MDRRP - CTO Realty Growth Yields 9.25% And Looks Interesting Going Into Earnings

2023-04-21 09:00:00 ET

Summary

• CTO's CEO and CFO recently purchased shares on the open market in Q1 2023, which should generate some confidence among the investor base.
• CTO's management has structured their debt well as 97% is fixed and $0 of long-term debt matures in 2023 and 2024.
• CTO has an interesting model as they focused on business-friendly regions experiencing population growth.

Sometimes going against the grain when mass fear occurs can pay off in spades. Real Estate Investment Trusts (REITs) have been taken to the woodshed during the rising rate environment as fears of higher debt payments, rising borrowing costs, and the possibility of lower property valuations have impacted the sector. Investing in REITs carries significant risk, but eventually, the Fed will pivot, and the REITs that survive could be trading at low valuations today. CTO Realty Growth ( CTO ) is very interesting as it's a smaller REIT that focuses on markets and states that are business and tax-friendly. CTO acquires and operates properties where they feel long-term cash flows and underlying real estate values are supported by significant population and job growth. There has been an exodus of companies fleeing states such as California for business-friendly environments, with some of the biggest names being Tesla ( TSLA ), Charles Schwab ( SCHW ), and Oracle ( ORCL ). What I see occurring should benefit REITs such as CTO as more companies and people move to states like Texas, Florida, New Mexico, and the Carolinas. CTO has an interesting portfolio and looks undervalued. I think this is a speculative buy, and I am waiting until after the upcoming earnings to see the commentary before starting a position.

CTO has a strong business model that plays into the shifting landscape as companies look for greener pastures

CTO is a self-managed equity REIT that focuses on ownership, management, and repositioning high-quality retail and mixed-use properties. CTO operates in faster-growing locations due to attractive tax policies, which have spurred job and population growth. CTO owns and manages 23 commercial real estate properties in nine states, consisting of eight single-tenant and 15 multi-tenant income-producing properties comprising 3.7 million square feet of gross leasable space. In addition to their property portfolio, CTO has a management service where they generated fee-based management fees for managing Alpine Income Property ( PINE ), CTO operates a commercial loan and investment business which consists of three commercial loan investments and one private equity investment.

The investment in PINE is interesting as PINE has a market cap of around $222 million and generated $33.7 million in EBITDA in 2022. CTO owns 14.6% of PINE's equity, including limited partnership units that are redeemable for cash. The investment in PINE generates investment income through the dividends distributed by PINE, and CTO could see appreciation in the future.

During 2022, CTO acquired four multi-tenant income properties and one portfolio of three single-tenant properties for a total acquisition cost of $315.6 million. CTO sold six properties that reflect a total disposition volume of $81.1 million, resulting in aggregate gains of $4.7 million. The current portfolio of 15 multi-tenant properties generates $66.6 million of revenue from annualized straight-line base lease payments and has a weighted average remaining lease term of 4.8 years. The eight single-tenant income properties generate $8.6 million of revenues from annualized straight-line base lease payments and have a weighted average remaining lease term of 5.7 years.

Over the years, CTO has decreased its number of properties by 11, to focus on increasing its portfolio's sq footage and annualized cash-based rents. While the number of properties has decreased by -32.35%, CTO has increased its sq footage by 106% and its annualized rents by 163.04%. This is a testament to the success of its business model, as it shed assets to reinvest in more desirable locations.

After looking at CTO's progress, I am interested as they are positioned well for the future.

CTO has a market cap of roughly $380 million and generated $82.3 million in revenue and $48.7 million in EBITDA throughout 2022. In 2022, CTO grew its core funds from operations (FFO) by 35% to $1.74 per diluted share and its adjusted FFO (AFFO) by 26% to $183 per diluted share. CTO funded its growth by issuing five million shares through its inaugural follow-on equity offering and under its ATM offering program at a weighted average gross price of $19.73 per share, for total net proceeds of $95.3 million. CTO was also able to expand its revolving credit facility from $210 million to $300 million and extended the maturity date to January 2027.

On the investing side, CTO allocated $314.0 million into mixed-use or retail property acquisitions concentrated in Atlanta, Dallas, Richmond, and Houston at a weighted-average going-in cash cap rate of 7.5%. CTO also entered into four structured investments to provide $59.2 million of funding towards the development or redevelopment of retail mixed-use properties in submarkets of Atlanta, Dallas, and Orlando at a blended initial yield of 8.2%. CTO was able to sign 217,000 square feet of new leases, renewals, and extensions with an average comparable increase of 17%. The comparable new leases signed during 2022 increased cash base rents by 58% over the expiring cash base rents. CTO is projecting that they will see between 1-4% in same property net operating income (NOI) growth in 2023 and that they will finish the year with an occupancy rate between 94-95%. CTO is also looking to invest between $100-$250 million in income-producing properties, with a target investment cash yield of 7.25-8%.

The big concerns with REITs include occupancy rates which are more geared toward office REITs, floating debt, and debt maturities. CTO addressed its debt maturities in the Q4 2022 presentation. CTO has just under $450 million in total debt on its balance sheet, with $0 of its long-term obligations due in 2023 or 2024. Management has done an exceptional job at its debt management, as 97% of its debt is fixed while only 3% is at a floating rate. CTO also locked in very low rates on the majority of its debt and has $17.8 million tied to 4.06% interest and $51 million tied to 3.88%. While some REITs are in questionable situations regarding debt, CTO is in a strong position. By the time the first tranche of debt maturities, rates should be considerably lower than they are today, and refinancing could be much more enticing than what the landscape affords today.

CTO looks interesting compared to its peer group

Seeking Alpha lists CTO's peer group as:

• One Liberty Properties ( OLP )
• Gladstone Commercial Corp. ( GOOD )
• Alpine Income Property ( PINE )
• Modiv Inc. ( MDV )
• Medalist Diversified REIT ( MDRR )

For my comparison, I also added Realty Income ( O ), and National Retail Properties ( NNN ). I will look at dividend yield, FFO coverage ratio, Price to FFO, Debt to EBITDA, discount to book, and discount to tangible book.

CTO offers the third-largest dividend yield at 9.26% with a 1.01x FFO coverage ratio. The average dividend yield in the group is 7.58%. CTO has said in their annual report that they will try to return as much capital to shareholders as possible, so I am not that concerned with the coverage ratio as they have stated their intent within the 10-K.

CTO trades at a 10.73x price to FFO compared to a group average of 10.83x. CTO is right on the bubble, and while they aren't that undervalued on an FFO basis, this wouldn't stop me from investing.

CTO has a 9.16x total debt to EBITDA ratio. Some look at net debt, I like to look at total debt. CTO trades above the group average of 8.63x. While this would normally raise questions, CTO has a strong debt structure, and I am comfortable with their debt maturities and interest rate structure.

What is very interesting is that the group trades at an average premium to book value of 24.06% and 57.70% compared to tangible book value. CTO trades at a -25.68% discount to book and -3.53% to tangible book. This is compelling because CTO's properties are not in areas where companies are leaving, their asset base is in areas that are seeing population growth. Today, you are able to pick up its assets under their book value, which is a value proposition.

Conclusion

I believe now is a good time to go against the grain and find strong REITs that will make it out of the current situation. I think, in many cases, strong REITs have been grouped into the doom and gloom scenario and are trading at compelling valuations. I am not a shareholder of CTO, but I am bullish on its future. Its debt structure is compelling, and I like its business model. I will be waiting until earnings to see what has transpired in Q1 prior to making an investment. I believe it's also a strong signal that the CEO and CFO acquired shares on the open market in Q1. I don't have a crystal ball, but CTO is a small REIT that I would pay close attention to as it's positioned for significant growth and operating in desirable areas.

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