Summary
- Kennedy-Wilson shares have sold off 20% in the past year as investors have fled real estate-related equities as interest rates have increased and the economy has slowed.
- Relative to REITs, Kennedy-Wilson has greater flexibility to invest across asset classes and geographies.
- With 70% loan to value, Kennedy-Wilson has much higher financial leverage than REITs.
- While I see a nearly 30% upside in Kennedy-Wilson shares, I see the risk-reward of investing in Kennedy-Wilson as being inferior to investing in REITs.
Shares of real estate investment firm Kennedy-Wilson ( KW ) have declined 20% over the past year, producing a total return roughly in-line with the broader REIT index/ETF ( VNQ ).
While I appreciate the potential benefits of KW's more flexible mandate (discussed below), given the mixed nature of its assets and higher financial leverage, I see the risk-reward of investing in Kennedy-Wilson as being inferior to investing in REITs.
Key Differences between Kennedy-Wilson and REITs
As a non-REIT real estate investment firm, KW has a more flexible investment mandate. The company does not face the same constraints as REITs - it invests across real estate asset classes (multifamily, office, retail, hotels, industrial). While REITs typically have a very conservative leverage profile, KW uses debt more aggressively, with leverage ratios more consistent with a private market real estate capital structure. KW also invests across geographies, with holdings on the US West Coast and Mountain West as well as in Dublin and London. Lastly, KW has an asset management business similar to Blackstone ( BX ) which earns fees for managing real estate on behalf of third-party investors.
Kennedy-Wilson Overview (Investor Presentation)
Why I'm staying on the sidelines
Higher leverage - I estimate a total market value of ~$10 billion for KW's gross assets (taking into account JVs on a proportional basis). The company carries net debt (again on a proportional basis) of just over $7.2 billion which works out to an LTV (loan-to-value) of roughly ~70%. This is significantly higher than most apartment and office REITs which have LTVs ranging from 20% to 50%. With a higher risk due to elevated leverage, I would expect to have a higher upside but as I discuss below (in Valuation), this is not the case.
Office Exposure - As shown below in the valuation section, inclusive of its development/lease-up assets, 20-25% of Kennedy-Wilson's gross asset value is comprised of office assets - primarily in London and Ireland. KW's office exposure increased meaningfully in 2017 when it issued shares to acquire KW Europe following Brexit. While the company saw this as an opportune time to buy assets at a discount, the onset of the pandemic in 2020 has led to unforeseen challenges for office real estate due to work from home (further compounded by a European recession). Similarly, KW office developments have been slow to lease (again driven by work from home) and it appears that these investments will ultimately be worth less than KW's investment.
Valuation
As shown below, I see KW shares as offering nearly 30% upside using a SOTP (sum of the parts) valuation. I use the company's current NOI for operating assets and value this income with cap rates consistent with what I've used to value REITs here on SA (based on expected 'normal' private market cap rates). While I see KW as being undervalued on an absolute basis, many of the REITs I've written about over the past few months here on SA offer similar quality assets with even greater upside potential and significantly less financial leverage. Moreover, REITs allow investors to pick and choose which asset groups/geographies they wish to own.
Operating | NOI | Cap | Value | |
Resi | 266 | 4.5% | 5,920 | |
Office | 130 | 7% | 1,857 | |
Industrial | 12 | 4.5% | 258 | |
Retail | 34 | 6.7% | 510 | |
Hotel | 12 | 8% | 149 | |
Total | 454 | 8,694 | A = Total Operating Asset Value | |
Development | Cost | Adj | Value | |
Lease Up | 456 | 0.8 | 365 | mainly office |
Development | 834 | 0.9 | 750 | mainly res |
Other | 242 | 0.8 | 194 | Raw acreage in HA & SoCal |
Total | 1309 | B= Total Development Asset Value | ||
Other Assets | EBITDA for AM | Mult | Value | |
Loan Portfolio | 147 | |||
Cash | 522 | |||
Asset Mgmt | 44 | 13 | 572 | |
Value of Other Assets | 1241 | C = Total Other Asset Value | ||
Less Debt | ||||
Secured | 5,220 | |||
Unsecured | 2,539 | |||
Total Debt | 7,759 | D | ||
Value to Equity | 3,485 | E=A+B+C-D | ||
Shares o/s | 163 | F | ||
Value /share | 21 | G=E/F | ||
Current Price | 16.6 | H | ||
Upside | 28.8% | I=G/H |
Non Pure-plays tend to trade at a discount - While one might expect that KW's flexible mandate (not constrained by asset class or geography) would allow it to earn excess returns by opportunistically pursuing the assets with the highest expected returns, KW has actually underperformed the broader REIT market as shown below (underperformed slightly on a total return basis):
10 year share price performance KW vs. VNQ (Fidelity )
Most REITs tend to focus on a specific asset type and/or region. For instance, the Essex Property Trust ( ESS ) is comprised of only West coast apartment assets. By contrast, KW owns not only multiple property types (apartments, office, retail, etc.) but also invests internationally (KW has significant exposure to London & Dublin). While most apartment REITs have traded at (or even above) NAV at times over the past decade, KW has traded with a more persistent discount. Sum-of-the-parts stories tend to be discounted by the public market as few investors want to own all of asset types/geographies within KW (for instance an investor may want exposure to the Mountain West apartments but be uninterested in London offices). Investors generally prefer pure-play REITs which allow investors to gain exposure to a specific region/property-type. Further, there is a greater degree of difficulty in valuing KW as analysts must estimate NOI and cap rates for a wider collection of assets.
Conclusion
Despite higher risk (leverage) and more complexity (asset classes, geography), the upside in Kennedy-Wilson shares is less than the upside offered by investing in REITs. As such, I see KW as an inferior investment for those seeking to take advantage of the dislocation in the real estate market. Instead, I'd encourage investors to check out my recent articles on the REITs, for instance Equity Residential ( EQR ) or Camden ( CPT ) for what I believe to be a superior risk return opportunity.
For further details see:
Kennedy-Wilson: Why I'm Not Buying This 5.8% Yielder