Don’t rock the boat

An offering to issue shares is attractive. As long as rates stay low

November 17, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

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What interests Steadfast apartment REIT are multifamily properties. In 2015, Steadfast bought 75 percent of its current portfolio at an average price per unit of $126,000. And now the non-publicly traded REIT is raising capital by issuing ten million shares at a price of about $14.  

The ask-price is attractive at first glance. Net Operating Income per share was $1.74 and $1.67 in 2015 and 2014, respectively. Because multifamily properties trade between seven to nine percent capitalization rates, the offering capitalization rate is twice as cheap. Also the ask-price represents a 20 percent discount to the value of Steadfast’s almost fully occupied multifamily portfolio.

It is a good time to raise equity. Apartment REITs are trading at high multiples and except for Equity Residential (NYSE:EQR), all apartment REITs found in iShares U.S. Real Estate ETF have increased in value in the past twelve months. The rise in market value is likely due to an increase in demand to rent homes alongside a decline in home ownership during the second quarter of 2016, noted Louis Rosenthal of Axiometrics, an analytics company. 

“Today, thirty percent of Millennials are still living with their parents,” noted Rodney Emery, boss of Steadfast. “When they get a job, Millennials will rent moderate income apartments, creating a housing demand." Institutional investors are taking an interest. The single-family market consisted of about 12 million homes in 2008 and has now increased to 15 million homes. Institutional investors own a mere fraction of that - less than two percent. 

Yet Steadfast variable rate debt is lurking around the corner. Only two of Steadfast’s multifamily properties were financed with fixed rate debt. The remaining 28 multifamily properties were financed with variable interest rate debt. It was indexed based on a 1-month LIBOR plus 170 basis points. While the 1-month LIBOR rate is now 51 basis, it was not too long ago when it was tenfold higher.

Interest rate risk exposure is not the only concern. Steadfast spent $30 million in the past two years on acquisition-related fees and expenses. It resulted in a two-year loss in Funds from operations. In 2015, the company lost 38 cents a share; in 2014, the company lost $2.51 a share. And while acquisition fees are often classified as non-recurring expenses, they do affect a company’s ability to service debt and to distribute dividends.