Description

Let’s face facts; most REIT investors only care about the dividend. As we learned in 2009, a REIT will often lever up and buy mediocre assets to pay investors 50bps more on the dividend—only to dilute investors 50% in a recession. Still, investors chase yield because analyzing a few dozen different property assets with hundreds of leases, is just too hard to do. Dividends and dividend growth rates are easy to track and model.

Unfortunately, when it comes to property investing, the guys who make the real money are the ones who do creative things—who develop assets—who re-purpose assets—who sit on dysfunctional assets without cash flow and wait for their moment in the sun. Think of the city where you live; are the wealthy property guys the creative types or the ones who buy mediocre assets at a slightly higher than market yield? Of course, you take on some risk for being creative—but you often get paid for that risk. Unfortunately, in the stock market, investors struggle to comprehend this—especially when taking some risk costs money today and reduces the current dividend, an investor’s primary yardstick.

Let’s look at Campus Crest Communities Inc. (CCG: USA). CCG owns, operates and develops student housing at universities in the US and Canada. In addition, CCG manages joint ventures for investors who want exposure to the development potential in student housing, thus allowing CCG to earn fee income off of 3^rd party capital.

Think back to your college days—you wanted to live near your friends, near the fraternity house and near to campus. CCG’s properties haven an average distance to the campus that they are built for of .6 miles. That’s something of a moat in the property business which often is a commodity industry. While CCG operates 35,801 beds currently (14,920 wholly owned, 5,148 JV and 13,177 Copper Beach), during 2014, they are expected to deliver 7,455 additional beds (a 21% increase)—which will drive rents and cash flow. Unfortunately, today, these assets are not yet producing cash flow, are distracting management and leading to all sorts of volatility in results—the bane of REIT investors.  

How low is the valuation? At 6.25 a share, the stock trades at a 22% discount to tangible book value of $7.98 and a dividend yield of 10.6%. In the great property bubble of 2014, you can still buy a growing property group at a discount to stated book value—quite crazy really. How did it get here?

To start with, there have been plenty of missteps; a new premium concept called EVO has been slow to lease-up, there is recurring confusion over the portfolio composition as CCG constantly changes their percentage ownership of their various JVs, buys out some properties and swaps GP interests for other properties. In addition, volatility in development and fee income has added volatility to quarterly numbers. Finally, the company completely bungled the acquisition of Copper Beech, a competing student housing company—over the past two years, it has gone from being an acquisition of a 48% interest in 35 properties (30 of them student housing), to the acquisition of a 67% interest in a select 28 properties with an option on future acquisition of the remainder along with two new developments, to a 48% minority interest in all 37 properties. Along the way, there have been various preferred returns and other waterfalls on the earnings (or lack thereof at Copper Beach), to further confuse investors.

Added to all of this, is the fact that the company has consistently and repeatedly missed earnings over the past few quarters, leading investors to question the stability of the dividend and to dump the shares. Fast forward to today, at current dividend yields, you are buying at an above-market dividend yield while CCG is still subsidizing a bunch of development assets with no revenues—any revenue at all from these assets will increase the dividend yield. No wonder development companies tend to be private businesses—Wall Street gives them no respect at all. They are volatile, confusing from an accounting standpoint and difficult for shareholders to model.

What is fair value?

There is $1.273b of assets, mostly made up of investments in property assets. This is offset by $603m of liabilities, mostly made up of mortgages and debt. Finally, there is $153m of preferred debt outstanding. Tangible book value is $517m on 64.8 million shares, or $7.98 a share.

All that CCG needs to do is to cover the dividend over the next year as the new properties come on-line, and the shares are likely to revalue. Why do I think that this will happen? To start with, the company already covers the dividend (barely). However, for the first time since listing, it seems that the company has found religion and cut back on development, in order to focus on operations. For 2015, they plan to only build 4 projects, which is a 60% reduction from 10 projects in 2014.  This will result in a substantially larger portion of the portfolio being steady state cash flow assets—as opposed to development assets—going forward. Remember, most property investors just want yield and predictability—CCG is now maturing into a boring yield play that will be easy to model. Ironically, the stock should appreciate because of that fact. From a valuation standpoint, I see the shares returning to the low double digits where they were before these missteps occurred.

In terms of operations, their lease-up for 2014/2015 year is 210 bps ahead of where it was as of last year, during July 27, 2014—the date of the Q2 earnings. This bodes well for occupancy and cash flow for next year. Remember that student housing companies do the majority of their leasing during a short window each year, so weakness in lease-up will impact earnings for the remainder of the year.

The final question is what will be done about Cooper Beach. The portfolio is underperforming to the point of being unprofitable. Clearly, CCG needs to find a solution for this asset. My guess is that they ultimately re-negotiate the terms again and end up with a 100% interest in some subset of the assets.

As a side note, CCG recently hired Aaron Halfacre, an industry veteran, formerly of Cole Real Estate Investments which was recently sold, who will focus on capital markets—which means telling the story to investors.  Aaron just purchased $850,000 in shares—so clearly he believes in the stock. Anyone interested in the company should listen to his comments on the Q2 conference call. He clearly understands where the company has made mistakes.

In the end, with the full lease-up of the new development assets this year, the company should more than cover the dividend and it is likely to show a whole lot more stability in earnings going forward. As more of the portfolio switches over from initial lease-up to steady state, returns should improve and you are left with a student housing REIT at less that book value and with an above market yield—in a market with very few bargains.

Disclosure: I am long shares of CCG and may buy or sell shares without further notice.

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