I’ve had a few emails and phone calls from fellow RNY unitholders of late. Rather than answer them individually, I thought I’d put my thoughts on this ASX-listed property trust up on the blog for all to read.
As most of you know, we have owned the stock in the Forager Australian Shares Fund since early 2010. We’ve made roughly three times our money on it (about 24% per annum) and it’s still the largest holding in the Fund by some margin.
The tone of the emails and calls suggest that fellow unitholders are getting frustrated. Until this week, the stock price hadn’t moved in the past 12 months, despite a plummeting Australian dollar. The manager provides fewer updates than any company I have ever owned (half and full year results are often all you see). And occupancy at its US suburban office buildings remains stubbornly low despite rapidly improving employment markets in the United States.
The solution, according to some, is to either force management to liquidate the trust or encourage them to make a takeover bid for the 80% of RNY they don’t currently own (the manager, New York based RXR Realty, owns 20% of RNY and an additional 25% of the underlying assets). At the very least, I’m told, they should reinstate dividends so that the stock attracts investors looking for income and trades closer to its NTA.
Firstly, we write about some of our ideas in detail to explain to our investors how and why we’re investing their money. Some people choose to invest in the ideas themselves rather than our funds and that is perfectly understandable. I used to do the same myself. If that’s you, you need to recognise that our job is to get the best return possible on our clients’ (and our own) money. And there may be times where our interests diverge from yours. We may have different liquidity constraints, different investment horizons or simply different views on the value of a stock.
All of that is obvious, but worth keeping in mind.
In any case, here’s why I don’t like any of the alternate plans.
1. Management hasn’t expressed any desire to buy the rest of the vehicle
Forager owns 14% of RNY, second only to RXR, and we have talked to management at length about the different options for the trust. They haven’t once expressed an interest in buying the rest of us out. If they do, we’ll listen, but any offer would need to reflect the opportunities outlined below.
2. The vehicle has structural issues that need to be fixed before we can achieve anything like fair value
RNY’s significant assets are interests in three pools of office property, each of which has its own limited recourse debt facility (it also owns a very small stake in a fourth pool, which is unlikely to be meaningful). One of the pools has a debt facility that can be repaid at any time but the other two have fixed-term debt facilities that don’t expire until 2016 and 2017. For both, the cost of repaying them early is prohibitive.
Of course, you could try and sell the assets with these structures in place, but management is of the opinion we’ll get a much better price if they are unencumbered.
Some of the properties have significant vacancies while others are well positioned with good long-term tenants. To get the best price, you need to sell the good assets to an investor looking for safe, reliable income and sell the troubled assets to someone who specialises in turnarounds. Each pool currently has some of each type of asset, so if they are sold in their current pools we are unlikely, again, to get fair value. If we wait until 2017, when the debt issues are dealt with, the assets can be reshuffled into different groups and sold to the most appropriate buyer.
In the meantime, management can focus on doing most of the turnaround themselves. The full year result, which will be released on Friday 27 February, is expected to show occupancy rates falling below 80%. We’ve just been through a year with a lot of lease expiries where significant tenants chose not to renew their leases. The next few years look a lot more manageable and, with demand picking up rapidly, we would hope to get occupancy back above 85% before the time comes to sell.
3. The market for assets of this type is still depressed but could improve dramatically
While the office property market in the US has improved dramatically since 2010, the properties RNY owns are in the ‘un’ part of what is a decidedly uneven recovery. Prime assets in locations like Manhattan and San Francisco, particularly those with long-term creditworthy tenants, are seeing red-hot demand and white-hot prices. New developments in hipster neighbourhoods like Brooklyn and Queens are also very easy to sell. The types of office buildings RNY owns, free standing office blocks in the suburbs surrounding New York, have not participated in the recovery.
Some of this is fundamental change in the market. Companies now want to locate their offices in downtown areas surrounded by bars and restaurants and accessible for the increasing number of Gen Y workers who don’t own a car. It is probably permanent, and we have tempered our expectations about the potential recovery in the values of RNY’s suburban office complexes.
But the assets are still yielding north of 7% and we still see room for prices to increase. The recovery in prime markets has been driven by low interest rates rather than economic recovery but, as the employment situation continues to improve and potential purchasers get more confident that there will be tenants, these assets will become more appealing. It’s not essential to the investment case, but we think market conditions should be better in 2017 than they are today.
4. The cash the properties are generating is better spent re-investing in the assets than paying out distributions
There’s little doubt paying a distribution would increase the unit price in today’s yield-starved world. Apart from flattering short-term performance figures, though, what is that going to achieve for us? We can’t sell our 14% stake on market without taking a huge hair cut in any case.
We want to own these assets for the next couple of years and then, if the market is right, we’re looking for a transaction that will allow us to realise our investment in one go. The only thing a short-term pop in the share price can do is force us to sell some shares because the stock has become too large a part of our portfolio.
And RXR probably need more cash to best prepare this portfolio for a sale, not less. Leasing up empty space is a very capital intensive business (more so than we realised when we first started buying distressed property trusts). But increasing the occupancy by 5% and extending some of the tenants for longer periods is going to make for a much more saleable portfolio. Money spent on leasing up vacant space is going to be worth a lot more than money paid out to us as dividends.
Our plan, as simple as it is, is to sit on our hands and do nothing for the next couple of years while management go about their thing and work towards an appropriate exit for RNY unitholders. We expect to be handsomely rewarded for our hand sitting.
Everyone recognises that these assets don’t belong on the ASX, but now is not the time to be doing something about it.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.