Description

I am recommending Industrial Logistics Properties Trust (ILPT) as a long.  ILPT was previously written up on VIC as a long four years ago when the stock was at $21.60.  The company has paid $1.32 annually in dividends during that period, but even so shareholders are down: today it's at $14.  In fact the decline has been both recent and significant: a month ago the price was $21.  With a current yield of about 9.4% and a significant acquisition in Q1 2022, we think it is a good time to revisit the name.

The previous writeup gives good background information, which for compactness I briefly summarize/update.  ILPT focuses on logistics properties (e.g. distribution centers).  Their crown jewels are ~226 properties in Hawaii, most or all of which are ground leases.  These are extremely high in quality: Hawaii has limited land, so occupancy has been above ~98% for almost 20 years; and tenants have built large buildings on said land, which revert to ILPT if rent is unpaid.  Rents reset to fair market value periodically; the current average lease term has 13 years to go.  About 31% of their rental income comes from Hawaii.

The remaining ~157 properties are mainland logistics properties, the majority of which are rented to investment-grade tenants under long term leases.  The largest three tenants are FedEx (21%), Amazon (9%), and Restoration Hardware (2%).  There is some concentration risk with the first two, and both FedEx and Amazon are tough negotiators.  On the other hand, both need logistics properties for their core business.  The mainland properties are located in 38 states, with the bulk in the Eastern half of the country.  The average lease term is somewhere between 5 years (legacy business) and 8 years (newly acquired business; see below).  About 69% of their rental income comes from the mainland.

During Q1 2022 ILPT completed its acquisition of Monmouth Real Estate Investment Corporation (former ticker: MNR), acquiring a total of 126 Class A buildings.  Including extinguishment of debt, redemption of preferred, etc., the total cost was $4.1b; with the exception of $409mm in assumed debt, everything was paid cash.  But how was that cash raised?  An equity joint venture partner paid $587mm for a 39% interest in 95 buildings; the joint venture raised $1.4b in CMBS floating-rate debt and assumed $323mm of existing MNR debt.  The balance of the purchase, roughly $1.8b, was paid with a mixture of a $700mm fixed-rate CMBS loan and a $1.4b bridge loan.  ILPT expects to reach a net debt / adjusted EBITDA of 8.0 by year end.

ILPT has declared its intention to repay the bridge loan by selling ~30 additional MNR properties (more or less, all of the properties not in the JV), a new credit facility, and/or the sale of additional JV equity interests.  Assuming ILPT wanted to retain 51% control of the JV, it could raise about $150mm for a further 10% stake.  On the Q1 2022 balance sheet, the ~30 buildings identified for sale are valued at $732mm, presumably by dividing the total purchase price into the individual buildings "somehow."  Alternatively, if every square foot is valued the same, these buildings are worth $760mm (the ~30 buildings are about 19% of the acquired square footage).  If every building is valued the same -- too optimistic as presumably the gems have been retained in the JV -- then the buildings identified for sale are worth $984mm.  In any event, under reasonably positive scenarios, we assume $250-500mm will be put on a new credit facility.  I'd hope that the sales are being done strategically, but it's not clear how the individual buildings were chosen.

A key risk, clearly, is that this bridge loan will not be so easy to replace.  Perhaps additional joint venture partners are hard to come by.  Credit facilities may dry up.  In an emergency there are some levers management can pull, e.g. cutting the dividend, but that's unlikely to be good for shareholders in the short term.  Concern over this refinancing risk in a challenging environment is probably a major reason the stock price has declined.  This concern is reasonable, but I think sales are likely to go through in the end.  At the end of the day, interest rates are still very low and these buildings are high-quality assets.

Another negative is that ILPT is externally managed by the (in)famous RMR Group.  External management is always a challenge for REITs, and the RMR group has its detractors.  We note that the sellers of MNR took cash, not ILPT shares; not exactly a ringing endorsement.  Management is paid 3% of gross rents, among other things, so there is obviously an incentive to grow rents even when the pricing is not brilliant.  Although the story is still being written, it's possible that part of the reason for the decline in ILPT's price is because shareholders are worried ILPT overpaid.  Since they have been able to find a joint venture partner, it seems unlikely that they overpaid egregiously.  Moreover, the fee structure at ILPT is better than at some RMR-managed REITs in the past: ILPT's management fee goes down with the market capitalization.

To ballpark an acquisition value, assume ILPT overpaid for MNR by 10% on a square foot basis, i.e. other buyers would pay $3.6b for 26mm sq ft.  If every sq ft is worth the same, the legacy (pre-acquisition) business in ILPT has 36mm sq ft and "should" be worth $5.0b.  (Probably the HI ground leases are better, but let's ignore that.)  ILPT (not including the JV) has about $2.7b in debt, which should reduce to about $2.0b after selling the ~30 remaining MNR properties.  Thus, the net equity in the legacy business should be worth about $3.0b.   To this value, one should add $0.9b for ILPT's 61% equity interest in the JV (if they sell additional JV interests, they'll reduce their debt further; tomayto/tomahto).  This gets to a fair value of $3.9b, which is an interesting number as it works out to... $59.80 / share.  The market really doesn't like RMR... who knew?

An obvious risk is that as interest rates go up, triple net buildings "should" go down in value.  There is some danger that the refinancing does not go smoothly, which will be painful for shareholders even if ultimately the company navigates through it.  RMR's management is a negative, as always focused on growing AUM rather than maximizing value per share.  But, well, we're value investors.  Most cheap things have some hair on them.  Annualized FFO is about $1.68 / share, so a purchaser today is paying about 8.3x FFO, or about a 12% FFO yield.  Assuming the dividend holds, shareholders are getting about a 9.4% cash yield.  If you think the bridge refinancing will ultimately go through all right, buyers should do fine.

Catalyst

Value is its own catalyst.  Dividend.  Refinancing the bridge loan.