In Jan 2021, I revealed an article describing the similarities within the set-up of Normal Development Properties (GGP), a previously bankrupt mall REIT that Invoice Ackman famously made 14x his cash on in 2008/2009, and Pennsylvania Actual Property Funding Belief (NYSE:PEI) in 2021. I advocated for a small speculative place within the widespread inventory. Since that article, the widespread inventory is down ~90% and the popular inventory is down ~80%. The popular inventory, notably Pennsylvania Actual Property Funding Belief 7.375% Collection B Cumulative Redeemable Perpetual Most well-liked Shares (NYSE:PEI.PB), now affords a compelling risk-reward ratio with 10x upside to par worth and 12x upside to par worth + accrued dividends. I imagine the popular shares have been largely de-risked at this value, with even extraordinarily conservative valuation assumptions implying large upside.
Overview of PEI.B
The Collection B shares are the very best on the capital stack, with Collection C and Collection D beneath them. The Collection C shares have a liquidation choice of $197.7M, and the Collection D shares have a liquidation choice of $137.9M. Mixed there’s a vital $335.6M buffer in liquidation choice between the Collection B and Collection D shares.
The next is an outline of the Collection B shares.
Worth $2.45 Par worth $25 Accrued dividends (9 quarters unpaid) $4.15 Par worth + Accrued dividends $29.15 Dividend yield on issuance 7.375% Dividend yield on price right this moment 75.2% Click on to enlarge
Underlying Enterprise Continues to Enhance
In 2019, PREIT recorded $227.7M in NOI, which dropped dramatically to $158.6M in 2020. 2021 marked a powerful restoration from 2020, with NOI recovering to $200.5M. NOI development to date in 2022 has been slower than I anticipated at 1.7%, with $93.1M in H1 2022 vs $91.5M in H1 2021. Making use of this 1.7% NOI development fee to the total yr, we get $204M in NOI for 2022. I imagine that is conservative given the robust leasing quantity this yr.
Core mall occupancy is now at 93.8% as of the top of Q2 2022, in comparison with 89.2% on the finish of Q1 2021.
PREIT Valuation
In my earlier article, I outlined a internet asset valuation of $165 a share ($11 per share earlier than the reverse break up) for the widespread shares primarily based on an 8% cap fee on 2019 NOI. I proceed to imagine that PREIT is on the trail to completely recovering to 2019 NOI, with the robust restoration in 2021 and occupancy rising strongly. This valuation could seem far-fetched given the decline within the inventory value. As such, I need to present a deeper dive into the assumptions made in my valuation on a mall-by-mall foundation to be able to illustrate simply how absurd the present market valuation is.
My view continues to be that PREIT is a largely class A and A- mall REIT, with the majority of its asset worth coming from its high 6 malls that are Class A and A- malls and produce 45% of NOI.
The next is a property-by-property view of this valuation and cap fee assumptions made. The 8% portfolio cap fee is inside the affordable vary when wanting on the beneath mall-by-mall breakdown and recognizing that the overwhelming majority of worth is pushed by the highest half of malls within the portfolio.
In demonstrating the margin of security for the popular shares implied with right this moment’s pricing, I’ll use a extra conservative NOI of $204M, simply 1.7% above 2021’s NOI.
The Absurdity of At present’s Pricing
In its COVID lows of $4.95 (split-adjusted), PEI had severely depressed earnings and had simply filed for Ch 11 chapter. The widespread inventory is now buying and selling beneath its COVID lows, as are the popular shares, regardless of large enchancment within the underlying enterprise.
I imagine that shareholders of the Collection B Most well-liked would obtain a full restoration of par worth plus accrued dividends at $28.69 even at an 11% portfolio cap fee, would obtain $25.34 at an 11.5% portfolio cap fee, and would obtain $5.20 at a 12% cap fee.
Once you begin to apply ridiculously conservative cap charges to the portfolio, you find yourself with situations the place many malls are value lower than their mortgage debt. In these situations, PREIT can enhance NAV by strategically defaulting and handing the keys of those properties again to their lenders. Invoice Ackman highlights this in Pershing Sq.’s 2010 Investor Presentation on GGP as a good thing about property-level non-recourse mortgage debt.
An 11.5% portfolio cap fee state of affairs, at which PEI.B shareholders would nonetheless probably 10x their cash, appears to be like ridiculously conservative as seen beneath.
This state of affairs assumes a 50% haircut to the valuation of the portfolio’s crown jewel, Cherry Hill Mall, which was valued at $786M in 2018. This additionally assumes an 8.5% cap fee for the remaining A/A- malls within the high third of PREIT’s portfolio, a ridiculous 17% cap fee for the A- malls within the center third of PREIT’s portfolio, and a 22% cap fee for the underside third of the portfolio. Moreover, Trend District Philadelphia is valued at $0 and administration’s projected $200M in land/outparcel gross sales are discounted 25% to $150M. It additionally components in a terminal NOI of $204M, which continues to be $23.7M shy of 2019’s NOI regardless of quickly bettering occupancy.
On this 11.5% cap fee state of affairs, 7 malls are value lower than their mortgage debt and might be turned again to lenders, rising NAV in a theoretical world of extraordinarily elevated cap charges. On this extraordinarily bearish case, the 7 malls (Willow Grove Park, Viewmont Mall, Patrick Henry Mall, Springfield Mall, Francis Scott Mall, and Cumberland Mall, and Trend District Pennsylvania) are value a mixed $282M with $582M of mortgage debt. Turning again these 7 malls would, on this state of affairs, wipe out of $582.8M in debt and cut back asset worth by $282.4M, rising NAV by $300.4M.
The next is the breakdown of the Collection B fairness worth at an 11.5% cap fee.
Property Worth (11.5% cap; $282.4M discount from default)
$1.45B Different Property ($150M held on the market + money + restricted property) $206M Complete Property $1.65B Debt ($2.15B – $582.8M discount from default) $1.57B Collection B Most well-liked Fairness $87.4M Collection B Liquidation Desire $99M Collection C Most well-liked Fairness $0 Collection D Most well-liked Fairness $0 Implied PEI.B Worth (88% of par + accrued dividends) $25.34 Click on to enlarge
In fact, I count on that every one malls are value considerably greater than the mortgage debt and that there shall be zero strategic defaults. This might imply a full restoration for all ranges of most well-liked shareholders, and a considerable acquire for widespread shareholders. Nonetheless, when analyzing the bear case the place malls are underwater, which might occur at wherever north of a 9.5-10% portfolio cap fee, it can be crucial think about strategic defaults which might restrict the draw back state of affairs.
Sensitivity Evaluation
In any 10%+ bear case cap fee state of affairs, all 7 of the aforementioned malls find yourself being underwater from a price perspective. As such, the $582M in debt and $282M in asset worth would nonetheless be extinguished through strategic defaults.
Even when malls had been liquidated at an much more disastrous 12% cap fee state of affairs, PEI.B shareholders would nonetheless double their cash. Any liquidation at a cap fee within the vary of 12.3%+ vary would fully wipe out shareholders in any respect ranges.
PJT, Cygnus Capital, and Capital Construction Optimization
Investor’s main frustration with PREIT is their sluggish motion in bettering the steadiness sheet. Whereas debt was decreased by ~$100M for the reason that starting of the yr as of Q2, buyers are hoping for extra asset gross sales to be able to cut back leverage. There are actually two events aiding with enchancment of the Stability Sheet.
In January 2022, PJT Companions had been retained by PREIT:
To help the Board of Trustees and administration group in pursuing strategic and monetary choices that can strengthen the Firm’s steadiness sheet, PREIT has engaged PJT Companions, a premier world advisory-focused funding financial institution.
Cygnus Capital, who personal 8.9% of the Collection B Most well-liked, 5.9% of the Collection C Most well-liked, 8.6% of the Collection D Most well-liked, and a pair of.1% of the widespread fairness, had two representatives elected in August 2022 to symbolize Most well-liked shareholders on the PREIT Board.
The next is their view on the popular and customary fairness, and what they imagine they will do to unlock shareholder worth.
Cygnus believes that PEI has priceless underlying property however is buying and selling at a big low cost as a result of it’s extremely leveraged. Cygnus believes its Nominees can work constructively with the opposite members of the Board to search out new methods to enhance the Belief’s steadiness sheet and market valuation. In Cygnus’ view, increasing the Board to incorporate two extremely seasoned and skilled professionals to the Board is a essential and necessary step right now and can profit all shareholders – not simply holders of the Excellent Most well-liked.
My major level of frustration with the PREIT administration group is that they aren’t actively advertising and marketing malls on the market. On the Q2 earnings name, administration was requested about the potential for promoting considered one of PREIT’s mall to pay down debt. This was the response, which I view to be weak.
We do have over $200 million of property gross sales pending. Our high precedence is maximizing worth for all of our stakeholders and we’ll think about all choices to realize this. It’s noteworthy that we just lately bought our 25% curiosity in Gloucester Premium Shops. From our perspective, all choices are on the desk.
I wish to see a extra aggressive strategy to promoting property together with income-producing malls, as $200M in land and outparcel gross sales should not going to maneuver the needle on $2.15B in debt. With the introduction of Cygnus Capital, I’m hopeful that mall gross sales could be extra significantly thought-about.
Main Dangers: Rising Charges and Potential Lifeless Cash for a Lengthy Time
Some buyers are involved with the potential for a compelled liquidation if the corporate isn’t in a position to prolong a few of its upcoming debt maturities. Given {that a} liquidation state of affairs at an excessively conservative 11.5% cap fee would end in 10x upside to shareholders of the Collection B Most well-liked, I’d really choose a liquidation over the established order. I imagine the first danger of this funding is that administration will proceed their present strategy to asset gross sales, specializing in land and outparcels that won’t transfer the needle on debt discount.
PREIT is now simply barely constructive on money movement from operations, and a big upward motion in charges would put PREIT into detrimental money movement territory as their ~$1B of time period loans are variable and are already at excessive rates of interest (8-9.25% as of Q2). If PREIT doesn’t kind out its strategy to asset gross sales, then curiosity funds will preserve chipping away on the firm’s underlying worth.