Description

Clipper Realty is a broken-IPO, New York City-focused multifamily REIT with below-market rents, trading at a large discount to its NAV.

The company has a $482 million fully diluted market cap ($1.3bn EV), but only a sub-$170 million free float and little trading liquidity (~$1m/day).

While I don’t have a view on where the stock will trade over the next 12 months, I believe you can make a credible case that the security has downside protection stemming from the value inherent in its Tribeca property.  Additionally, there appears to be significant long-term upside potential from improving under-earning properties and investing alongside a management team with a track record of creating a lot of value in New York City real estate.

The company is run by David Bistricer (Co-Chairman and CEO) and Sam Levinson (Co-Chairman, Head of Investment Committee).   Bistricer has spent his entire real estate career focused on New York City.  He took over from his father who started Clipper Equity in the 1950s.  Levinson is the CIO of Glick Family Investments and was a director at Canary Wharf group.

Bistricer and Levinson’s strategy is fairly straightforward: buy properties in attractive neighborhoods with below-market rents, invest a little capital improving the properties, and raise rents.  Management’s investment philosophy is probably very similar to a lot of members on this site: they focus on buying properties at a high implied cap rate a few years down the road.  They are also fairly aggressive with regards to their use of non-recourse leverage.

Their most recently closed acquisition exemplifies their investment approach.  In May, the company acquired an 11-story residential building in Brooklyn Heights from the Jehovah Witnesses.  Because the property was vacant upon closing and required a modest amount of renovation, other traditional buyers were less interested.  Consequently, management ended up paying ~40% less than the rumored potential sale price a year ago.

The low absolute level of Cap Rates that multifamily properties trade hands for in Manhattan may shock a few investors on this site.  I would recommend attempting to hedge out some of the rising cap rate risk.  However, given the high level of leverage, the low cap rates, and the NYC focus, it is difficult to find an adequate hedge in the public markets.

While the rental market in New York City has weakened over the past 18 months, the relatively more benign supply/demand dynamics in Clipper’s neighborhoods and low starting points have allowed the company to continue to grow rent per square foot at all of its residential apartments.

Background

The company conducted a 144A offering through FBR Capital Markets in the summer of 2015 to help finance their December 2014 purchase of the Tribeca property and create the foundation for a future public REIT vehicle.  10.7 million shares were issued at $13.50 in July 2015.  In February 2017 the company issued 5.7 million shares in its IPO.  The deal appeared to be fairly rushed as it was downsized, management committed to buy 1m shares in the deal, and the company announced it entered into an agreement to acquire its Brooklyn Heights property on February 15th.  Likely not helped by the rushed deal, small float, poor REIT headlines, a complicated story and poor liquidity, the shares broke below $13.00 in April 2017 and have yet to recover.

Clipper Realty Properties

• Flatbush Gardens – Low-Cost multifamily apartments in Flatbush, Brooklyn

• Tribeca House – 2 luxury rental apartments taking up nearly an entire city block in lower Manhattan

• 141 Livingston / 250 Livingston  -- Predominantly office space leased to the city of New York in downtown Brooklyn

• Aspen – Residential - Uptown Manhattan neighborhood benefitting from completion of Second Avenue Subway line

• 107 Columbia Heights – Recent acquisition in Brooklyn Heights neighborhood

Tribeca House – 50 Murray Street and 53 Park Place

• The company owns nearly an entire city block in lower Manhattan, on the edge of the Tribeca neighborhood

• Kitty-Corner from the new Four Seasons downtown, two blocks from the Tribeca Whole Foods and a couple of blocks north of the World Trade Center sites

• The properties were originally constructed as office space for the IRS in the 1960s; they were converted to residential buildings in 2002 and weren’t managed all that effectively until the acquisition by Clipper in December 2014

• This area of Manhattan has seen a significant amount of change over the past two years and will likely see a lot more change over the next 5-10 years

• Comprises ~480,000 square feet of leasable area with 505 residential apartment units and ~77,200 square feet of retail space with 8 retail tenants (53,000 square feet of street-level and mezzanine-level retail space and an externally managed garage), including the Tribeca Equinox fitness club as an anchor retail tenant

• Residential units are 94% leased with rates currently 15% below market ($67 Per Square Foot vs. $80+ PSF market)

• This is up from $61 PSF when they acquired the property in December 2014

• New apartments are being rented out in the $70 PSF range

• Retail is currently 65% below market ($49 PSF vs. $142 PSF market)

• The biggest below-market tenant is the ‘Amish Market’, whose lease doesn’t come up until 2022.  Currently paying ~$44 PSF, if the lease is renewed at $140 PSF, it would add $2m to NOI

• Re-branded as “Tribeca House”

• Completed renovations on both lobbies, targeted apartment renovations ongoing, upgrading amenities

• Management has fully renovated over 250 residential units at an average cost of ~$19k per unit

• tribecahouseny.com

• The company generated $36 million and $21 million in annualized Revenue and NOI in 2Q17

While management thinks that in the near term the highest and best use for the property is rentals, there is an opportunity to monetize the apartment units through a conversion to for-sales condo or co-op units.  Based on StreetEasy listings for comparable buildings in the Tribeca neighborhood, management thinks this a condo conversion could take place at $2,100+ per square foot.

While the REIT structure would not allow the company to own condos, I believe the value inherent in the property provides a source of downside protection.

If we assume that the units could be converted to condos and sold for ~$2,000 per square foot, that would imply an equity value in the Tribeca property well in excess of the company’s current market cap.  This would mean you are getting the Tribeca property’s retail revenue and all of Clipper’s other properties for free (albeit encumbered).  This is a simplistic analysis as it doesn’t include taxes on capital gains (the property was acquired for $998 per rentable square foot), and the supply/demand dynamics in the luxury condo market in lower Manhattan don’t currently seem great, but it does illustrate the potential value in the Real Estate.  You can also make the argument that $2,000 per square foot is below construction cost for luxury condos in this neighborhood.

Flatbush Gardens (Flatbush, Brooklyn)

• Acquired in October 2005

• 2,496 rent-stabilized apartments in 59 primarily six-story buildings on 21 acres in Flatbush, Brooklyn

• 21.4 acres of property, total of 1.7 million rentable square feet, space for ~240 vehicles in parking structures

• In-place rents on average 17% lower than legal maximum chargeable pre-rent regulation, in a gentrifying neighborhood

• Property is 97% occupied, average rental rates of $21.59 per square foot

• Rents are well below market of $30 PSF

• New leases are being booked on average at or above $26 PSF

• Currently undergoing $31 million comprehensive property renovation and modernization program, which management believes will help continue to push rents higher over time

• The complex is not built to its maximum floor-to-area (FAR) ratio

• Potential expansion of 500,000 square feet by adding four floors above some of the buildings

Downtown Brooklyn Office (141 Livingston and 250 Livingston)

• Two buildings purchased in 2002: 559,979 square feet office space and 26,819 square feet residential space

• 141 Livingston: 100% leased to City of New York at $40 PSF; contracted rent to increase to $50 PSF in 2019

• 250 Livingston Office: 100% leased to City of New York

• Potential $9.4 million annual rent increase by moving rent to $50 PSF, in-line with 141 Livingston beginning September 2020

• 250 Livingston Residential: converted top 4 floors to 36 apartment rental units ($51 PSF)

The Aspen (Manhattan, NY)

• Recent Uptown Acquisition (1st Avenue between 100th and 101st Streets)

• Opened in 2004

• 186,602 leasable square feet, 232 residential apartment units, three retail units, a parking garage

• Apartments are 98% occupied at average of ~$34 PSF

• 55% of units are free market (at ~$38 PSF)

• 45% subject to low-and-middle income restrictions

• Free market rents are ~24% below market ($38 PSFT vs. $50+ PSF)

• Management believes in can achieve market rental rates on its non-restricted units over the next 1 to 3 years

• Retail space is fully occupied at $42.55 PSF

• Play on increasing values associated with completion of Second Avenue Subway line

107 Columbia Heights (Brooklyn, NY)

• 11-story residential building comprising 154,000 square feet, 159 units and an indoor parking garage

• Acquired in May 2017, vacant, from the Jehovah Witnesses, for $87.5m off-market

• The acquisition price comes to $569 PSF; at the time when the property was put on the market in April 2016 it was speculated to fetch up to $1,000 PSF

• Property was recently renovated in 2007

• Current market prices in the area indicate rental rates of $65-$75 PSF

• Intend to create 12 additional residential units by converting various public areas on the property

• Plan to invest ~$10-$15m on further renovations and improvements to achieve market rents over time

10 West 65th Street, Manhattan, NY

• Recently entered into a contract to purchase for $79 million off-market

• 6-story residential complex comprising 82,000 square feet plus 53,000 square feet air rights with 82 units

• Located near Lincoln Center and Central Park

• Post-development, 80% of units expected to be free-market rents; 20% rent stabilized

Pro Forma NAV Analysis

There are a few different ways to think about the valuation for Clipper.  I believe the simplest way to think about the NAV is to apply market-by-market Cap Rates to current NOI and then layer in the three aforementioned identifiable step-function increases to NOI:

• Contracted step-up in rent at 141 Livingston from $40 PSF to $50 PSF in 2019

• Potential rent increase upon renewal by the city to $50 PSF rents at 250 Livingston beginning September 2020

• Large below-market retail tenant at Tribeca property stepping up to market rents in 2022

Using this methodology, I estimate a Pro Forma NAV of ~$15.87-$20.16/share.  This implies the security is trading at 0.53x-0.68x Price / NAV.  Moreover, this does not include any of the organic growth opportunities (getting residential market rents up to market, potential expansion at Flatbush Gardens, upside from Columbia Heights project) or future acquisitions, which should lead to the company compounding NOI and AFFO at above-peer rates.

Insider Ownership / Insider Buying

• The Bistricer families own $161 million of stock

• Sam Levinson owns $94 million of stock

• Levinson purchased an additional $938k worth of shares in the open market in June at $11.25/share.

Stated Acquisition Strategy

“We intend to continue our core strategy of acquiring, owning and operating multi-family residential rental and commercial properties within submarkets that have high barriers to entry, are supply-constrained, exhibit strong economic characteristics and have a pool of prospective tenants in various industries that have a strong demand for high-quality commercial space.  We believe that owning assets within New York City, one of the best residential and commercial markets in the United States, will allow us to generate strong cash flow growth and attractive long-term returns.  We will opportunistically pursue attractive opportunities to acquire multi-family residential and commercial properties, focusing our acquisition strategy primarily on multi-family residential properties in densely populated communities in the New York metropolitan area (primarily in Brooklyn and Manhattan).”

Risks

• Interest Rate Risk

• Leverage / Refinancing Risk

• The company is highly levered with $810m of property-level debt, a $482m Market Cap and only $41m of 2Q17 annualized EBITDA

• Macroeconomic Risks

• Supply/Demand Imbalance – Rent pressures

• New York City event risks

• Tenant lawsuit at Tribeca Properties

• https://therealdeal.com/2017/07/05/tenants-defeat-clipper-equity-in-rent-stabilization-suit/

• Tribeca Properties – construction of 45 Park Place tower obstructs tenants’ views at 50 Murray (management maintains no units will be permanently impaired)

• Regulatory Risks

Links:

Investor Presentation: http://www.clipperrealty.com/docs/Investment_Presentation_6_2017.pdf

https://www.wsj.com/articles/at-clipper-equity-generational-change-1444614281

https://therealdeal.com/issues_articles/the-closing-david-bistricer/

http://www.cushmanwakefield.com/en/research-and-insight/2017/cap-rate-survey-mid-2017/

https://therealdeal.com/wp-content/uploads/2016/08/APA-Brooklyn.pdf

https://therealdeal.com/issues_articles/bistricer-gets-busy/

https://therealdeal.com/issues_articles/ranking-new-condos-from-barnetts-one57-to-rudins-greenwich-lane-by-per-square-foot-prices/

Catalyst

Time, continued operating momentum, integration of acquisitions