LRT-TO - Lanesborough REIT

[Myth465]

Trading at 24% of BV, and getting towards cash flow positive.

After warrants convert still significant upside, I own the warrants. Trying to see what I am missing.

 

Stockhouse has great posts on the company.

Basically its a busted REIT which got in over its head debt wise. They have since been selling property at book value and paying down debt for the last few years.

I think they have finally reached the turning point. They have also been buying back warrants over the last few months.

 

The thesis is simple. The assets are worth at least book value, and even after dilution a few multiples of where its trading now. They will continue to pay down debt, buy back warrants, and lease up / sale none core properties. When cash flow becomes evident the stock will trade up...

[alertmeipp]

I was in this one long time ago (I recall that's when oil was trading low and FM real estate was tanking) and done quite well between the common and debt.

 

I remember there is conflict of interest between the property management company and the management back then. The fee the property management co charge was based on book value.. so even the rental income tanks, they still need to pay steep management fee... and the management actually have interests in the PM company?

 

I may have recalled this incorrectly tho.

[bizaro86]

I've been long this in the past, currently I have a small position in the mortgage notes. (LRT.NT on Toronto) They're currently trading at par and pay 9% until the end of 2015. I believe they're callable, which is what's keeping them at par. The mortgage notes are covered under pretty dire circumstances. They also have a convertible debenture outstanding with a similar yield but a longer maturity, but it is essentially unsecured.

 

As for the book value, the assets they've been selling are generally the oldest assets. They bought a lot of their assets during the big oil boom pre-2008, and although things have recovered nicely in Ft Mac, they haven't gotten back to that level. I don't think book is a conservative assumption.

 

Also, some of the sales were to Temple, which is controlled by the same company. So I wouldn't take those sales at face value as they weren't arms lengths and could be Shelter Bay (the control party for both) propping up one of its investments with cash from another one.

 

Finally, one reason Ft McMurray real estate is so expensive is that the land surrounding the town is owned by the Provincial gov't who hasn't wanted to expand development because then they lose the chance to collect royalties from the oil below the ground. However, the alberta government has finally decided to cancel leases on a huge amount of land, and allow Ft Mac to use it.

http://www.globalresearch.ca/canadian-city-of-fort-mcmurray-evicts-oil-sands-companies/5344433 (Cancel of Leases)

http://www.alberta.ca/release.cfm?xID=35768EE3DC55A-F9F6-F26C-67EA852FB210D981 (First transfer of land to city)

 

Anyway, this might turn out great, and there is certainly potential for a big gain here. I rode it up to nearly a double on my cost, but don't see a margin of safety at this level. Of course, I sold at around $0.70, so obviously I sold too soon and shouldn't be listened to in this matter...

 

 

 

[Myth465]

I believe ---

Canadian GAAP is based on IFRS which requires a valuation adjustment.

Book value isnt based on acquisition value, but based on what you can get past an auditor in terms of current value.

For property its based on recent sales, occupancy, and cap rates. Its easy for an auditor to verify and I think in general book value is usually pretty good / pretty hard.

I think they could sale the properties for book value today plus or minus 10%, and they are trading at 25% of BV...

 

I would also say the properties were sold at good prices for temple with cap rates of 10 plus.

I dont think Lanesborough got a great deal.

 

Unless im messing something its a hard book value, which only needs to be adjusted for warrant dilution....

Will read though on the expansion in FMM, thats a good link and something I hadnt considered.

 

 

For example -

 

Fair value adjustment of Parsons Landing

Parsons Landing is classified as an investment property and is carried at fair value. The Financial

Statements reflect the fair value adjustments throughout the reconstruction of the property.

 

During the first quarter of 2012 and in the absence of an agreement with the builder to reconstruct the

property in a coordinated manner with the insurer, the investment property was written down from the

carrying value of $47.8 Million at December 31, 2011 to $20.0 Million at March 31, 2012, which

represented the fair value of the investment property after accounting for the loss in value resulting from

the fire. The write-down of $27.8 Million was reflected as a loss in the Financial Statements for the first

quarter of 2012 under the line title, "Impairment of investment property".

Throughout the reconstruction period, the fair value of Parsons Landing was determined based on

historical results and normalized operating performance at comparable properties. A discount was also

applied to reflect the timing difference between the date of the valuation and the future re-occupation of

the property.

[Myth465]

---

Purchase price of $400 million, Carrying value of $421 - unless my math is wrong you can buy at 25% of BV not including warrant dilution.

 

More detail.

 

Portfolio Summary - December 31, 2013

As of December 31, 2013, the property portfolio of LREIT consists of 22 rental properties, 20 of which are

classified as "Investment properties" on the Statement of Financial Position of the Trust, including all of

the unsold condominium units at Lakewood Townhomes. The remaining two properties consist of two

seniors' housing complexes which are accounted for as "property and equipment" under "discontinued

operations" and classified under "Assets classified as held for sale" on the Statement of Financial

Position of the Trust. The entire portfolio of 22 properties has a total purchase price of approximately

$396.5 Million and encompasses 2,126 suites and 123,126 square feet of leasable commercial area.

 

--

 

FAIR VALUE MEASUREMENT

General

The fair value of the investment property portfolio of LREIT is determined quarterly based on the same

valuation techniques that are used by independent valuation professionals. The capitalized net operating

income method and discounted cash flow methods are typically emphasized although the direct

comparison method may occasionally be used when appropriate market comparables are available. In

addition, periodic external appraisals and market reports serve to substantiate and guide the internal

valuation process of LREIT, particularly with respect to key assumptions, including capitalization rates

and discount rates.

Fair value estimates are also sensitive to changes in forecasted net operating income and temporary

fluctuations have the potential to skew fair value estimates. As a result, actual operating results are

normalized to reflect stabilized future expectations regarding capital expenditures, vacancy rates,

inflation, operating costs and rental market conditions. Normalization adjustments are based on

appraisals, market reports, historic performance and management projections.

Parsons Landing

Throughout the reconstruction period, the fair value of Parsons Landing was determined based on

historical results and normalized operating performance at comparable properties. A discount was also

applied to reflect the timing difference between the date of the valuation and the future re-occupation of

the property.

Effective June 1, 2013, 84 suites were returned to active rental operations, providing more meaningful

valuation inputs as well as evidence of improved operating performance. On October 3, 2013, active

rental operations recommenced for the entire property.

 

---

 

Profit on Sale of Investment Properties

 

The profit on sale of investment properties represents the extent to which the net proceeds from the sale

of an investment property exceeds the carrying value of the property as determined at the end of the

preceding year.

During 2013, LREIT sold two investment properties (the Purolator Building and Nova Court), and three

condominium units, generating a profit on sale of $221,642. During 2012, LREIT sold one investment

property (the Siena Apartments) and nine condominium units resulting in a profit on sale of $915,531.

During 2012, LREIT also sold two seniors' housing complexes (Clarington Seniors' Residence and

Riverside Terrace) resulting in a profit on sale of $15,034,311. The profit on sale of the two seniors'

housing complexes is included in "Income from discontinued operations" on the Income Statement.

Fair Value Gains

In 2013, fair value gains on investment properties, excluding Parsons Landing, amounted to $6,970,031

representing a decrease of $3,338,692 compared to 2012. The fair value gains are included in the

income of the Trust.

During 2013, the carrying value of investment properties increased by $10,245,870, comprised of

valuation gains of $6,970,031 and capital expenditures of $3,275,839.

The determination of the fair market value of investment properties is based on a comprehensive

valuation process. Additional information regarding the fair market value of investment prop

 

Property Value

Number of

Properties

Carrying Value at

December 31, 2013

Valuation Update

Timetable

Greater than $10 Million 9 $ 367,258,874 Three years

Less than $10 Million 11 53,781,495 Five years

20 $ 421,040,369

 

 

Cap rate assumptions seem reasonable as well.

[bizaro86]

Myth, you are of course correct on IFRS property valuation, my apologies.

 

I still don't love book value as a valuation metric here. Fort McMurray is a hugely volatile rental market, and rents are currently very high there, at over $2300 per month per suite.  (P. 28 2013 annual report). However, significant new residential real estate capacity will come on line in Ft McMurray in the near future. Plus, demand growth shouldn't be as significant, as the oil sands industry is moving more towards in-situ projects (further away from the city, so workers usually stay in camps and commute by air to southern Canada). The REIT capitalizes these high rental rates at 7%.

 

However, there is a reasonable chance that Ft Mac real estate slows down (in my opinion) even without a drop in oil prices/activity. That would lower rents and push up cap rates.

 

Because the company is highly leveraged, any reduction in revenues has the potential to impair their ability to make their debt payments. They had 13% of their revenue as cashflow after interest (not including mandatory principle payments) in 2013. A revenue decline of 13% or greater is not an unlikely event, imo.

 

Looked at from a balance sheet perspective, they have $468MM in assets and $350MM in liabilities. If you assume Ft McMurray assets are a bit risky and deserve a higher cap rate (say the 10% cap they sold to Temple on), then the equity disappears. In fact, using an 8% cap rate for the company's 2013 NOI gets to a zero for the equity.

 

Basically, there are two mental models you can use for this company.

 

1) It's a cyclical at the top of the cycle, it looks cheap on most metrics, but that's because its revenues may be unsustainably high. If Ft Mac real estate does decline (50/50 chance imo) this company will be badly hurt due to its huge leverage.

 

2) It's a leveraged stub equity, "Manual of Ideas" style. If things keep improving in Ft Mac, this could be a 4 bagger (which would take it back to where it traded pre 2008)

 

Having walked myself through it, a 50% chance of a 4 bagger and a 50% chance of a zero is still +EV. Of course, that's not the type of opportunity to take a punch card/concentrated position in.

 

If you think its cheap and want exposure to the upside, I actually think the warrants make sense here. They give you the same upside exposure, with less downside exposure, as I think this is unlikely to fall by 50% and not fall to zero.

[Myth465]

You bring up really good points, and really show what Mr. Market is thinking on the idea.

 

My plan is to look at Q2 and Q3 numbers than go from there. There are too many puts and takes for now.

They have basically converted quite a bit on the balance sheet and we should get a good view on Q2 numbers.

 

Parson landings just came back into the picture, and is now an asset with debt missing cash flow due to leasing efforts needing time.

Utilization was 80% in Q1, and 87% in may or June, going to 91% in Q3.

 

Debt has also moved around quite a bit, they have collected various receivables, and have paid down some very expensive debt towards the end of Q2.

 

I think with the increases in utilization, and the pay down of debt we should be cash flow positive. The next thing to tackle would be the debentures, and they should either sale some property or up-mortgage some to begin to tackle that 9.5% debt. If they can get debt down to 6% across the capital structure, then the idea should work quite well.

 

We also should have the senior housing units sold off by end of this year or next. They are also selling off condos which should be fully sold in 2016. I think the high yield debt, and utilization is masking the earning potential of the property. If its cleaned up then there is more of a MOS to withstand the highly competitive leasing environment.

 

---

 

Basically I think we are saying the same thing, its a race against time.

Best to reduce the portfolio to a core holding of high quality FM property, clean up the capital structure, then sell out to someone else who is bigger at BV.

Its now a very concentrated play on Fort McMurray, and they would be better suited to sell to a bigger player who can provide a bit more diversity.

 

Will that happen, not sure. I will watch and see if they are moving that way, and how soon they will get there.

Thanks for your thoughts, very helpful. I see this as similar to ROIC, could be a home run, or crash and burn.

[bizaro86]

You bring up really good points, and really show what Mr. Market is thinking on the idea.

 

My plan is to look at Q2 and Q3 numbers than go from there. There are too many puts and takes for now.

They have basically converted quite a bit on the balance sheet and we should get a good view on Q2 numbers.

 

Parson landings just came back into the picture, and is now an asset with debt missing cash flow due to leasing efforts needing time.

Utilization was 80% in Q1, and 87% in may or June, going to 91% in Q3.

 

Debt has also moved around quite a bit, they have collected various receivables, and have paid down some very expensive debt towards the end of Q2.

 

I think with the increases in utilization, and the pay down of debt we should be cash flow positive. The next thing to tackle would be the debentures, and they should either sale some property or up-mortgage some to begin to tackle that 9.5% debt. If they can get debt down to 6% across the capital structure, then the idea should work quite well.

 

We also should have the senior housing units sold off by end of this year or next. They are also selling off condos which should be fully sold in 2016. I think the high yield debt, and utilization is masking the earning potential of the property. If its cleaned up then there is more of a MOS to withstand the highly competitive leasing environment.

 

---

 

Basically I think we are saying the same thing, its a race against time.

Best to reduce the portfolio to a core holding of high quality FM property, clean up the capital structure, then sell out to someone else who is bigger at BV.

Its now a very concentrated play on Fort McMurray, and they would be better suited to sell to a bigger player who can provide a bit more diversity.

 

Will that happen, not sure. I will watch and see if they are moving that way, and how soon they will get there.

Thanks for your thoughts, very helpful. I see this as similar to ROIC, could be a home run, or crash and burn.

 

Thanks for bringing this to the board! I've been long before and have some of the debt, but hadn't evaluated it from an equity point of view for some time. Based on the analysis I did trying to prove there was no margin of safety here, I bought some warrants, which I think is even more +EV than the stock.

[Myth465]

No prob, and I am looking at the debentures.

Hopefully I dont take you down with the ship....

 

This should be much more clearer in Q2 and crystal clear in Q3.

[biaggio]

I looked at this last week

 

Myth I like your other ideas better (your oil and gas, Clarke).

 

Management does not look trust worthy at all.

 

Why do I say that? Basically the fee structure they set up. The reverse of an Altius royalty from a LRT shareholder point of view.-the management gets paid 4% of rent + 0.3% on gross assets no matter how crappy or unprofitable. If they had a spectacular performance I would not even notice. But they don't.

 

I would feel better being the shareholder of the management company. No risk but still get cash flow

 

Though I don t know for certain , it looks like they bought bad properties or they bought at bad prices because it was still good for them the managers. I could be mistaken--it could be just bad luck

 

I would feel better if they cancelled the management contract + management took a huge stake in it, though with their past actions I would still worry enough not to get involved. I did not read to many of the filings because I was not interested after reading their last circular so maybe there has been a change.

 

Other concern is that Book value has a good chance of being inflated (from overpaying for properties). With huge debt plus questionable management there is a good chance of losing it all.

 

I could be wrong

 

Be careful fellas.

 

Debentures might be a better idea.

[bizaro86]

I looked at this last week

 

Myth I like your other ideas better (your oil and gas, Clarke).

 

Management does not look trust worthy at all.

 

Why do I say that? Basically the fee structure they set up. The reverse of an Altius royalty from a LRT shareholder point of view.-the management gets paid 4% of rent + 0.3% on gross assets no matter how crappy or unprofitable. If they had a spectacular performance I would not even notice. But they don't.

 

I would feel better being the shareholder of the management company. No risk but still get cash flow

 

Though I don t know for certain , it looks like they bought bad properties or they bought at bad prices because it was still good for them the managers. I could be mistaken--it could be just bad luck

 

I would feel better if they cancelled the management contract + management took a huge stake in it, though with their past actions I would still worry enough not to get involved. I did not read to many of the filings because I was not interested after reading their last circular so maybe there has been a change.

 

Other concern is that Book value has a good chance of being inflated (from overpaying for properties). With huge debt plus questionable management there is a good chance of losing it all.

 

I could be wrong

 

Be careful fellas.

 

Debentures might be a better idea.

 

A couple of comments: Management is very misaligned, which is why I would never suggest this as long term hold, and is why I sold my previous position.

 

This isn't a margin of safety good business, I have factored a 50% chance of it going to zero in my EV calculation. It's a lottery ticket type stock.

 

As for the debt securities, I like the mortgage notes much better than the converts. They're less liquid, but are secured debt instead of unsecured debt, and trade at the same yield, with a shorter maturity.

[Myth465]

Post on vic.