Is Global Net Lease A Value Trap?
Brad Thomas wrote this article and it has previously appeared on Seeking Alpha.
- A "value trap" is when a stock is cheap and it trades at a low multiple for an extended time.
- There is plenty of cheese in the trap (9.5% dividend yield) and I don’t see any catalysts that suggest that shares will move “materially” up.
- My advice: Focus on Quality and Don’t Get Too Cute!
I ran across another article on Seeking Alpha yesterday by Dane Bowler in which he ++wrote++,
Global Net Lease (NYSE:++GNL++) is among the cheapest NNN REITs with a 2017 FFO multiple of only 10.3X, and it is on the brink of a supply choke, which should send shares up materially.
Bowler went on to explain that “GNL has a significant number of accumulator type investors as it has many of the characteristics that group looks for (i) Big dividend yield at 9.4%, (ii) High fundamental visibility with a very long remaining lease term, (iii) High portion of investment grade tenants, and (iv) Reasonably low leverage.”
I began to ponder Bowler’s comments and I almost choked (pun intended Dane). Instead of debunking the comments, I decided I would explain whyI believe Global Net Lease REIT is one of the “worst” Net Lease REITs and very possible a value trap.
A "value trap" is when a stock is cheap and it trades at a low multiple for an extended time. The stock "traps" attract investors who are looking for a bargain because the shares look inexpensive. The "trap" springs when investors buy into the company at low prices and the stock price never rebounds.
Global Net Lease
Global Net Lease began trading on June 3, 2015. Formerly American Realty Capital Global Trust, a non-traded REIT, GNL was re branded (changed its name), but the REIT is being externally managed by AR Global Investments, LLC.
As a result, GNL’s executive officers, advisor and its affiliates face conflicts of interest, including significant conflicts created by the Advisor's compensation arrangements with U.S. and other investment programs advised by AR Global Investments, LLC’s affiliates and conflicts in allocating time among these investment programs and U.S. As GNL discloses in its ++Investor Presentation++:
Because investment opportunities that are suitable for us may also be suitable for other AR Global Investments, LLC advised investment programs, our Advisor and its affiliates face conflicts of interest relating to the purchase of properties and other investments and such conflicts may not be resolved in our favor, which could reduce the investment return to our stockholders.
As typical to many non-traded REIT listings, GNL launched a tender offer to acquire a maximum of $125 million of its shares of common stock at $10.50 per share. On February 28, 2017 the company completed a 1-for-3 reverse stock split.
Today, GNL's portfolio consists of over 312 net lease properties and around 22.2 million square feet. The overall portfolio occupancy is 100%.
Many of GNL's US properties were acquired in 2013 and 2014 - when ARCT and Cole Capital were also aggressively acquiring net lease properties. GNL has 94 tenants doing business in 40 industries.
In GNL’s Investor Presentation, the company states that its investments are “mission critical assets that are strategically important to tenants’ core operating businesses.” The Portfolio’s Top Ten Tenants Represent 38% of SLR:
What jumps out at me, is the fact that many GNL’s properties are office buildings. As you can see below, GNL has over 59% invested in office:
As I analyze the tenant roster, it’s apparent that there are many credit-rated tenants. The company states that 32.3% of the portfolio is leased to “actual investment grade” rated companies. The company says that 44.4% of the tenants have an “implied investment grade” rating.
So, if GNL seeks to differentiate itself as a credit buyer, it should also be competitive when it comes to its weighted average cost of capital (or WACC). After all, GNL suggests that it is a consolidator of net lease buildings leased to “largely investment grade tenants,” so it would seem reasonable to believe that GNL could be competitive as a buyer. Right?
This Smells Cheesy
In my article yesterday I provided a WACC illustration for Realty Income and I explained that “Realty Income’s investment spreads relative to its weighted average cost of capital remained healthy in the first quarter, averaging 170 bps, which were well above the historical averages. Realty Income defined investment spreads as initial cash yield less the nominal first year weighted average cost of capital.”
Now let’s compare to Global Net Lease (using apples to apples comparisons):
Here’s my back of the napkin WACC score for GNL:
2017 expected AFFO/sh: $2.21
Current stock price: $22.60
Cost of equity = $2.21/$22.60 = 9.9%
Cost of 10-year debt is tough because they don’t have any 10-year unsecured outstanding, but let’s just assume something like 4.25%.
WACC (assuming 1/3 debt) = .097 \ .67 + 4.25% * .33 = 7.9%*
To be clear, this is an “apple to apples” model, and to be fair GNL uses much higher leverage (~50%) than this model. I used the 33% leverage because that is what a “normal net lease REIT” balance sheet should look like.
Realty Income’s WACC is 4.78% - over 300 bps lower than GNL (on an apples to apples basis). However, using GNL’s actual leverage (of 50%) the WACC would be closer to 7.1% (but the company is taking on a lot more risk).
What does this mean?
With such a high cost of capital, it’s hard to believe that GNL can compete with peers such as Realty Income or National Retail Properties (++NNN++). It’s perplexing to see how GNL can grow AFFO/share by using 50% leverage and clearly the recent acquisitions are not accretive, based on the above-referenced WACC analysis.
Not only is GNL’s balance sheet more levered than most Net Lease REIT peers, but the company also has significant complexity risk associated with its comprehensive hedging program. GNL has just under 50% of its investments located outside of the United States.
Unlike like W.P. Carey (++WPC++), an internally-managed REIT, GNL is externally-managed and that means that it technically it relies on Moor Park Capital to manage the European assets. This provides more complexity risk and GNL is obligated to pay fees which may be substantial to its Advisor and its affiliates.
GNL has no employees whatsoever, so as an investor in the company you are paying out the following services (++source++):
- a base fee of $18.0 million per annum payable in cash monthly in advance (“Minimum Base Management Fee”);
- plus a variable fee, payable monthly in advance in cash, equal to 1.25% of the cumulative net proceeds realized by the Company from the issuance of any common equity, including any common equity issued in exchange for or conversion of preferred stock or exchangeable notes, as well as, from any other issuances of common, preferred, or other forms of equity of the Company, including units of any operating partnership (“Variable Base Management Fee”); and
- (an incentive fee (“Incentive Compensation”), 50% payable in cash and 50% payable in shares of the Company’s Common Stock (which shares are subject to certain lock up restrictions), equal to: [A] 15% of the Company’s Core AFFO (as defined in the Advisory Agreement) per weighted average share outstanding for the applicable period (“Core AFFO Per Share”)(1) in excess of an incentive hurdle based on an annualized Core AFFO Per Share of $0.78, plus [B] 10% of the Core AFFO Per Share in excess of an incentive hurdle of an annualized Core AFFO Per Share of $1.02. The $0.78 and $1.02 incentive hurdles are subject to annual increases of 1% to 3%. The Base Management Fee and the Incentive Compensation are each subject to an annual adjustment.
The annual aggregate amount of the Minimum Base Management Fee and Variable Base Management Fee (collectively, the “Base Management Fee”) that may be paid under the Advisory Agreement are subject to varying caps based on assets under management (“AUM”) (2), as defined in the Advisory Agreement.
In addition, the per annum aggregate amount of the Base Management Fee and the Incentive Compensation to be paid under the Advisory Agreement is capped at [A] 1.25% of the AUM for the previous year if AUM is less than or equal to $5.0 billion; [B] 0.95% if the AUM is equal to or exceeds $15.0 billion; or (++C++) a percentage equal to: [A] 1.25% less [B] (++I++) a fraction, (++X++) the numerator of which is the AUM for such specified period less $5.0 billion and (++Y++) the denominator of which is $10.0 billion multiplied by (ii) 0.30% if AUM is greater than $5.0 billion but less than $15.0 billion. The Variable Base Management Fee is also subject to reduction if there is a sale or sales of one or more Investments in a single or series of related transactions exceeding $200.0 million and, the special dividend(++S++) related thereto.
The Property Manager provides property management and leasing services for properties owned by the Company, for which the Company pays fees equal to: (++I++) with respect to stand-alone, single-tenant net leased properties which are not part of a shopping center, 2.0% of gross revenues from the properties managed and (ii) with respect to all other types of properties, 4.0% of gross revenues from the properties managed.
For services related to overseeing property management and leasing services provided by any person or entity that is not an affiliate of the Property Manager, the Company pays the Property Manager an oversight fee equal to 1.0% of gross revenues of the property managed.
Solely with respect to the Company's investments in properties located in Europe, the Service Provider receives a portion of the fees payable to the Advisor equal to: (++I++) with respect to single-tenant net leased properties which are not part of a shopping center, 1.75% of the gross revenues from such properties and (ii) with respect to all other types of properties, 3.5% of the gross revenues from such properties. The Property Manager is paid 0.25% of the gross revenues from European single-tenant net leased properties which are not part of a shopping center and 0.5% of the gross revenues from all other types of properties, reflecting a split of the oversight fee with the Service Provider.
In the ++Annual Report++ GNL explains.
“We are dependent on these third parties and affiliates for services that are essential to us, including asset acquisition decisions, property management and other general administrative responsibilities. In the event that any of these companies were unable to provide these services to us, we would be required to provide such services ourselves or obtain such services from other sources at potentially higher cost.”
GNL’s officers and directors face conflicts of interest related to the positions they hold with related parties, which could hinder the Company's ability to successfully implement its business strategy and to generate returns, as explained in the Annual Report.
Certain of the Company's executive officers, including Scott Bowman, chief executive officer and president, and Nicholas Radesca, chief financial officer, treasurer and secretary, also are officers of the Advisor, the Property Manager and other related parties. Nicholas Radesca is the chief financial officer, treasurer and secretary of American Finance Trust, Inc., which is a non-traded REIT sponsored by the parent of our Sponsor that has investment objectives similar to our U.S. investment objectives. The Company's directors also are directors of other traded and non-traded REITs sponsored by the parent of the Sponsor. As a result, these individuals owe fiduciary duties to these other entities which may conflict with the duties that they owe to us.
What Does It Take To Move The Needle?
On the latest earnings call GNL’s CEO ++explained++,
We are actively working with a number of different firms on research both Nick and I are engaged in that in a daily really weekly basis. We do believe that you will see additional research coming online as people open up availability to add names and we are working to make that happen as soon as it can.
I’m not sure that research alone will send GNL’s share price up materially.
Remember that GNL has outsized office exposure… and this means that there are considerably more costs to lease space, remodel space, and pay leasing fees (to brokers). There is essentially “no margin of safety” in terms of GNL’s payout ratio. All it takes is one hiccup and guess what…?
Also, this elevated payout ratio means that GNL will have a difficult time growing the dividend. The company pays out $2.12/share in dividends and the prospects for earnings growth are modest (source for chart below: FAST Graphs), just 3% in 2018:
Net Lease REITs should be predictable and based upon my analysis GNL is riddled with complexity. Simply said, there’s a good reason that GNL’s dividend yield is 9.5%.
As far as I’m concerned, Mr. Market is pricing GNL squarely. There is plenty of cheese in the trap (9.5% dividend yield) and I don’t see any catalysts that suggest that shares will move up “materially”. Bowler thinks the trap will spring, but until GNL provides a more predictable path for profits (i.e. lower cost of capital) I’m not convinced that shares will spring, thus, I consider this REIT a VALUE TRAP!
I just don’t think the thrill of victory is worth the agony of defeat! My advice: Focus on Quality and Don’t Get Too Cute!
In the July edition of the ++Forbes Real Estate Investor++ I will be providing a dashboard for WACC for all Net Lease REITs.
Author's note: Join me at the DIY Investor Summit where I share detailed tips on my core investment strategies, top advice for DIY investors, and specific ways I'm positioning for the second half of 2017. ++Sign up here++.
Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).
Sources: FAST Graph and GNL Investor Presentation.
Disclosure: I am on the Advisory Board of NY Residential REIT, and I am also a shareholder and publisher on the Maven.
Disclosure: I am/we are long AHP, APTS, ARI, BRX, BXMT, CCI, CCP, CHCT, CLDT, CONE, CORR, CUBE, DLR, DOC, EXR, FPI, GMRE, GPT, HASI, HTA, IRET, IRM, JCAP, KIM, LADR, LTC, LXP, NXRT, O, OHI, PEB, PEI, PK, QTS, ROIC, SKT, SNR, SPG, STAG, STOR, STWD, TCO, WPC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.