I recently came across One Liberty Properties (OLP), and whereas I usually find a generic name usually bodes negative for the investment potential, I have to admit I was positively surprised when I looked under the hood. In fact, I was so surprised I immediately initiated a long position. In this article, I will briefly discuss the REIT’s Q2 results and I will explain what caught my attention and why I see the possibility for a 50% capital gain.
The second quarter and H1 2020 were stronger than anticipated
During the second quarter, One Liberty generated $20.9M in rental revenue which is pretty much in line with the second quarter of the previous year. This resulted in an operating income of $8.2M and a net income of $2.28M or $0.10 per share.
Source: SEC filings
Of course, the net income doesn’t matter at all when you are analyzing a REIT and one should look at the FFO and AFFO to figure out how interesting a REIT is. Looking at One Liberty’s performance, its FFO came in at $0.87 in the first semester while the AFFO was approximately $0.97 per share.
Source: Company presentation
As you notice on the screenshot above, the H1 result isn’t very different from the full-year results the past few years, and although the FFO in FY 2020 will come in lighter due to the COVID-19 impact as well as the higher share count after having paid 50% of the July dividend in stock, One Liberty’s performance shouldn’t be too bad.
A dividend cut? That’s possible, but there are sufficient reasons to like One Liberty
One of the main reasons why the market remained (and still remains) uncertain about One Liberty were the high amount of rent deferral requests and low rent collection rate during the COVID-19 pandemic. Indeed, whereas rent collections totaled 100% in March, this dropped to just 71.9% in April and a rent collection rate in the low seventies makes it difficult to defend One Liberty.
The company took swift action and confirmed in June its dividend payable on July 31 would be paid 50/50 in cash and stock and this perhaps was optically the best solution to avoid an outright dividend cut. I’m however radically against a forced stock dividend so I would be totally in favor of OLP rebasing the dividend to, say, $0.35/quarter which can be fully paid out in cash rather than pursuing mandatory stock dividends which only erode the NAV/share.
Fortunately for One Liberty, the rent collection performance improved pretty fast. It recorded 77.1% of the rental income in Q2 was collected and the REIT entered into deferral agreements for an additional 20% of the rental income. But what was even more important (and it looks like the market completely missed this) was the July result: One Liberty collected 92.7% of the July rent and if one would take the approved deferrals into consideration, the collection rate was 96.6%. So from collecting less than 72% of the rent in April, One Liberty’s rent collection performance has increased rapidly to 92% in July. Deferred rents will be paid in H2 2020 ($0.4M), 2021 ($2.7M) and 2022 ($0.15M).
So, rent collections are key and this, in combination with the high occupancy rate of 96.9% make One Liberty Properties very interesting.
A third element that convinced me to dig deeper was One Liberty’s willingness to sell properties. Subsequent to the end of the quarter, it sold a property hosting a Carmax facility for $18M, and recorded a capital gain of $10.3M on the asset. I don’t care too much about the capital gain (considering the property had been acquired in 2004) but I was very interested in the assumed rental yield Carmax was willing to pay for the building.
One Liberty disclosed the asset generated $573,000 in rental income in the first half of the year, resulting in an annual rental income of $1.15M. A purchase price of $18M indicates the buyer was valuing the property at a gross yield of 6.3%. The FFO of this property (defined as rental income minus interest expenses) was $0.82M, indicating the buyer paid 22 times FFO for the asset. A good sale, and One Liberty repaid the $8.5M mortgage and repaid $8.7M on the credit facility. This means that although the rental income will decrease by $1.15M after the sale, the total interest expenses will also decrease, by approximately $0.6-0.7M so the net impact of the sale on the FFO will be minimal.
Quick and dirty, my own NAV/share calculations
Considering US based REITs (contrary to their European counterparts) need to include depreciation expenses on their respective properties, I wanted to figure out a reasonable NAV/share (and LTV ratio) based on more reasonable valuation assumptions. I will use a required gross rental yield of 8% and use $75M as contractual rental income (down from the $76M the properties are currently generating).
Source: company presentation
This results in the following calculation:
Source: Author compiled table, based on publicly available information
Based on the current data, I see approximately 50% upside potential to $25.5/share once rent collections normalize again towards 96-97%. Note, in my calculation above I also do not take contractual rent hikes into account. Some rental agreements contain annual rent increases and this should continue to boost the rental income.
One Liberty’s main task is now to keep the occupancy rate high and convert expiring leases into new leases.
I’m quite charmed by the underlying asset base of One Liberty, and with an average weighted lease term of about 6.5 years I think the asset book looks good. Fortunately One Liberty doesn’t have to try to re-lease properties in the current market. There are no lease maturities in 2020 and the leases expiring in 2021 represent just 1.4% of the rental income. 2022-2024 will be more important for One Liberty and I hope the commercial teams can pull off some nice extensions.
Source: company presentation
The current dividend yield is questionable and may not be fully covered at the 92% rent collection rate. Some investors will prefer the REIT to stick with the current quarterly $0.45 payment in cash and stock but I’m strongly in favor of rebasing the dividend to a lower but sustainable rate. The excess cash could subsequently be used to buy back stock at a discount to the fair value of OLP.
I didn’t know OLP before but I am very charmed by this REIT. Granted, it’s not easy for real estate companies these days but a rent collection north of 92% in July is a clear positive. I will be looking to build a long position in One Liberty Properties over the next few weeks and months, with an initial purchase in the next few days.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in OLP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.