Description

SUMMARY

Gyrodyne LLC (GYRO) is a thinly-traded, micro-cap liquidation with a twist: Before marketing its last two significant real estate assets, the Company is investing to potentially secure what it believes will be value-enhancing entitlements for the parcels.  If one is optimistic about GYRO’s likelihood of obtaining the zoning and subdivision changes it seeks, the current stock price provides an opportunity for a reasonable return in the medium term.

[Note: We started this write-up at year-end with the bid at $20.08. The bid has moved up a little since.]

BACKGROUND

GYRO may be best know as a special situation because of its multi-year litigation against the State of New York [Gyrodyne v. The State of NY, #2010-033-604 Claim No. 112279] over an eminent domain taking of a large portion of GYRO’s property in Smithtown and Brookhaven, NY that abutted SUNY - Stony Brook.  In July 2012, Gyrodyne received $167,530,657 from the State of New York in payment of judgments in Gyrodyne’s favor.  The judgement consisted of $98,685,000 in additional damages, $1,474,940.67 for Gyrodyne’s costs, disbursements and expenses, and $67,370,716 in interest. The $167.5mm payment concluded Gyrodyne’s case, commenced in 2006, for just compensation for the 245.5 acres of its Flowerfield property taken by the State.

Upon receiving the judgement from the State of NY, GYRO issued a number of special dividends, commenced its liquidation proceeding and began selling off assets.  As of 9/30/17, the Company retains ownership of two significant properties:  (i) the remaining 68-acre parcel at Flowerfield (Smithtown, NY) and (ii) 12-acre parcel in Cortlandt Manor, NY.  It also owns one medical building in Port Jefferson, NY and a residual interest in a Florida development project.

ASSETS

The Company’s corporate strategy is to pursue zoning and/or entitlement opportunities which are intended to increase the values of its two remaining major properties, Flowerfield and Cortlandt Manor so that they can be sold at higher prices (compared to those achievable under their current entitlements).  The Company believes these land development initiatives will maximize distributions to shareholders during the liquidation process within a reasonable period of time.  The most recent filing indicates the liquidation will be completed by the end of 2018, though we think it may be extended in order to secure the desired subdivision of the Flowerfield property from the town of Smithtown.

Gyrodyne Remaining Real Estate Assets:

• Flowerfield
• Cortlandt Manor
• Port Jefferson Medical - 1 building
• The Grove - Limited partnership interest
• Flowerfield residentially zoned parcel - 5 acres

Flowerfield (map)

During the condemnation litigation GYRO and the State of NY each produced an appraisal of the entire Flowerfield parcel at trial to establish the value of the 245.5-acre property being “taken” by the State for use at SUNY Stony Brook.  The State’s appraisal postulated that the “highest and best use” for the property was a “light industrial” development, in keeping with the property’s existing zoning.  GYRO’s appraisal suggested that the highest and best use was residential development even though that would require a zoning change in both Smithtown and Brookhaven NY.  GYRO’s appraiser produced an “expected value” based on probabilities of approval of a zoning change in each of the two towns.  

Ultimately, the Judge sided with GYRO based largely on the ineffectiveness of the Assistant Attorney General of NY and the expert witnesses he called on the State’s behalf.  The ruling was upheld on appeal.

Notwithstanding the opinion of the Company’s appraiser in the condemnation proceeding, GYRO is currently pursuing a modified “light industrial” development at Flowerfield as the State’s appraiser suggested.  Based on our visit to the property, discussions with knowledgeable parties and a review of the Smithtown budget and zoning regulations, we believe this course of action is logical.

Current Gyrodyne Subdivision Proposal for Flowerfield

The critical open question with respect to the Flowerfield parcel is will the requested subdivision be approved and over what time frame?  Smithtown has a history of lengthy development approvals.

After nearly two years of preliminary work, GYRO has recently filed an application with the town of Smithtown seeking an 8-lot subdivision of the parcel for mixed-use development.  None of the property in the proposal is in the town of Brookhaven.  GYRO maintains that it can pursue all of the following uses for the property “as of right” given the existing Light Industrial zoning of the parcel.  Importantly, the proposed density is considerably below permitted density in a nod to surrounding uses and the Town’s desire to maintain open space.  

Proposed development on subdivided parcels (excludes residential zoned parcel):

Note: the parcel numbers on the map don’t all match the above table from the GYRO 10Q

• Demand for proposed uses:
  • Growing 75+ population nationally and in the St. James/Stony Brook Area
  • Proposed growth at SUNY Stony Brook medical center (nearly doubling by 2020) increasing demand for medical related office space
  • Strong demand at existing hotel on other side of SUNY campus
    

• Economic Impact to Smithtown (based on GYRO consultant)
  • $3.5mm in new net property taxes
  • $90mm in direct economic output
  • 900 jobs
  • No increase in school enrollment anticipated

• Status of Subdivision Application
  • The Suffolk County Planning Commission approved unanimously (11-0) without conditions on 8/2/17.  As a result, only a majority of the 5-member Smithtown Town Council is required for approval.  Had Suffolk County applied conditions, a Super-Majority would have been required.  Subdivision application now referred back to Town of Smithtown Planning Board which is reviewing the traffic impact study and environmental matters.  View video of GYRO presentation to Planning Board on 11/15/17 - here.  Public concern expressed was overwhelmingly related to potential traffic impact.

• Likely Smithtown concerns/considerations in assessing subdivision application
  • Town Budget

GYRO claims the proposed subdivision, when fully built-out, will deliver an additional $3.5mm in annual property tax revenue.  In 2016 Smithtown Real Property Tax Revenue was $55mm thus the potential GYRO impact would be a 6% increase in property tax revenue.

Smithtown has a significant budget challenge.  Like many other municipalities, Smithtown’s budget has a ticking time bomb in the form of OPEB or “Other Post-Employment Benefits” related to health care.  The problem is caused by an ongoing, very generous (for long-serving retirees) split of 90% of cost borne by the Town and 10% by the retiree.  For reference, some municipalities (at least in MA) are now 50/50, which is still expensive, but materially better than 90/10.  From 2016 Audited Smithtown Financials - $79mm OPEB obligation and growing each year:

The most recent budget presented to the town is a “no tax increase budget” for 2018.  Smithtown received a rating from Moody’s of Aaa in 2016 and takes pride in “having the lowest debt per capita in Long Island.” (see most recent Town Report).  

If a town is not going to raise taxes, they have to grow revenue through “growth”, i.e. bringing land onto tax rolls, just what GYRO is proposing.

• Planning Board Recommendation

As mentioned above, the subdivision proposal is before the Smithtown Planning Board, currently.  However, earlier comments by the Planning Board to the Town Council indicate they are receptive to development of the GYRO parcel.  A 9/22/16 letter from Planning Board to Town Council said:

The current GYRO subdivision plan meets these objectives.

• New Town Supervisor

After 40 YEARS(!) in the role, Smithtown Town Supervisor Patrick Vecchio stepped down last month (Dec 2017).  His replacement, Republican Ed Wehrheim, took over on Jan 1, 2018.  Wehrheim has stated: “I have a good track record of making empty properties into something valuable and profitable for Smithtown.”  This, coupled with his real estate development track record is a positive sign for the Flowerfield subdivision approval. According to reports, Wehrheim worked to renovate the Smith Haven Mall, negotiated deals to develop stores on Crooked Hill Road in Commack, helped Whisper Vineyards set up shop in Smithtown and more to help increase tax revenues for the town.  (See Newsday endorsement and optimism for new leadership.)

• Traffic

A review of the public hearing shows a traffic concern in Smithtown and Brookhaven (though it is not clear what, if any, say Brookhaven has in this process as none of the proposed subdivision is located in Brookhaven).  A formal traffic impact study was prepared by GYRO’s consultants and has been submitted to the Town for review.  Our tour of the property confirms that road access to the property (three roads) are not well suited (as currently configured) to dramatic increases in traffic.  GYRO recognizes the traffic issue and has tried to address it with its chosen mixed-use development.  

Off-site mitigation is proposed at six of 16 intersections that were identified as problematic in the Impact Study. The two most impacted intersections are Mills Pond Road/25A and Stony Brook Road/25A.  GYRO has mitigation for both.  For example, NY Dept of Transportation is studying a roundabout at 25A/Stony Brook Road, per Cameron Engineering, and GYRO has an alternative solution if NY State does not progress with this idea.  Additionally, re-opening the railroad crossing on the south side of the property will enhance linkage with SUNY and reduce pressure on 25A, per Cameron.

• Wastewater

GYRO’s proposal includes a wastewater treatment facility on site which will, among other environmental benefits, permit existing industrial users of the property to move from current cesspool systems to the sewer facility. This new facility may also help mitigate a looming problem related to SUNY-Stony Brook’s own wastewater facility which is apparently at capacity.  SUNY could benefit from (and perhaps share the costs of) a new facility that would permit further growth.  

• Other political considerations

NY Assemblyman Steve Englebright, representing the 4th District which includes Stony Brook Road and Brookhaven (though not Smithtown), expressed opposition to the project at Planning Board meeting on 11/15/17 based largely on “sustainability” and associated environmental concerns.  Supervisor of Town of Brookhaven (Ed Romaine) is also concerned about traffic impacts and miffed he was not notified about the Suffolk County approval ahead of time.   Michael Fitzpatrick is the NY Assemblyman representing Smithtown and he did not speak at 11/15/17 meeting.

Some politicians are eager for the State and/or County to buy and preserve the property.  The Suffolk County Legislature is requesting an appraisal.  According to that 11/22/17 press release, the move by the SC Legislature “...allows the Planning Division to assess the owner’s interest in selling this environmentally sensitive tract to the County for open space purposes.  If the property owner, GSD Flowerfield, LLC of Smithtown, expresses an interest in participating in this voluntary open space protection program, the County’s initial outreach will be followed by appraisals and additional legal and environmental reviews required for a potential future sale....If Suffolk is able to negotiate the purchase of these parcels, funding will come from the County’s Drinking Water Protection Program.”

Interestingly the current Governor of NY, Andrew Cuomo, was on the losing side of the GYRO eminent domain case as NY Attorney General.  Would Cuomo agree to send another big check to GYRO?

Subdivision Proposal Conclusion

Given the all-Republican Town leadership, an apparently supportive Planning Board, a new, ostensibly pro-development Town Supervisor and a long-term budget challenge related to OPEB, we believe that ultimately the Town Council will approve GYRO’s plan based on increased town property tax revenue and other positive economic impacts including additional jobs in Smithtown. GYRO appears to have opted for a relatively lower traffic impact proposal recognizing neighbor’s concerns and has designed mitigation solutions.  In addition, the proposed uses would likely not increase the school-age population in Smithtown.

An open question is neighbor Brookhaven’s concern about traffic and apparent opposition to GYRO’s proposal.  It is possible that GYRO will be asked to mitigate some traffic issues in the Town of Brookhaven as a condition of subdivision approval.

Cortlandt Manor (map)

The Town of Cortlandt Manor has worked cooperatively with GYRO and NY Presbyterian Hospital over the past two years to address zoning constraints that preclude commercial development of GYRO’s property directly across the street from NY Presbyterian Hospital.

On March 15, 2016, the Town of Cortlandt Manor adopted a 2016 Sustainable Comprehensive Plan (or the “Master Plan”) in which one key strategy was the creation of a Medical Oriented District (“MOD”). The purpose of the MOD is to expand the Town’s existing medical infrastructure and encourage economic development, including capital investment, job creation and housing options. The MOD allows for a continuum of care, i.e., independent living, assisted living and nursing/hospital care, within or in neighboring facilities by centralizing medical services and related activities. As a designated zoning district, the MOD could include hospital, ambulatory surgery, primary and urgent care, hospice, laboratories, social services, boutique hotels and a wide range of housing.  While the MOD was approved in general with the adoption of the Master Plan, the Town must approve specific zoning changes within the designated 100+/- acres in the MOD to permit development other than residential (its current designation).

Momentum within town government for the zoning changes should continue as the November 2017 elections saw incumbent Town Board member Debra Carter-Costello re-elected and James Creighton, who was the Planning Board representative to the Master Plan committee, elected to the Board replacing Seth Freach who did not seek re-election.  Importantly, Creighton was a supporter of the MOD while serving on the Cortlandt Planning Board and is expected to continue to support the effort on the Town Board. Town Supervisor Linda Puglisi, a supporter, was also re-elected.

In a recent conversation, Cortlandt Manor town planner Chris Kehoe indicated that approval of the new zoning regulations should take place this calendar year (2018).  Though he indicated that there may be some tweaks to the proposed development to address traffic concerns, particularly as it relates to the amount of residential development permitted.

In summary, the designation of the MOD and the attendant change of zoning has not been a trivial undertaking and it strikes us as reasonable to assume that securing these entitlements will indeed enhance the value of the GYRO property.

On March 31, 2017, GYRO filed an application with the Town of Cortlandt Manor to develop the property as follows, pending zoning revisions mentioned above:

Located directly across the street, GYRO’s Cortlandt Manor property provides exceptional and unique access to the New York/Presbyterian Hudson Valley Hospital (“NYP”).  It is reasonable think that NYP could be a buyer for some or all of GYRO’s parcel, particularly after the subdivision application has been approved with the flexible density GYRO is requesting.

A neighboring project called Evergreen Manor is offering a parcel for sale and broker stated it is under Letter of Intent as of 1/2/18.  As with GYRO, this project is dependent on rezoning of its parcel in accordance with the MOD.  The owner of this parcel Val Santucci, has been working with GYRO, the Town and the Hospital to secure the rezoning over the last two years.  Importantly, the Evergreen parcel reportedly requires substantially more excavation and grading to be comparably developable as the GYRO parcel.

Port Jefferson Medical Office Building

The last remaining existing medical office building (on Medical Dr.) is for sale in Port Jefferson.  All other medical offices in this development have been sold over the past two years at an average price of $867k per 4,000 sf +/- building or $216/sq ft.

The Grove

GYRO retains a limited partnership interest in a real estate development project in Palm Beach County, FL referred to as “The Grove”.  Based on the disclosure in the 12/31/16 10K, GYRO states “it is unclear what amount, if any, the Company could expect to receive in any final liquidating distributions from the Grove.”  Certain long term shareholders of GYRO believe there may be value in the LP interest.  We have attributed no value to this asset.

Flowerfield 5-acre residential

GYRO owns a 5 acre parcel at Flowerfield on the opposite side of the LIRR tracks from the balance of the Flowerfield acreage.  This parcel, unlike the rest of Flowerfield, is zoned residential permitting one dwelling per acre.  We have attributed no value to this asset in our Base Case.

VALUATION

FLOWERFIELD Valuation Considerations

Assisted living (proposed: 220 units)

Evergreen Manor listing (near Cortlandt Manor, NY) with asking price of $35,000 per unit.  It is under contract (LOI).  Like Flowerfield, it is located very close to a hospital.  According to the listing, the property under LOI is to be delivered by Master Developer fully approved shovel-ready with main roads, sewer, town water, gas and all off-site improvements.  

Putting the asking price per unit in context:  Siena Village Senior Community in Smithtown, NY was sold in 2015:

• • Units: 298 (Section 8 - affordable housing)
  • Sale Price: $62mm
  • Additional capital investment post closing: $9.2mm
  • Total purchase price plus expected investment: $71.2mm or $240k per unit

Hotel (150 Rooms)

Good occupancy at nearby Hilton Garden Inn due to persistent demand from SUNY.  Will also benefit from adjacent existing catering and event facility at Flowerfield Celebrations.

Medical/Research and Development offices (100,000+ sq ft)

Good demand for offices given proximity to SUNY - Stony Brook.  Medical center proposed to double in next three years according to GYRO consultant, Cameron Associates, in presentation to Smithtown Board 11/15/17.

Existing Industrial Parcel

Existing industrial parcel uses can be continued or buildings could be repositioned and upgraded to meet market demand.

Cortlandt Manor Valuation Considerations

Project neighboring GYRO Cortlandt Manor parcel - also within MOD awaiting rezoning.

• 120 Residential units - UNDER CONTRACT WITH LOI (according to listing broker - Jan 2018)
  • Asking $45,000 per unit
  • Lower-end residential compared to GYRO’s plans in Cortlandt
  • Asking price $5.4mm  
  • LOI price unknown

• 120 Unit Assisted Living facility - UNDER CONTRACT WITH LOI (according to listing broker - Jan 2018)
  • Asking $35,000 per room OR $1.4mm per acre
  • Per listing: delivered fully approved, shovel-ready with main roads, sewer, town water, gas and all off-site improvements.
  • 3 acre site
  • Asking price $4.2mm  
  • LOI price unknown

• Additional proposed uses on the balance of the property include a hotel (90 rooms), 18k Sqft Office and retail
  • Owner: Santucci (VS Construction) Project @ 2001-2003 Crompond Road, Cortlandt Manor, NY

Low Case - 9/30/17 Balance Sheet NAV

Based on the 9/30/17 balance sheet prepared in accordance with liquidation accounting and assuming the liquidation is completed by 12/31/18, the Net Asset Value is as follows:

Note: (i) this balance sheet is based on 12/31/16 appraisal values for remaining real estate assets without explicit consideration of the entitlements GYRO is currently seeking and (ii) it reflects roughly $3.5mm of land development expenses in pursuit of the desired entitlements with no offsetting increase in real estate values.  

The company states that the appraised values for Flowerfield and Cortlandt Manor (not broken out by the company) are below the 12/31/13 appraised values which form the basis for the Retention Bonus Pool for the Board and management.  Hence the estimated costs above do not include a Retention Bonus Pool payment for disposition of Flowerfield or Cortlandt.

Given that the Bonus pool receives no funding if the real estate assets are sold for less than 12/31/13 appraised value plus whatever land development costs have been expended, we find it highly unlikely that management will sell the assets at a price that does not trigger a bonus payment.  Given this, the following is a revised “Low Case” that includes the minimum real estate values to trigger a Retention Bonus Pool payment:

Low Case - Adjusted for Bonus Pool

Base Case

Comparables for a re-zoned vacant land at Cortlandt Manor are a challenge.  Recent information indicates that two vacant parcels at a neighboring project are under LOI.  We have assumed LOI contract value is 20% below asking price.  

High Case

Valuation Summary

Return Scenarios

RISKS

• Politics in Smithtown
  • Tax revenue is appealing, but the Town has been resistant to development (in general) in the past.  Does new Town Supervisor change this?
  • Traffic concerns need to be addressed, but likely not fatal as GYRO has mitigation recommendations.
    

• Alignment of GYRO Board with shareholders?
  • The GYRO Board has structured its bonus compensation based on the amount of the gross sale proceeds of each property individually exceeds a 2013 appraised value.  In May 2016, the Board amended its bonus plan to add the land development costs expended to the 2013 appraised values on Flowerfield and Cortlandt Manor, thereby increasing the threshold amount of proceeds required before a bonus is payable.  
  • Shareholders are at risk to the extent the Board does not carefully manage expenses given that Board/Management are incentivized at “top line”. Board Chair Paul Lamb owns 2% of company; officers and directors as a group own only 3.7%.
  • If Flowerfield subdivision approval drags out, how long with Board spend money to see it through before selling the parcel?

• Timing
  • How long does Flowerfield subdivision ultimately take?  How long does Cortlandt Manor MOD rezoning take?  Senior Town Planner at Cortlandt predicts it is completed “this calendar year”.  Flowerfield timeline less clear.

• Tax status  (not a risk per se, but take note)
  • Treated as a Partnership for Federal tax purposes.  Following merger transaction in 2015, GYRO no longer a REIT, but now an LLC.
  • K-1 issued annually

• Overall real estate market condition
  • A negative shock to real estate market and/or lending rates could negatively impact the value of remaining properties and GYRO’s ability to monetize them.

• New tax legislation a positive?
  • Benefit to pass-through entities and therefore potential purchasers of GYRO properties.

Catalyst

• Cortlandt Manor re-zoning approval
• Flowerfield subdivision approval