Description

The Opportunity

At $8.17/share, I think Clipper Realty has 145% upside plus a 4.7% dividend while you wait in the next 1-3 years.  I think that the bear case upside is 50% and the blue-sky upside is as much as 170%.  Clipper was stress tested during 2020/2021, cashflow has troughed, and are now starting to inflect towards double digit FFO gains for the next 3 years.     

Investors today are buying Clipper Realty at a trailing 12-month P/AFFO of 22x multiple.  Due to apartment rents rebounding back to pre-Covid level in NYC, we believe that Clipper’s P/AFFO multiple will compress to 9-12x in the coming years.  This may result in a dividend that may increase to $0.70 versus the current $0.38 per share or 84% higher.  This will take some time, but this will equate to an 8.6% dividend yield in 2-3 years at today’s price.  If Clipper can make some attractive acquisitions with its $98mm cash balance and develop some properties, the next 5 years can be a period of rapid growth in both NOI and AFFO due to:

1)      Normalization of rent back to Pre-Covid levels  

2)     Rapid rent growth that often follows a period of mothballed NYC construction activities which creates supply demand imbalances i.e. 9/11, GFC, and Covid

3)      Opportunistic buys and/or development

4)      Optionality in owned air rights 

Why Is This Opportunity Available? 

5)      On the surface Clipper Realty looks like it contains too much leverage, but it really has only 50% LTV and max 60% LTV versus arm’s length private market value   

6)      We believe this is due to lower trading volume and the company being under followed and not having the infrastructure in place to communicate with institutional investors.  Most institutions require $3-5mm of daily trading volume to build a position.  Clipper trades a fraction of that volume.     

7)      Please review the 2019 write up by byronval, he does an excellent job on the different dynamics

8)      I read and re-read the 2017 and 2019 VIC write up.  Most of the thesis are correct.  But I think it is a result of timing and scale.  Investor fatigue is certainly an issue here.  CLPR even bought back a $10mm stake from one of its institutional investors in late 2020.  

9)      Clipper AFFO has troughed due to Covid and we expect it to inflect to $30-$40mm in approximately 3 years vs a market cap of $346mm

This is the 3rd write up on Clipper, why will it work this time?

10)   I think Clipper works now because it is about to start comping double digits growth in AFFO for the next 3 years and that will get picked up by algorithms and investors in general.  I expect the AFFO to double in the next 3 years from $16.3mm Q2 2021 run rate to over $30mm.  This is mostly based on the company going back to pre-Covid level rent and adding the 1010 Pacific Ave (new ground up development) AFFO contribution of $4mm expected.  

11)   We believe that the management team, Bistriciers, are smart people.  When they IPO at $13.50, that was a fair market price.  They raised the equity capital and put it to work and made some acquisitions to further build out scale.  I think they run into a handful of roadblocks.

a.       Company was subscale even after the IPO in 2017

b.       2017-2019 was a tough time to create value in NYC via “off market” deals as everything were priced to perfection. There was a spike in 2015 new housing units permitted due to the expiration of the old 421a (15) tax abatement. This backlog of permitted units was delivered over the next 3 years resulting in record unit completions in 2018. The supply trend looks more favorable going forward as the average 3 year units permitted has gone down by approximately 10,000 units. In addition, the anticipated expiration and non-renewal of the current 421a (16) program in 2022 will further limit new housing unit supply.

c.       Significant rent increases in the office buildings in Downtown Brooklyn (141 and 250 Livingston) did not occur till 2020 when Covid became the key concern

d.       Their value add investments did not contribute to the income or cashflow statements until late 2019/early 2020 when Covid became top of mind

e.       New York State passed rent stabilization laws in 2019 that made Clipper look less attractive on the surface.  The laws affected a large portion of their portfolio by square footage, but the affected NOI is less than 35% currently and will be less than 30% once we stabilize back to pre-covid levels.   

12)   I think Clipper did not work during this period due to timing of IPO, scale of the business, trading volume, and positive catalysts of 2020 that got marred by the negative impacts of Covid.  Clipper never had an opportunity to show normalized cashflow.

13)   Large coastal urban REITs such as Avalon Bay and Equity Residential have already re-rated since the vaccine news.  Clipper has been left behind. 

14)   New York City apartment rent is already back to its pre-Covid levels, yet the market is ignoring this very important development.  I think the results will start to come in and come in with fury in the next 12 months. 

Business Descriptions

Clipper Realty owns 2.6mm sqft of multi-family, 500k sqft of office, and 114k sqft of street level retail.  All of the street level retail are ground level floors of the multi-family buildings.  Clipper also has a 114k sqft of multi-family ground up development in Brooklyn by Barclays Center called 1010 Pacific Ave which is expected to be complete in 2 years.  The revenue breakdown is 81% multi-family, 14% Office, and 5% retail.  The base rent is 58% from Brooklyn and 42% from Manhattan.  The following chart is a good summary of their real estate holdings.

Key Summary of Owned Assets

The Tribeca House and Clover House are Class A multifamily buildings with market rent in the $70-80 per square foot.  Think $6,000 for a nice 2 bedrooms.  Tribeca House has an Equinox gym and some street level retail.  Clover House is a newly renovated apartment building in Dumbo (Down by Brooklyn Bridge for Non-New Yorkers).  On a $/sqft basis, it is likely worth the most with a cost basis of roughly $1,500 per square foot.  It is near by Brooklyn Bridge in a tree lined area with great water views of lower Manhattan.  These 2 buildings are the crown jewel of Clipper Realty.  The equity value of these 2 buildings plus the cash on the balance sheet is roughly equal to the current market cap. 

10 W 65th Street – This is a part market rate and part rent stabilized pre-war buildings located about 1 minute walk from Central Park on the west side.  The location is great and close to Lincoln Center. 

Aspen is on 1st Ave by 100th Street.  It is about a 5 minute walk to the last stop on the new Q train.  It is a more affordable apartment building.

141 and 250 Livingston are 2 office buildings under long term leases with New York City government.  It is in Downtown Brooklyn near 5-6 subway station.  It has access to great public transportation.  The office rent is reasonable at $43-50 gross per square foot. 

Flatbush Garden – This is out in the eastern part of Brooklyn.  It is very affordable at $25/sqft. This means roughly $2,000 in rent for a 1,000 sqft apartment.  This is mostly rent stabilized and a good amount of the total square footage.  This property should be viewed in similar way as a regulated utility. 

Downside Protection and Stress Testing

Let’s get it out of the way.  Covid was potentially the worst thing that could happen to New York City.  Some buildings lost 20% of its residences as people flee to the suburbs and rent collapsed by 20%.  As a result, the NOI for Class A buildings dropped by half in some instances.  Covid had the potential to bankrupt Clipper if the balance sheet was shakier and/or the debt maturity ladder had more near-term expirations.  In May 2020, Clipper shored up its balance sheet by executing a $329mm cash out refinance with New York Community Bank and increased its cash balance by $83mm.  In early 2021, Clipper refinance its 141 Livingston St mortgage and increased the cash balance by about $20mm.  After a tumultuous 2020 and 2021, Clipper is in great shape.  In Clipper’s worst quarter, it generated $58.8mm of annualized NOI and $11.4mm of annualized AFFO.  The worst quarterly NOI equates to roughly 4.4% cap rate for the portfolio excluding non-cash generating air rights and development projects such as 1010 Pacific Ave.   The worst quarter AFFO equates to a P/AFFO ratio of 33x excluding non-cash assets.  In short, investors are paying reasonable cap rates and P/AFFO for trough NOI and AFFO with upside and optionality from simply reverting to normal pre-Covid results.  The optionality from future rent growth and developments of air rights and projects is icing on the cake.

All of Clipper’s debts are at the property level and are non-recourse to the company.  There is also $98mm of cash at the Holding Company that can buffer any sort of unforeseen risk events.  This cash balance is an astounding 28% of the market cap that investors are paying.  Excluding the $20mm construction loan, the earliest maturity is 2027 which is only $33mm.  Both loans can be easily covered by the cash on the balance sheet.  The $360mm mortgage on Tribeca House is the real test for the portfolio.  But that is 7 years away.  Shareholders should get 7 years of uninterrupted dividend payments of 4.7% at the stock prices before we risk any dividend cuts.  This gives the company time to recover back to its 2019 performance and then grow from there.  The ultimate stress test has happened.  Clipper passed and survived and is now on the offensive.  I would argue it has never been more exciting to own Clipper than its entire public history.  From a bankruptcy analysis perspective, this is the proper way to look at the company.  It is very easy to see that there are 9 pockets of equity value available to shareholders in ring fenced entities ranging from $10mm of equity in 1010 Pacific Ave up to $224mm in Tribeca House.  We used gross book value for some of the buildings because we believe it is representative of the private market value upon recovery back to Pre Covid performance.  You can use your own assumptions of what the assets are worth and do your own stress test or bankruptcy analysis.  But this is the right framework to think about “how the company will break.”  Clipper manages its bankruptcy risk by putting non-recourse mortgages on each individual property.  The portfolio level loan-to-value may seem high.  But it is below what a private owner may put on this portfolio.  It is higher than what a traditional apartment REIT like Equity Residential or Avalon Bay would put on their property.  We believe the LTV figures are reasonable and conservative as we would personally put a higher amount of debt on it.  The positive is that the long-term shareholder return will be higher than EQR or AVB.  But the optics may be worst as the traditional REIT investors may give it a bigger discount due to not conforming to traditional metrics.   

First Principles of Owning New York City Real Estate

I believe that there is one asset class that is squarely within my circle of competence after spending 20 years in the NYC residential market.  Back in the early 2000s, my family bought a 3-unit rental property.  Since then, we have managed to parlay that into a dozen buildings.  The rest of the family also went into developments in recent years.  I wisely stay out of the development deals as I prefer to buy existing buildings that already generate cashflow financed with long term non-recourse mortgages.  Clipper is one of the most compelling opportunities to play the New York City recovery followed by crisis.  I have personally witnessed 3 crises in my 2 decades of private market experience.  The first crisis was when the World Trade Center towers fell on 9/11.  Lower Manhattan was practically uninhabitable.  A recession followed and people moved out of New York City.  We were not sure what will happen to New York City.  If you would have bought then, you would have done extremely well.  The next time was during the Great Financial Crisis, people thought the glory days of NYC was over.  As a former investment banking analyst working on sell side real estate deals, this really hit home for me.  If banking and finance were to go away, what is left of NYC?  Technology emerged as a growth sector in NYC with Google, Facebook, and a ton of technology startups brining adding to tech talent.  During this whole time, apartment rent experienced years of rapid growth. 

I have never been so humbled.  This meme is a good summary. 

A ton of smart Ivy League graduates thinks “I can get a job in IB, parlay it into a buyside gig at a PE/HF, and maybe make principal or partner.”  Yet, the most certain way that people grew wealthy in NYC were the so-called “simple money” crowd who paid 5-6% cap rate for apartment buildings when mortgage rates were 5-6%.  It pains me to say that a good chunk of my personal wealth came from my first investment property purchased during the peak real estate bubble years of 2006 with a 6.25% 30 year mortgage.  I also have relatives who do not speak English and they have amassed millions of net worth by parlaying a first property into a portfolio of buildings.  So why do people get wealthy buying apartments in NYC?  Yes, low interest rates in the last 20 years helps.  I believe that this immense wealth creation is due to NYC’s unique geography and the city serving as a 2 sided market place for talent, dating, and culture.  While the financial outcomes of my Ivy graduate friends are scattered, it is interesting to note that my relatives (who can't speak English) are often wealthier than them.  The former group is still mostly renters and the latter are landlords who extract one fourth to one third of their pre-tax earnings.     

NYC’s Unique Geography

New York City is surrounded by water and its lack of development sites is obvious.  But I have never really processed the implications until I got much older and real estate became a core part of my investment strategy.  Remember Buffet talked non-stop about moats?  Look at the darkened map on the right.  New York City is physically surrounded by water.  Manhattan is an island.  Brooklyn and Queens are part of Long Island (strictly based on geography, not culture).  Hence, if you want to build anything in New York City, it will cost you an arm and a leg.  It generally involves buying an existing warehouse or low rise building and trying to get approval for higher density uses.   The best data point is that Clipper Realty bought a site for $31mm that allow them to build 112k sqft.  This equates to $260 per buildable square foot.  30% of the future unit is allocated to affordable housing and only 70% will be market rate.  The all-in cash cost will be about $715 per square foot.  This does not include the time value of money (4-5 years) and the necessary developer’s profit.  This is what it takes to create new housing in New York City.

Benjamin Franklin once said, “but in this world nothing can be said to be certain, except death and taxes.”  I want to add that the other certainty is that “building in New York City will always be expensive, full of risk, and take longer than you expect.”

The reason being that there just aren’t any green field sites.  You are typically tearing down an existing house or a warehouse to make way for the new development.  You must do foundation work next to your neighbors’ building and they will complain to the building department, and it could potentially stop your work progress.  Some neighbors and tenants will even try to extort you by threatening ligitation. It can cost 7 figures to buy out individual tenants in order to demolish the building for redevelopment. You are fighting tooth and nail with the existing neighbors, the landmark group, and homeowners who are concerned about a taller building that may obstruct their views.  While New Yorkers are politically liberal, they are some of the worst NIMBYist in the world.  San Francisco and California may be the only other geographies that rival NYC in NIMBYism.  While this sounds terrible, it is actually a great way to create wealth for the owners of existing buildings.  If you own an existing market rate apartment building, you can pass through 3-5% of annual rent increases.  Supply will always be limited and take many years to come onto the market. 

But supplies do eventually get delivered after 4-5 years.  Crises like September 11, Great Recession, and Covid Pandemic mothballed projects for 2-3 years and starts the clock for severe supply/demand imbalances.  I believe we are about to enter another period of rapid rent growth following Covid and the supplies will not keep up for another 4-5 years.  Thus the most ideal time to invest is following a period of market crisis.    

Construction Cost Inflation = Replacement Cost Growing At 3-5% per Year

This is an anecdote, but I think it offers great insights into how the market works.  When I personally closed on the purchase of my first investment property in 2008 (we committed to buying pre-construction in late 2006), the transaction price was roughly $250/sqft.  This includes land, cash construction cost, entitlement process, time value of money, and developer profit.  Today, the land alone will cost $150 to $200 per sqft.  The cash construction cost will likely be $300.  Today, I keep getting quoted a number in the low to mid $200s. The truth is that no one gets their projects built in the $200s.  With the recent cost inflation in materials and labor, $300 is the bare minimum for basic apartment constructions with minimal amenities for locations in cheaper parts of Queens and Brooklyn.  The replacement cost of my existing building will be $500 per sqft plus time value of money plus developers’ profit.  Despite 12 years of depreciation of the interior, the market price of the building is roughly $450-500 per sqft. 

The replacement cost for Clipper’s buildings such as Tribeca and Clover House will be in the $1,200 to $1,5000 range.  I also cannot imagine any projects getting built in less than 4 years from the closing of land acquisition to the start of leasing.  If you are building today, you will likely build something nicer with better amenities.  At the end of the day, the cost of the land is the same whether you build luxury or affordable.  Therefore, only luxury projects get the green light in NYC. 

As a portfolio, Clipper Realty trades at roughly $420 per square foot and investors get the air rights of Flatbush Garden and West 65th Street and 1010 Pacific Ave construction in progress for free.  Let that sink in for a minute.  The minimum cost to build new supply is $500/sqft for the affordable units plus the time value of money and the developer’s profit.  Clipper Realty owns some buildings where replacement cost is as high as $1,500 per square foot.  Investors get to buy the portfolio at $420 per square foot today for something that cost $500 to $1,500 to recreate. More importantly, the equity is about $108 per square foot with the mortgages accounting for about $314 per square. Thus, there is significantly upside to the equity.

The Value Components of NYC Apartment Buildings

Have you ever stopped to consider “why do people make money with real estate?  Aren’t the buildings getting older?  Isn’t depreciation real?”  Is real estate just a Ponzi scheme of lower interest rates?  Where are all the cashflow?  Don’t they have to pay down all the mortgage debt?  Let’s look at the components of value of an apartment building in NYC.  This applies to buildings elsewhere as well.  But this holds true more so in NYC than elsewhere due to the unique geography and the difficulties of building in NYC.  In my opinion, there are 4 components that makes up the value of real estate.

1) Location/land value which goes up over time in NYC

2) Structure – this is the foundation, the beams, and all the structural components that hold up a building.  The structures have hundreds of years of useful life.  New York City is full of residential buildings from over a hundred years ago and they are perfectly fine and do not become obsolete over time. 

3) Uses/Entitlement – this is the right to build to the existing use.  This process alone can take 2-3 years and often involves remediation of environmental issues, getting through government red tape, and dealing with NIMBYist neighbors

4) The depreciating component which includes flooring, paint, roof, appliances, etc. 

An owner in NYC becomes fabulously wealthy over time because the land value and structure value of the buildings they own tend to appreciate faster than CPI while the depreciating component lose value over time.  The ratio of land, structure, and entitlement can be 70-85% of the overall building value.  A landlord will have 70-85% of the buildings value compounding at 3-5% a year and 15-30% of it depreciating down to zero over 10-40 years.  Coupled with long term fixed rate financing, owners can generate double digit returns even at 4.0% cap rates today.  I feel that it is important to highlight these unique dynamics of NYC versus other open/green field markets such as Tampa, Dallas, or Kansas City.  Net migration helps the Sunbelts.  But they could potentially be riskier as it is easier to bring on supply.  Sunbelt investors are also paying more for the depreciable components of the building such as the interior paints, appliances, and finishes.  The land and structure value are a smaller component of the overall value.  While Sunbelt apartments are all the rage now, I think investors are getting a much better risk-reward today by buying Clipper after the Company just inflected from trough NOI and AFFO and are now on the pathway to comp FFO by double digits.  

New York City As 2-Sided Market Place for Dating, culture, talent, and innovation

During 2020, there was no shortage of articles proclaiming that New York City is dead and everyone is moving to Miami or the suburbs.  There is some truth to the movement of the family of a wife, husband and 2 kids to the suburbs for the better school districts.  Many of the 35-35 cohort was likely to move eventually.  Covid pull forward this mass migration.  This dynamic can get tangled in politics regarding taxes, Covid policy, and net migration.  My view is that “no sh@t Sherlock, you have a virus that can send people to the intensive care unit and there were no vaccines or known ways to treat the diseases in 2020.  People with financial means will move out and ask questions later.”  We always believed that the youth and the talent will come back.  Because New York City is a great place for young talents, it will continue to attract the best and the brightest.  Being an Ivy graduate is mere table stakes in this city.  We have seen these dynamics for 20 years on the private side, I do not think that a 25 year old Ivy graduate who works for Facebook, Google, Goldman, or Cravath would want to live in Nashville over NYC.  Okay, some may.  But the majority want to live, work, and most importantly date in New York City.  Nearly half of the entry level employees in investment banking, PE, VC, technology, and big law are East Asian and South Asian.  This is the best dating pool for these folks.  While Channing Tatum will do well regardless of what city he is in, New York City offers the best dating prospect for these individuals.  Being a member of the East Asian group, I can say with certainty that I am very thankful that I lived in NYC in my 20s. Anecdotally, many of my friends tell me “I have a date every single night of the week in NYC, there is no way I can do that in any other city!”  These guys don’t look like Channin Tatum.  If you pay attention to the loudest proponent of the “NYC is dead” narrative, they tend to be right leaning married white men with kids who has already established their careers.  Again “no sh@t Sherlock, you shouldn’t pay the premium.  Move aside and make room for the next guy.”  In short, the best talents are willing to pay a hefty “Tinder Premium” to live in New York City if they remain single.  We believe that the long-term trends of people delaying marriage and living in big cities until their 30s and 40s will continue.  We believe New York City will continue to attract these talents in 10, 20, and 30 years. 

There is that famous quote "You never actually own a Patek Philippe. You merely look after it for the next generation."  The slogan for NYC apartment should be “You never actually own a New York City apartment; you merely look after it for the next 25-year-old Ivy League graduate.”   

Why Did Rent Fall So Quickly and How Did it Recover the 20% drop in mere months? 

New York City operates under a 1-2% vacancy rate for apartments under normal circumstance.  It is this tight inventory that permits 3-5% rent growth during most years.  At the depth of the Covid crisis, apartment vacancy went to the 5-6% range.  This creates extreme downward pressure on pricing and landlords offered the best concessions in my 20 year experience to fill up their buildings.  Because the market only has 5% vacancy and NYC previously had an affordability issue, this drove many younger renters into the city.  This new demographic generally considers themselves in better shape to deal with Covid.  As early as this past winter, many buildings were still offering 2 months concessions.  As the buildings fill up, more people got vaccinated, offices called back more employees, and universities opting for in person classes, there was a rush to get an apartment in New York City.  Twitter is full of anecdotes of “bidding wars” on desirable apartments.  A glut of apartment turned into a dearth and people freaked out about losing out on apartments.  This is resulting in apartments being rented for hundreds above asking price.   

Valuation

Based on the Q2 2021 supplemental, the run rate NOI is $16.1mm which implies a $64.3mm annualized run rate.  Net debt is about $1.005bn and the market cap is about $346mm for an enterprise value of $1.35bn.  This implies that the company is trading at a 4.8% cap rate today based on a near trough NOI figure about to inflect higher.  On a P/AFFO basis, the company trades at 22x P/AFFO.  Most importantly, we believe that the P/AFFO will compress down to 9-12x in the next 2-3 years.  Stocks can linger flattish for a long time.  But they tend to work when the market witnesses a period of rapid growth in NOI, AFFO, and increased dividends.  I think this is what ultimately makes the stock work.  

Most importantly, this package of assets trades at a substantial discount to replacement cost.  At an EV of $1.38bn, this implies roughly $420/sqft.  We believe the portfolio is worth almost $600/sqft plus air rights and construction in progress for 1010 Pacific Street.  On an unlevered basis, we are buying at a little over 70 cents on the dollar plus free optionality in the 500k to 1.0mm sqft of air rights at Flatbush Garden, 50k sqft of air rights near Central Park, and 119k sqft of land already paid for at 1010 Pacific Street.  Using the existing capital structure, we are buying the equity at about 43 cents on the dollar!  As rent continues to grow after getting back to Pre-Covid levels, the private market equity value should compound at 10% a year.  This gives us 23% CAGR at today’s price.  But investors can do much better as the narrowing of the price-to-value gap can easily add 10-20% to the CAGR each year assuming a holding period of 2-3 years.     

Bridging To a $80mm NOI and $30mm AFFO 

We can see from the chart below that Tribeca is running about $14.3mm versus a peak of $22.3mm.  There is $8mm of upside from here.  On the Q2 call, they mentioned that new leases are done at $78/sqft.  The highest quarterly rent Tribeca achieved was $71 in late 2019 to early 2020.  Flatbush Garden has about $2mm upside from its highest quarterly run rate.  Clover House has $1.4mm upside from its highest quarterly run rate.  West 65st and Aspen has $0.5mm upside each from its highest quarterly run rate.  There is $12.4mm of upside from just getting back to previous peaks.  Adding $12.4mm to $64.3 gets us to $76.7mm of NOI.  1010 Pacific will add about $6mm of NOI per management commentary.  This will bring NOI to $83mm. 

Company level interest expense is roughly $40mm and corporate G&A runs about $10mm a year.  Permanent financing on 1010 Pacific will likely add $2.0 to 2.5mm in additional interest expense.  This amounts to $30-31mm of AFFO including the 1010 Pacific St development.  If we assume 10% of NOI for cap ex, this knocks off $8mm a year.  This leaves about $22mm available for distribution.  This will be $0.50 versus the $0.38 being paid out currently and equal to a 32% increase in dividend.  Now assume that CLPR can grow rent 3-5% a year for 3 years after stabilizing at $80-83mm.  This will likely get us over $90mm of NOI and roughly $40mm of AFFO for a REIT trading at $380mm today.  At $9mm for maintenance cap ex, this will bring dividends to $31mm which will be $0.70 per share which will be an 8.6% yield on today’s price.    

Are these assumptions reasonable?  I think so.  After spending 20 years on the private side in NYC residential real estate, 3-5% annual rent increases are the norm rather than the outlier.  The period after Clipper IPO is towards the tail end of a supply delivery period resulting in little rent growth.  Long periods of flat rent are the exception rather than the norm. 

Additional levers.  The company has $100mm of cash which they probably only need about $30-50mm.  If they can acquire a development site like 1010 Pacific for $20-50mm and then get construction loans.  That could potentially add another asset that generates $5-8mm of NOI and another $3-5mm of AFFO.  They could potentially pick up a distressed asset.  Longer term, CLPR could develop the air rights at 65th Street and Flatbush Garden.  There is a pathway to get to over $100mm of NOI with some rent growth and conversion of land/air rights. 

Cash Out Refi = Big Component of Shareholder Return

One of the dynamics of creating wealth owning real estate in New York City is the cash out refinance at higher valuations.  While the yield on the cashflow may not be eye popping, most investors understand many of the land constrained dynamics of investing in New York City apartment buildings.  Hence the levered cashflow yield can be rather low.  As landlords have a few years to pass through rent increases, they can often go to the bank and execute cash out refinances (assume interest rates are flat).  Clipper has done this a few times since its IPO.  Assuming that things do not go haywire, shareholders should expect this mechanism as a non-taxable way to create more shareholder value when building level NOI increases more than 20-30% due to rent growth over time.  

Options

For a tiny little company, Clipper has options that trade.  We own mostly common equity.  But we have some allocation to the $7.50 calls expiring in March of 2022.  On a look through basis, we are getting exposure via "3% down" on a $2bn market price portfolio.  This is not investment advice.  Do your own work.  I am just suggesting a creative way to have more exposure while putting less capital at risk.  People who sell the options maybe viewing it from a “yield plus options premium” perspective.  Selling cover calls does yield some nice returns.  But I think the upside is much juicier.  Difference in opinion makes markets! The lowest price that the stock traded at was low $4s during Covid when the balance sheet was not as robust. You can buy the shares and sell the March $7.50 calls and get to over 10-13% return in less than 5 months. Your breakeven will be in the high $6.82 in case the shares don't take off and you get a $1.35 in options premiums. If you are adventurous, you can sell the higher strikes.

Risks

Net Migration Out of NYC – If there is sustained net migration out of New York City or if young talented top achievers no longer want to come to NYC, then this thesis could be impaired.  But we just experienced a surge of young talents flooding into NYC as rent got cheap in early 2021.  The recent behaviors are reassuring. 

Management – The management team owns more than 50% of the equity via their operating units.  They have control here, plain and simple.  We have spoken to the previous CFO multiple times and met with both the Bistriciers.  I think they are competent operators.  They are not the typical polished public company REIT.  This probably means that Clipper deserve a bit of a discount, 15% perhaps?  But I think they played the capital markets well.  The IPO at $13.50 was at fair price for them.  The deals they did since the IPO was simply in a tough environment where deals were hard to come by.  If you read google reviews of Flatbush Garden, there will be a ton of negative reviews.  This comes with managing rent stabilized apartments in East Brooklyn.  As the land lord, you are providing housing as a “roof over your head” basis.  They even bought back $10mm worth of shares in late 2020 at $5.70 a share.  If you believe that the private market equity value is $15-20 per share, this is 160-250% return on $10mm. It is what it is. But you are getting a "real owner's" return via the dividends.

Politics – De Blasio was probably the worst thing that could happen to NYC with crime and anti-businesses stances.  He never courted any of the wealthy to come back to NYC.  The quality-of-life issues matter.  If you are paying $6,000 for that nice 2 bedroom apartment, you do not want to get mugged outside of your building.  Electing a former cop in Eric Adams is the right choice for the city and huge relief.  He is no Rudy Giuliani.  But he is no May “defund the police” Riley either.  I hate getting political.  But the crime and quality of life policies really matter.  If no one feels safe in NYC, then the talents will not come.  De Blasio really held back rent increases on rent stabilized buildings.  Eric Adams has publicly shown support for rent increases.  I am not a political expert.  But it is easy to see that one administration was borderline communist and the new administration is more moderate.  Eric Adams has commented that he want to court the wealthy folks to come back.  

Covid – People have learned to live with Covid.  Vaccination rates are high and natural infection rates are high in NYC in 2020 as well.  This is a city that can adapt to change.  

Trading Dynamics – Worst print was between $4-5 from April 1st to April 8th.  The balance sheet only had $50mm of cash vs $98mm today.  This was before a $7mm NOI increase in the Downtown Brooklyn office leases.  The Company today is in much better shape, bigger, and more resilient than April of 2020.  I doubt Clipper ever trades below $5 again.

Trading Volume -  Historically a low trading volume is a bug not a feature. This dynamic has been flipped on its head. If you look at SPACs, the ones with over 90% redemption worked the best recently. There is a certain meme quality to a small float company with a "New York City is Back" battle cry. This is something that I would have never mention prior to 2020. But one must be cognizant of the zeitgiet. Good investing is combinining good fundamental and good market set ups. The limited trading volume may be a feature not a bug.

Catalyst

Catalyst - Inflection of Rent and Occupancy

Rent increases is no longer hypothetical.  It is happening now.  You can verify this by talking to people looking for apartments and at various news outlets.  The first half of 2021 were full of stories of landlords giving out unheard of concessions and rent reductions to entice existing tenants to stay and new tenants to sign.  But the vacant inventory was quickly absorbed.  Then the offices announced return, Broadway opened, and colleges announced plans in person classes.  Just like there was a mad rush to exit, there was a mad rush to come back into the city.  This creates almost unthinkable dynamics of prospective renters getting into bidding wars over apartment rentals.  Rent is already back to pre-Covid levels.  Clipper said on its Q2 earnings call those new leases at Tribecca are done at $78/sqft.  Its previous peak average was $71/sqft.  Here is a recent Bisnow article:     

If you closely follow Twitter chatters and talk to your NYC friends, it is becoming obvious that 1) vacancy is drying up 2) pricing is getting back to pre-Covid levels and maybe even higher and 3) an apartment hunter must commit quickly. 

There is even an article talking about etiquettes of apartment hunting which includes being nice to the broker and having all your documents ready.  The market has turned 180 and it is now a landlord’s market.  These recent developments are not priced into Clipper’s stock price! Since most leases are 1 year in duration, it would require roughly 4 quarters to fully exit leases with "Covid concessions."

For Clipper to re-rate, I think the market accept the following:

1) Clipper Realty is a great way to play NYC recovery = $10-11 stock any day now

2) Recovery back to pre-Covid rent = $13-15 in under 4 quarters

3) Exceed Pre-Covid rent and achieve $90mm of NOI and $40mm of AFFO = $20 in 1-3 years