yet, because you are going to need to pay some taxes too.  Using management's estimate NAV at the highest marginal federal tax rate, that's $1.34 in taxes too (see below for details on the calculation).  Well, you are now paying $3.32 for something that BHOM & Duff & Phelps says is worth $5.60 per share.  Still looking pretty good.

What?  You don't want to take Duff & Phelps word for it?  Even though the Company likely paid them millions for their opinion??  You want to know more about what you are buying?  Well, don't worry.  You can also have Mustang tell you what it's worth, and I'll do it for free for members of VIC.  

According to the SEC 10-12B filings, you are getting:

- $14.7mm of mortgage notes

- $44.9mm of preferred equity investments in single-family home rental ventures

- 1,789 homes with a cost basis of $317mm

- You are also getting $157.3mm of cash less $76.5mm of debt for net cash of $80.8mm

Note that BRG stockholders will hold 35% of the Company, while Bluerock's OpCo will own 65%.

For the homes, I'm valuing them two ways.

First, I looked at national home price appreciation since the time of BHOM's purchase and applied the same % increase to the Company's properties, that results in the following estimate of FMV:

Second, I look at two single family rental companies that are publicly traded, INVH and AMH.  Each trade for just above 4% cap rates.  

That results in the fair value estimates below:  

I think the main impediment to them achieving a valuation in-line with comps is that BHOM will be externally managed.  We'll pay 1.5% + 20% over an 8% hurdle rate.  How much will that ding valuation?  I'm not sure, but imagine we'll never get to $5.58, but bet we'll trade over $4.86.

The other issue with this trade is that you've got to layout a lot of capital to get to BHOM exposure.  For ever $ of BRG, you are getting roughly 13 cents of BHOM exposure.  That probably all works fine, as your main risk is that the merger doesn't go through.  As noted above, the merger is far along.  Additionally, according to the proxy, the nearest bidder was fairly close on valuation.  That said, BRG traded around $10.85 prior to reports of strategic alternatives got into the market in September 2021.  So, that could represent a lot of downside if the deal breaks. To protect your position, you can buy a $22.50 put for $0.30 per share.  That caps your downside at $4.04 ($26.24 - $22.50 + $0.30) or 15.4% on BRG stock's price.  That changes the table above on FMV to the below:

So, from a risk arb perspective, you are risking 16% on a break to make 6% in about a month in a taxable account or 16% in a non-taxable account counting the entire risk capital in the denominator.  

Catalyst

Completion of spin-off and merger