March 27, 2013 - 2:59pm EST by
2013 2014
Price: 9.50 EPS $0.00 $0.00
Shares Out. (in M): 198 P/E 0.0x 0.0x
Market Cap (in $M): 1,881 P/FCF 5.5x 5.3x
Net Debt (in $M): 583 EBIT 0 0
TEV ($): 2,464 TEV/EBIT 0.0x 0.0x

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  • REIT
  • Commercial Real Estate (CRE)


     NorthStar Realty Finance is an internally-managed real estate company operated as a REIT. Its primary business has been commercial real estate lending. It is most often compared to Arbor Realty Trust (ABR), Newcastle (NCT) and RAIT Financial Trust (RAS which was written up by Lindsay790 on 3/17/13. His fine write up gives further flavor to how the business is run and the industry perceived). NRF was founded in 1997 by David Hamamoto and went public in 2004. Prior to NRF, Mr. Hamamoto had been at Goldman Sachs from 1983 until 1997. He helped establish the Whitehall Funds at Goldman and was a general partner of Goldman from 1994 until 1997. He is well regarded in the real estate business. The other executives of NRF are also experienced and well regarded.
     Real estate, especially commercial real estate, is as much about financing as it is about the physical stuff that makes a building. During the boom years, there was an orgy of buying, borrowing and lending in the real estate markets. When the credit markets and the economy collapsed, real estate prices collapsed and the real estate lending business imploded. Many firms failed. Those that survived repaired their balance sheets, have begun to prosper, and should do well in the future. I own the industry through holdings in ABR, NCT, RAS, SFI and NRF. I like them all, but I like NRF the best. It has developed in a different manner than the others. As a consequence, I believe that it is worth a premium.
     Up through 2009, NRF operated three business segments. It owned a portfolio of tripled net leased real estate, it financed real estate loans directly, and it financed real estate loans through nine CDO's it sponsored which were backed by either real estate debt (direct mortgage investments originated by NRF) or by real estate securities (CMBSs structured and sold by Wall Street). Each of the CDOs was seperately financed with multiple tranches of debt which were only recourse to the issuing CDO, non-recourse to NRF, except to the extent of its equity investment. As a business, NRF received rental cash flow from its net leased portfolio, management fees and interest income from its CDO investments. Although NRF shows $4.2 bil of debt on its balace sheet, only $583 mil is recourse to NRf, the rest is non-recourse financings.
     When the bottom fell out of the real estate market, the value of CDOs were particularly effected. The major underwriters of CDOs and CMBSs either went out of business a la Lehman Brothers or collapsed their dealing desks. The securities in the market lacked market-makers. Banks, mutual funds, hedge funds and insurance companies that had been investors, now became sellers as they needed liquidity. NRF's stock, which had traded as high as $16.00 in 2007, collapsed to $1.39 in early 2009. The management of NRF used the collapse of the real estate lending market to improve their business. As others were selling CDO debt, NRF was buying. Between 2009 and the end of 2012, NRF repurchased $708 million of the investment grade debt issued by their CDO's. Of that, $558 million was repurchased at an average discount to par of 68%. The discount to par was not taken as a gain but will flow through the balance and income statement over the next several years. The CDOs had assets of $5.2 billion as of 12/31/12 and liabilities, including NRF-owned debt, of $$4.2 billion. In addition, NRF has traded the holdings within their CDO portfolios in order to improve the quality of the assets of the CDOs. NRF will realize over $1 billion of profits from their CDOs over the next several years. Last, NRF's CDOs continue to enjoy very cheap LIBOR-based financing rates against the real estate assets within the CDOs. It is easy to miss the positive results in the CDO business as NRF adopted "fair-value" accounting treatment for their CDOs. Under this treatment, declines in the prices of outstanding debt issues are treated as gains and increases in prices are treated ass losses. The gyrations caused by "fair-value" should lessen as time goes on.
     To further take advantage of the dislocations within the market, NRF purchased the debt, equity and control of two CDOs which had been formed by CapLease (LSE) and CapitalSource (CSE). The rates of return on these opportunistic purchases is expected top be greater than 25%.
     During the downturn, NRF had an advantage in owning a net leased real estate portfolio which provided steady cash flow. The company has a portfolio of 83 healthcare facilities ($551 mil gross), 12 office properties ($259 mil gross), 10 retail properties ($60 mil gross), and 1 industrial property ($26 mil gross). Due to defaults in their direct loan portfolio, NRF has acquired a REO portfolio of $359 mil. Altogether, these assets generated $117 mil of rental income in 2012.
      Being a lender and an owner means that NRF sees a lot of different opportunities. They acquired a portfolio of 36 mobile home parks with 6,269 pads for $326 mil. in 2012 which they expect to produce a 15% rate of return. In Feb of 2013, they announced that they are in due diligence on another portfolio of mobile home parks consisting of 71 communities with 17,000 pads for a purchase price of $825 mil. If the latter closes, it will, like the first, be financed with non-recourse debt for about 70% of the purchase price.
      NRF's most interesting transaction was the purchase of limited partnership interests in 51 real estate private equity funds, managed by top institutional quality sponsors. The funds had NAVs of $765 mil and NRF is paying $390 mil for their interest in them. Under the terms of the transaction, NRF will receive 85% of all cash distributions from the funds until it has received 1.5 times it investment. After that hurdle has been reached, NRF gets 15% of the cash flow until the seller has gotten its investment back. After that hurdle, 51% of the cash goes to NRF and 49% to the seller. Under these terms, NRF will receive a 10% IRR if the funds show no increase in value from their 6/30/2012 valuation.  The transaction is detailed in an 8-K filed on Dec. 10, 2012.
     During 2012, NRF continued to make indvidual real estate loans and sponsored the first new CMBS since the crash which raised $351 mil.
     Last, NRF raised $600 mil for a non-traded REIT, NorthStar Income I. It believes that the fund will close with $1 bil by the end of the June. NRF has registered and started to market a second fund, NorthStar Heathcare Income, for which it plans to raise $1 bil. NRF then plans to raise another $1 bil for a new fund, NorthStar Income II. The transaction and management fees for these funds are estimated to be 3% ayear. If successful, that is $90 mil a year of high-margined, recurring cash flow.
     In 2012 NRF had $1.71 a share of AFFO (adjusted funds from operations) versus $1.60 AFFO in 2011. In 2013, AFFO should be around $1.80 a share. At the current time NRF pays a $0.18 quarterly dividend or $0.72 a year for a 7.6% yield. This yield is comparable to what other real estate lenders provide. However, it is substantially more than what equity REITs yield. As NRF is constituted today, it is closer to an equity REIT than a mortgage REIT. As such, there is a good chance that it will be rerated to a higher multiple as investors come to appeciate the strenght and diversity of its business and asset base.
     On Feb. 15, 2013 NRF put out an informative 8-K on its business and outlook.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


 Increases in the dividend rate.
Completed and integrated acquisitions.
Investor awareness of the equity investments that have been made.
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