|Shares Out. (in M):||48||P/E||0||0|
|Market Cap (in $M):||737||P/FCF||0||0|
|Net Debt (in $M):||902||EBIT||0||0|
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Tier Reit, Inc. is a simple collection of 33 Class A office properties that we can buy at a significant discount to market value, thus creating a highly favorable risk/reward tradeoff. How and why does this opportunity exist? The story of TIER Reit is a familiar one – spawned from the dark underworld of non-traded REITs, TIER came public in July 2015 via an unmarketed listing of its shares. As a result, TIER’s shares have traded at a significant discount to the comparable assets, despite management engaging in a value enhancing combination asset sales, stock buybacks and debt retirement.
TIER’s roots are in a non-traded REIT called Behringer Harvard that came into existence in 2004. For years they raised money through the retail channels, went on a buying binge – acquiring trophy property after trophy property – without much care or discipline with respect to price. During the financial crisis the Company teetered on the brink under an enormous debt load. A new management team entered and began selling properties, and as the real estate markets recovered the Company slowly but surely emerged from its heavy debt load into a more normalized capital structure, paving the way for TIER to list its shares in July 2015. Without a single sell side analyst covering the security (up until very recently when Janney and JP Morgan initiated), TIER was completely off the radar and its shareholder base had not been held captive in TIER for 10+ years. TIER’s first few earnings calls devolved into nonsensical queries from retail investors such as:
“I kind of got hooked up here on a whole bunch of financial documents on your thing, but what do you think the book value is on property as far as the dollar per share on the stock price? Can you help me out and just give me a ballpark here because I'm not an accountant?”
“Is there now a dividend on the shares? It seems to me there was a dividend from something I saw online. And if so, will there be a dividend reinvestment program?”
“My simple question is if you really believe that the value of the shares were $26.88, why would you go on the stock market knowing that you're not going to get more than $19 to $21 on the first days. It just seems like it would be easier for the TIER REIT to sell the properties individually; yes, it would take time, but I think we would all rather have $26.88 a share than $17 to $18 a share.” [Note for readers: the $26.88 was a reference to an independent NAV appraisal that was conducted prior to going public – we have not seen this appraisal and cannot comment on its accuracy – we lay out our own valuation assumptions below]
Despite this unfavorable setup, the Company boasts a very attractive portfolio of properties and a management team that, to their credit, has nursed this entity back to good health and is doing the right things to develop institutional support for the stock and ultimately position the Company for a sale.
Since going public, management has continued to sell properties at attractive prices, buy back stock (through a significant dutch tender), and do their best to develop institutional support (eg, they now have 2 analysts covering them and had well attended meetings at NAREIT recently). Furthermore, the management team has bought stock in the open market and is incented to create value. They have only sold assets and not acquired anything since becoming a public Company. Management has also disposed of properties at attractive cap rates (~$850m disposition since 2014 at ~6.2% cap rate). Our discussions with management around capital allocation have been favorable to date – they are clearly focused on selling down assets, paying down debt and buying back stock. We had initially looked at this situation as one ripe for an activist (their board is not staggered and are an easy target from that perspective), but after spending time with management are more inclined to get them their space for the time being.
In addition to the dynamics noted above that have caused this REIT to be under the radar, they also suffer from the bad optics of owning a fair amount of property in Texas – their Houston properties comprise 27% of NOI. Austin (which is a tech oriented market, not energy) is their second biggest market. Dallas is a significant market for them as well, and the Company is based in Dallas. Even the CFO’s name is Dallas (not making this up)! So there is some Texas exposure, which we have become quite comfortable with.
Our thesis here is simple – today you are buying the collection assets at an 8.83% cap rate across the portfolio, which is simply an enormous discount to fair value. We have gone through the properties one by one (which is not that difficult of an exercise as there are just 33 of them), and valued each one individually. We have talked to local brokers and real estate investors, discussed the dynamics of each individual property and have come up with a pretty clear value thesis around each individual property. We are simply going to present that work for purposes of the writeup so you can see how we put it all together.
Here is what the math looks like at a high level:
Here is how the Company’s NOI breaks down on a market by market basis:
Below you will find the detailed drivers of our valuation along with some discussion of each individual property or market to back up our assumptions.
Property and Net Asset Value Notes
a) Austin Properties: Terrace Office Park and the Domain properties are very high quality assets in a robust Austin market, driven by a growing tech market. The Domain in particular is an incredibly strong asset – it is a premier mixed-use development in Northwest Austin with an upscale shopping center, entertainment, multifamily properties and office space. The Domain has and continues to attract top quality tech firms as tenants. TIER’s assets in the Domain include 2 wholly owned Class A office buildings and a 49.8% interest in two other Class A office buildings. Several local brokers have confirmed the quality of TIER’s Austin assets and indicated that these should easily trade at a 6% cap rate. CBRE’s cap rate survey suggests 5.25-6% cap rates for Class A office space in Austin. It’s important to note that TIER also owns 18.1 acres of land in the Domain area, which can be used to develop 1.3m sf of Class A office, and is currently constructing another property in the Domain (Domain 8), a 291,000 sf Class A office building. TIER owns a 50% interest in Domain 8 (Shorenstein Properties owns the remaining interest) and it is expected to be completed in Q1 2017 with a total estimated NOI of $8m. At a total cost of $88m for the project, management is essentially building Domain 8 at a 9% cap rate when the Austin market is trading at a 6% cap. We think that TIER’s land position at the Domain can be developed at a $100 per square foot spread between construction cost and market value, representing over ~$130mm of embedded value in the land position (based on potential to build 1.3mm square feet of office space). We would note that this embedded value represents nearly 20% upside on the current market capitalization and is not contemplated in our NAV analysis above.
b) 5950 Sherry Lane: High quality, class A suburban office asset that is located in the prominent, amenity-rich Preston Center submarket. Dallas is another healthy market that has seen strong job growth over the years. This is a very strong property.
c) Burnett Plaza: High quality, class B/A office property located in downtown Forth Worth – it is sort of a stalwart, has performed very consistently over time. Burnett is currently non-stabilized due to the bankruptcy of Quicksilver Resources (a 116,000 sf tenant) which has caused occupancy to temporarily dip into the low 80s. We think this is a temporary disruption at Burnett - on its most recent earnings call, management indicated that they’ve completely backfilled all of Quicksilver’s space to GM Financial. Burnett is currently generating ~$8.7m of NOI and management believes stabilized NOI is $13.5m. With an economic occupancy of 69% compared to 82% physical occupancy, Burnett currently has higher than normal free rent and we have assumed in our analysis that Burnett gets the benefit of free rent rolling off but we are not assuming TIER can increase occupancy to 92%. For the quality of this asset, several brokers have indicated that this asset should trade between 6.5% - 7.5%.
d) Houston Properties: Despite the challenging market, TIER’s Houston assets are high quality, Class A properties and considered some of the best assets in their respective areas.
The gems of the Houston portfolio are the Eldridge Place and BriarLake properties, Class A office properties that are home to extremely high quality tenants. Several brokers have indicated that the Eldridge/Briarlake assets in particular should likely trade at 8% - 9% cap rate on current NOI. We spent a lot of time talking to brokers about the current dynamics in the Houston market, where pricing is and how TIER is positioned in particular. We came away feeling that a mid 8s cap rate is the right number and fairly reflects the challenges in the current market and the quality of TIER’s assets (note that this represents a 200bps increase in cap rates vs. 2 years ago).
With respect to near term trends in Houston, TIER has limited lease expirations over the next 3 years (0.9% of total sf in 2016, 2.7% in 2017 and 0.6% in 2018). On the q1 earnings call, management noted that about 20% of the ’17 lease expirations were renewed at a higher rate than in place rent. Furthermore, TIER’s key energy related tenants are very large, high quality companies that aren’t going away (BP and Apache are the largest energy related tenants). The Quiksilver bankruptcy is already in the numbers as discussed above and the Company is dealing with it effectively. For all of these reasons, we feel comfortable with TIER’s position in Houston –they are well situated due to quality of assets and the modest level of lease expirations.
e) Loop Central: Solid B quality asset that is well located in the Galleria submarket. The center of the Galleria submarket is very expensive to lease and Loop Central is considered to be a cheaper alternative for tenants.
f) One & Two & Three Eldridge Place: Very high quality, class A office assets in the Energy Corridor.
g) One & Two BriarLake: Like the Eldridge properties, these are extremely high quality, Class A office assets. Two BriarLake is new construction, in lease up phase, and is not yet stabilized. Management estimates stabilized NOI will be $8m. I would encourage you to take a look at their website at http://www.briarlakeplaza.com/gallery.html to get a sense of the quality of this asset. TIER will benefit from free rent rolling off given current economic occupancy is 56% while physical occupancy is 68%. It’s also worth noting that management received a construction loan of up to $66m for the development of the Two BriarLake project. We think our assumption of $81m for the property is likely very conservative (representing a 10% cap rate on stabilized NOI).
h) Bank of America Plaza: A landmark high quality, class B office property. In-place rents are ~23% below market so there is substantial opportunity to create value. In April 2016, Starwood Capital sold One Wells Fargo Center for a reported cap rate of 5.5% - a comp to Bank of America Plaza. One Wells Fargo is a class A office property that was 98% occupied and located next to the Bank of America Plaza in downtown Charlotte. We think a conservative cap rate for this asset is a 6.25% given the below market rents and quality of the asset. Website for the property is here http://www.tierreit.com/our-properties/detail/bank-of-america-plaza.
i) Buena Vista Plaza: Solid single tenant B office property in a steady submarket in Los Angeles. TIER executed an 11-year renewal with Disney in 2015 with 1 year of free rent which rolled off in February 2016. Stabilized NOI is at $3m. Given an 11 year lease with Disney, low cap rates in Los Angeles office properties, we think a 6.5% cap rate is appropriate.
j) Louisville Properties: This is a collection of 7 suburban office properties that are not great assets in a lower quality market. Despite these limitations, management has been able to improve occupancy from 78% in 2012 to 90%. We think an 8.5% cap reflects market values in Louisville.
k) Plaza at MetroCenter: A low quality suburban office asset in Nashville but ~50% of the property is leased to State of Tennessee through 2029.
l) Eisenhower I: Solid single tenant office property with a great location next to the Tampa International Airport. Long term lease with Bristol-Myers Squibb. TIER also owns 5.2m acres of land adjacent to Eisenhower I with a potential build-to-suit opportunity for Bristol-Myers Squibb. Brokers have suggested cap rates between 7% - 7.5% for the asset.
m) Washington, D.C. Properties: Consists of 3 quality office properties. Two of the properties are located in downtown D.C. and TIER owns a 10% interest. D.C. is a strong market and we have heard from brokers that cap rates are currently around 6%. The third property is located in Rockville and will likely trade at a higher cap rate than 6%.
n) 500 East Pratt: High quality, newly constructed class A office property in downtown Baltimore. Columbia Property Trust recently sold 100 E. Pratt, a class B/A office property that is older than 500 E. Pratt. CXP sold this for a 6.75% cap rate. Brokers have suggested 500 E. Pratt should trade between a 6% - 6.5% cap rate.
o) Woodcrest Corporate Center: Single story class A building that was originally an industrial property and completely renovated into an office property in 2005. Brokers we spoke to have indicated cap rates for the market to be between 7% - 8%.
p) FOUR40: Class A office property that used to house the Chicago Stock Exchange and a host of other financial firms. Since the financial crisis, occupancy has taken a hit. As a result, TIER decided to renovate the property in 2015 and re-brand the building to attract more non-financial sectors. FOUR40 is a non-stabilized property that is in lease up phase after substantial capital investment / property improvement. Current occupancy is 73% and NOI is just $7.8m; management believes stabilized NOI is ~$16.5m. In late June, TIER reached an agreement to sell the property to CIM Group for $191m (4% Cap on current NOI and 8.25% on management’s stabilized NOI) plus an earnout of $12.5mm which we are not including in our valuation. We think this is a pretty good outcome as it takes a key risk off the table while allowing TIER to monetize some of the upside in the property. Although FOUR40 is a nice asset, the consensus view from brokers is that it is not in a desirable location in Chicago and it is uncertain when FOUR40 would get to more “stabilized” occupancy levels. Note that the sale of FOUR40 is a huge deal from a valuation perspective and we think is a key factor not appreciated by the market – it is a huge asset for TIER and they are effectively selling at a ~4% cap because the building is below occupancy and just coming out of a significant reposition. Since the entire Company is trading at a high implied cap rate, selling a huge asset at a sub 4 cap and using the proceeds to reduce enterprise value is a huge lever on valuation, making the remaining assets insanely cheap in our view. This is likely the most underappreciated factor in TIER’s valuation.
q) Wanamaker Building: A historic, high quality office property that is in a great location in downtown Philadelphia – everyone in Philadelphia knows this building. Wanamaker was built in 1911 and was originally a department store that was later converted into offices (Macy’s still has a flagship store location at Wanamaker leased through 2027). This is a property that has been on the market for some time and there were reports in November 2015 that there may be a deal to sell the property to Rubenstein Partners for $200m. We have heard there are some delays on closing this sale - the property is owned through a JV (TIER – 60% / Amerimar Enterprises– 40%). We have heard that the delays on closing are related to tax issues for TIER’s JV Partner that are being resolved. We think there is a good chance that this building will be sold in the very near future.
r) Three Parkway: Currently listed in its future disposition pipeline, Three Parkway is a solid class B office property that is not as well located as Wanamaker. Brokers that we spoke to have suggested cap rates in the mid 7s.
s) Hurstbourne Plaza: A non-operating property, Hurstbourne Plaza is a retail shopping center that TIER is not actively leasing. The Company plans to eventually sell or redevelop the property.
t) Fifth Third Center: Another non-operating office property, Fifth Third Center is currently in default and TIER is working with the lender to dispose of the property. This property has $49m of non-recourse debt on the balance sheet that will get eliminated once the property is disposed.
u) Property held for development/land: This represents the cost basis on Domain 8 (under construction) as well as excess land. We think that cost is a very conservative number because TIER is seeing very strong interest in Domain 8 and as discussed in (a), there is a huge amount of embedded value in the land position at the Domain (potentially $130mm of spread between construction cost and market value). We are not taking into account any upside related to Domain 8 (which is already under construction and going quite well) or any future development projects in our valuation.
v) Corporate overhead: We believe that TIER is being positioned for a sale to another REIT – they are disposing of non-core assets in order to make the Company as attractive as possible to a buyer. Clearly TIER is subscale as a REIT and they are of a perfect size to fit into the portfolio of a larger entity – perhaps a buyer like Equity Commonwealth for instance who is massively overcapitalized and looking for the right asset to add to their portfolio. As such, we are valuing TIER as an acquirer would (pure NAV basis) and not including a multiple on their corporate overhead as part of our analysis. We think a sale is the endgame for TIER in the next 24 months, but if you want to value the Company as a subscale going concern based on $24mm in G&A, this would reduce our NAV number by $5.50 or so.
This is a pretty straightforward investment with a simple reason for mispricing – lack of institutional following. We can debate the assumptions that we use in our analysis above, but I think we will always conclude that this trades at a very meaningful discount to comps, NAV etc. I also happen to think that management is doing a good job here and making decisions that will accrue to the benefit of shareholders. Ultimately this will be sold which will be the ultimate catalyst for bridging the gap between price and intrinsic value. The Four40 sale in particular takes a significant risk off the table and highlights the significant discount this trades to NAV.
Increased in sell-side coverage and institutional investors, sale of Wanamaker and asset dispositions, de-leveraging, sentiment improvement in Houston, activist involvement / sale of the company
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