When the fundamentals aren’t being discussed

Release Date: 04 April 2015 (Extra Edition)

Last week, I posted a ranking of the US top-yield equity REITs. NorthStar Realty Finance Corp (NYSE: NRF) topped the list, sporting an 8.8 percent dividend yield. This week the stock is up slightly (0.7 percent), but the dividend yield continues to be attractive. As such, the stock is worth exploring in a little more detail. However, a look at NorthStar’s recent press releases shows that property fundamentals have not been the main point of discussion.

Background

NorthStar Realty is a Maryland-based diversified portfolio REIT in the commercial real estate realm, allocated largely in the health care and hotel sectors (65 percent of the 31 December 2014 portfolio). Its European assets will likely be spun out into a new NYSE publicly-traded company called NorthStar Realty Europe (NRE) by the second half of 2015. Over the past five weeks, NorthStar has raised US$ 353 million in common equity to buy properties in Europe, including the recently-closed acquisition of a €1.1 billion pan-European office portfolio.

Although it went public in October of 2004 as a mortgage REIT, NorthStar recently flipped into an equity REIT. It still has a debt component, but this is a minor portion of the portfolio (6.6 percent of its portfolio).

This past June NorthStar segregated its management off into NorthStar Asset Management Group Inc. (NYSE: NSAM), and since then both companies have been trading separately. NSAM acts as a brokerage firm for four non-traded REITs.

“Tension” between traded and non-traded

Conflict of interest has been the “elephant in the room” for this REIT. NSAM manages several funds, and there are questions about how management will deal with competing interests between different funds’ shareholders.

For instance, one question is whether NSAM will be able to fairly oversee both a traded fund (NRF) and non-traded funds, which have different asset management fee levels (management, acquisition, disposition and incentive fees). Remember that NSAM manages a pipeline of potential acquisitions and so must choose which fund gets to pick the best deals. This concern was also raised when the company decided to use NRF’s common equity offering proceeds to promote NorthStar Realty Europe’s growth and consequently spin it off. Although management argues that the spin-off unlocks value (as they discussed in their 6 March 2015 presentation, “Immediate value to NRF”), it still isn’t clear what’s in it for NRF.

This is a cloud hanging over NRF that could potentially harm stock performance in the long run. In my experience, concerns over conflict of interest have always driven share prices to discount territory that never realizes full value.

European arm

NorthStar’s European assets are valued at approximately $2.0 billion, and the real estate portfolio is comprised of 50 properties with five million square feet in prime locations, mainly in the United Kingdom, Germany, and France.

There are a number of positive points for NorthStar Realty Europe as part of an investment strategy. European real estate valuations haven’t recovered since the Great Recession. Cap rates relative to long-term interest rates have reached an all-time high. Upside on property value as appreciation of European REITs has historically signaled future appreciation of properties. And, of course, property diversification by country and type is almost always a valuable strategy.

Short interest spike

This March, short interest in NorthStar Realty rose more than 1,000 percent to 57,093,856 shares. About 19.2 percent of the company’s shares are now short.

Takeaway

Recent news associated with changes in management arrangements and the European spin-off has put NRF’s fundamentals on the back burner. I’m hoping that NSAM will refocus its energies on what matters. By the way, NorthStar is one of the few REITs (perhaps the only one) that does not disclose the operational metrics AFFO/FFO in its 10-K report.

Source: NorthStar Realty website, WSJ


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Written by Heli Brecailo

Disclaimer This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy. Disclosure The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.​