KW - Kennedy-Wilson's Out Of Favor Stock And Bonds Offer A Compelling Opportunity

2023-11-26 00:02:37 ET

Summary

• Kennedy-Wilson is a real estate development company with a strong track record and $25B in assets under management.
• The company is focused on increasing cash flow in global credit, growing its stabilized multifamily portfolio, and expanding its industrial assets.
• Despite a decline in financial results, the stock is undervalued and offers an 8.31% dividend yield, making it an attractive opportunity for long-term investors.

Kennedy-Wilson Holdings ( KW ) is a diversified real estate development company with over 35 years of investing experience and boasts $25B in AUM across its real estate equity and debt investment portfolio. The company has a history of being opportunistic and forward-looking in the markets that it participates in. KW is finishing up the last remnants of an aggressive development program that has greatly improved its NOI generation. The company owns high quality assets in good markets, and its investment management program offers a major platform for future growth. The stock has gotten clobbered this year along with many other real estate equities, but the carnage has gone too far, offering opportunity for long-term investors.

Management’s goal is to increase its cash flow in three key sectors, including global credit, where it welcomed 40 new employees from Pac West during Q3. In June, KW acquired $4.1B of construction loans from Pac West at a material discount, which was the largest single transaction in the company’s history. This was like a deal the company did in 2011, when it purchased a $2.2B loan portfolio secured by 23 assets in London, where KW ended up collecting 100% of the principal balances. In Q3, KW closed the final tranche of loans from Pac West for $212MM, along with an additional $252MM of fundings, and realized $376MMof repayments, which included $12MM of discounts. KW is one of the few active construction lenders in the U.S. market given the credit contraction in the banking sector, so the company is building its pipeline of new loans, including in the UK and Ireland where it believes it can find similarly attractive double-digit returns. The company can fund these loans using its asset management division funded by internal and third-party funds. The debt portfolio totals $6.5B in loan commitments, including future fundings, having doubled in size in 2023. KW’s investment in the debt business currently sits at $255MM in loans outstanding. In October, KW closed its first loan with a total loan size of $77MM and there are another six loans that they are expecting to close in the next few months. The platform has additional capacity to grow by approximately $2B based on the commitments already in place.

Secondly, the company is focused on growing its stabilized multifamily portfolio, where in Q3 KW acquired a minority position with a partner in a brand new 315-unit apartment community in suburban Seattle, which was its first multifamily acquisition in nearly 18 months. KW also stabilized two projects within its 12,000-unit Vintage portfolio and delivered 1,000 newly constructed units in the Dublin and Mountain West markets, with another 1,300 units expected to be delivered by the middle of 2024. The company’s U.S. portfolio is comprised garden-style communities, 90% of which are suburban. KW puts a big focus on improving the amenities and aesthetics, offering affordable luxury.

The company’s 33,000 stabilized units are 94% occupied, with another 4,000 units in development and lease up that are expected to add $40MM to $45MM in NOI to KW once completed and stabilized. KW’s Dublin, Ireland portfolio is 98% occupied. Multifamily represents 54% of the stabilized portfolio and produces $468MM on NOI, of which KW’s shares is $260MM. In Q3, globally, same-property multifamily revenue grew by 4% and NOI grew by 3%. In the U.S., renewal growth rates were 5% and blended leasing spreads were 2%. The strongest performance was in the Mountain West, which generated same-property NOI growth of 5%. New Mexico and Colorado really stood out with 14% and 9% growth, respectively. The Mountain West portfolio’s average rents are very reasonable at $1,600, which is one reason why the area is expected to see continued growth. California is facing some headwinds with the end of some government assistance programs and elevated delinquencies as a result, but that ultimately will work itself out after a few quarters. In Dublin, Ireland, robust demand for housing resulted in same-property NOI growth of 4.5%. In Q3, the company delivered nearly 800 units at is Grange and Coopers Cross developments, as well as adding units to its existing Stamford Lodge community, where leasing velocity has outperformed expectations. Management used the example at the Grange, where the building is half-leased within 10 weeks of completion, with average rents that are roughly 10% ahead of business plan.

Thirdly, the company is focused on growing its industrial assets under management, which currently totals nearly 11 million square feet, and where leasing trends are more attractive. The company added 183,000 square feet to its logistics portfolio in the quarter and there is a lot more potential growth in the pipeline in both the U.S. and Europe, including a recently closed $115MM industrial property that was acquired in the Western United States a few weeks back. Market rent in the European industrial portfolio grew by a solid 8% YoY. AUM in this portfolio now totals $1.6B and is 97% leased. Leasing transactions completed in the quarter resulted in a 66% increase in in-place rents, which were 13% above underwriting. YTD KW has completed 40 leasing transactions, delivering a 55% increase in rent, due to the significant under-market rents embedded within the portfolio. Management sees real opportunity in European logistics where it can now acquire quality assets at higher projected stabilized yields than in recent years. The joint venture has over $1B in AUM capacity, while the investment management platform has an incremental $3B, which can be deployed across the various platforms, which should add significantly to the existing $8.2B in fee-bearing capital, which grew by 4% sequentially and has doubled over the past three years.

Kennedy-Wilson’s stock is likely being hurt by having an office portfolio, as the office sector is the most distressed area in the real estate market. Most of KW’s portfolio is invested in high quality assets located in Dublin and the UK. Same-property revenue and NOI in the European office portfolio was largely flat in the quarter, with positive NOI growth in Ireland, offset by declines in the noncore Italian portfolio. The stabilized European office portfolio has an occupancy of 95% and a weighted average lease term of 8 years, so it is in excellent shape. In the U.S., the portfolio is primarily owned through its funds and partnerships, in which KW has a minority position. There are six assets in which KW’s ownership is greater than 50%, which represents less than 7% of the stabilized portfolio. Globally, the company completed 120,000 square feet of office leasing in the quarter, and roughly 800k square feet on the year thus far. Overall, stabilized office occupancy totaled 93% as of September 30 ^th .

KW has invested heavily in development over the last decade, nearing completion on a $3B construction pipeline, including spending $300MM on construction and value-add projects in 2023. This spending is expected to decline to less than $100MM in 2024 and the company is focused on reducing costs at both the corporate and property levels. Approximately 70% of the company’s development and lease-up portfolio is expected to stabilize by year-end 2024. KW has completed 82% of total expected development costs of $592MM, with its share of remaining expected cash investment to complete construction totaling approximately $32MM.

KW’s financial results in Q3 were negatively impacted by non-cash fair-value markdowns on some of its real estate assets, due to the higher interest rate environment. The GAAP net loss was $92.2MM or $($.66) per share, down from a gain of $16.4MM, or $.12 per share a year ago. Adjusted EBITDA was $33.2MM in Q3, down from $165.9MM a year ago, while YTD adjusted EBITDA of $165.9MM is down from $444.4MM a year ago. Adjusted net income YTD of $68.7MM is down from $195.5MM a year ago. KW’s share of recurring property NOI, loan income and fees totaled $131MM in Q3, up from $130MM at the same time last year. Fee-bearing capital grew to a record $8.2B and estimated NOI totaled $485MM as of quarter end.

KW ended Q3 with $331MM in cash and cash equivalents and $146MM drawn on its $500MM revolving credit facility. KW’s share of debt had a weighted average effective interest rate of 4.3% per annum and a weighted average maturity of 5.4 years. Approximately 100% of the company’s debt is either fixed or hedged with interest rate hedges. In October, KW sold a wholly owned office property located in the UK for a sale price of $46MM, resulting in a gain on sale of roughly $13MM.

The primary risks for KW are a prolonged recession and higher rate for longer combination scenario. This could pressure occupancy levels, driving down property values. As the company’s debt matures, it will need to refinance or sell assets to pay it off, so the situation would be further exasperated over time. With that said, I think a recession will lead to lower rates allowing opportunity for refinancing, and that KW’s assets will hold up quite well given their quality of lease structures.

To value KW we will take a look at the individual components. Multifamily generates $260.2MM of estimated annual NOI for KW, which we will value at a 6% cap rate, for a total valuation of $4.337B. Office generates $140.4MM in annual NOI, which we will value at a 8% cap rate for a valuation of $1.755B. Industrial annual NOI is $14.3MM, which we will give a 5% cap rate, for a total valuation of $286MM. Retail NOI is $24.3MM, which we will give a 6.5% cap rate, for a total valuation of $373.84MM. Hotels NOI is $20.6MM, which we will give a 5% cap rate, for a total valuation of $412MM. KW is generating $25.6MM in annual NOI on its loan investments that are valued at $255.9MM. The lease-up and development portfolio has a gross asset value of $1.753.7B, which we will value at 1.25x for a total value of $2.192B. The asset management division has generated $122MM in TTM fees, which we will put a 7 multiple on totaling $854MMof value. These assets combined total $10.47B, offset by $7.3784B of net debt, for a total NAV of $3.092B/177MM shares outstanding equals $17.46 per share of NAV. At a recent price of $11.54, KW trades at just 66% of my estimate of NAV. The stock pays a dividend of $.96 per share, offering a current yield of 8.31%. KW is not a REIT; therefore, it does not have to pay a dividend and I want to be clear in warning that there is the possibility of a dividend cut to reduce debt and invest. Capex is going to be dropping so it isn’t a guarantee they will cut, but one can find bonds in KW offering double-digit yields, which we’ve been buying along with the common stock. My biggest criticism of KW is that the company pays themselves like they are investment bankers, and the stock has simply not delivered for investors, or justified that cost in any way. I’m very glad management says they are focused on costs because investors like me have been frustrated and something needs to change on that front. With all that said, I’m optimistic about the opportunity in both the equity and the debt of KW as a long-term investor.

For further details see: