2023-12-02 05:44:51 ET
Summary
- RMR Group offers exposure to the real estate market without the downsides, generating steady income from managing other REITs.
- The company has steadily grown its assets under management and related fees, allowing for great downside protection and income accumulation.
- RMR is pursuing a transformative acquisition of Carroll Multifamily, we believe it is undervalued by around 30% to a fair price per share of $30.
We believe that the RMR Group offers an interesting opportunity to gain exposure to the real estate market without many of the downsides associated with it. Indeed, the company has no RE properties in its own balance sheet, but extracts revenues from managing other REITs. Despite significant headwinds in the market, with rising interest expenses and contracting valuations, RMR’s income is still flowing steadily with limited volatility. For this reason, we believe the stock is undervalued by some 30% and should trade closer to its fair price of $30.
Business Overview - The managed REITs
The RMR Group manages various publicly traded REITs. They take various fees for this activity, both management fees and performance fees. While the former are somehow fixed and vary little over time, the performance-based compensation is based on a mix of variables, but mostly attached to stock price performance.
Historical AUM (RMR Website)
Over time, the company steadily grew AUM, mostly through M&A and the setup of more publicly traded REITs that they later managed. Today they have some $36 billion allocated, and they have a diversified footprint across various sectors and states.
Sector AUM (RMR Website)
This allows them to benefit from valuation gains that are concentrated in certain sectors, or limit losses from contraction in others, such as CRE and in particular offices during 2023.
Let’s have a look at the most important managed REITs by AUM and exposure:
Name | Sector | AUM |
Service Properties Trust | Hotels and Retail | $11.3 billion |
Diversified Healthcare Trust | Healthcare | $7.6 billion |
Office Properties Trust | Office | $6.0 billion |
Industrial Properties Trust | Industrial and Logistic | $2.7 billion |
All these are also publicly traded as standalone companies, and some experienced some severe underperformance. But the share of RMR profits is still steadily benefiting RMR shareholders, one could argue at the expense of the REITs’ stakeholders.
Revenues and Net Income (Seeking Alpha)
With the exception of a few great years between 2018 and 2019, revenues and net income (after minority interests), remained relatively stable over time. Net income even appreciated as a result of margin improvements and cost-cutting, as synergies kicked in as AUM grew.
Fees by managed REIT (10-K)
Useful to know is also the distribution of fees across the managed REITs and how these commissions are structured. For 2023, as performance has been depressed in the entire RE sector, RMR only collected base fees and construction fees. Base business management fees are the most relevant ones, and they tend to vary very little YoY. Between 2023 and 2022 they only declined 10%.
Resilience: the case of ILPT
To better understand the resilience of the RMR Group revenue model, we analyze the case of ILPT. We previously wrote about this business, and we analyzed how shareholders are being exposed to dangerous, company-threatening, debt maturities. The company, under the management of RMR, closed a very large acquisition in 2022 that was almost entirely financed with debt. As interest rates increased rapidly, the floating debt interest expense followed, causing significant distress and dividend cuts.
ILPT Performance (Seeking Alpha)
The shareholders of ILPT suffered major losses and underperformance after this transaction closed, and are still at risk with some interest swap maturities approaching. But the detail that impressed us the most, was the actual trend of fees paid to RMR by ILPT during this period.
RMR - Fees from ILPT (10-Ks)
Despite a little contraction in 2021, when the large acquisition was not closed yet, the commissions received from the management of this underperforming asset continued to increase over the years. Most of the increase was driven by the increase in the number of properties managed following the closing of the acquisition. Indeed, RMR put fees based on the size of the balance sheet, and not on its performance in terms of income. This strengthens our thesis about the resiliency of the RMR business model even in periods of severe stress driven by macroeconomic conditions. We noticed that while not as serious as ILPT, also the other REITs experienced some turbulence over the last 2 years, but the fees were not significantly reduced.
A new opportunity: Carroll acquisition
It is recent news, but RMR is also pursuing a significant, transformative new acquisition . They decided to acquire the Carroll Multifamily platform, for a total cash consideration of $80 million plus another $20 million post-closing contingent on future performance. We find this transaction very interesting for three main reasons: (1) it is happening during a period of depressed multiples and valuations, (2) it provides further diversification by adding multifamily properties to RMR assets, and (3) Carroll has important exposure in fast-growing markets like Florida.
Carroll AUM (Presentation)
This slide is a good summary of pre- and post-transaction AUM. For only $80 million, RMR will put its hands on $7 billion of additional fee-generating AUM. On top of this, the transaction would also diversify their sector-wise exposure. The company would diversify its concentration in office and entertainment RE, which are notoriously cyclical, in favor of more multifamily assets.
The multiples of the transaction are around 6.2x to 7.3x of CARROLL’s recurring 2024 EBITDA adjusted for synergies, which is fairly conservative considering also the third point: exposure to fast-growing markets.
Carroll Exposure (Presentation)
More than 60% of Carroll’s 2023 NOI was from markets where population growth was above the national average. We are particularly pleased with the total Florida exposure, which is above 35% of the total portfolio. We believe that a confident flow of financial jobs moving away from the high-taxes NYC area to Florida’s Miami will increasingly benefit portfolios like Carroll’s.
Risks
While very resilient, of course, RMR is still exposed to some significant risks. First of all, if the REITs they are managing go bankrupt, the company will be left with zero recoverable fees. While unlikely, it cannot be ruled out for certain situations like ILPT’s current maturities. We believe that continued stress on valuations and high rates could eventually lead to some severe restructurings or bankruptcies even in the RMR portfolio. However, investors should appreciate that while the majority of REIT investors suffer major losses even during a mild downturn, RMR shareholders are much more protected.
To wrap up: a fair value for RMR
To conclude, we aim to find a proper, fair price for the RMR Group. We will consider two main variables: (1) relative valuation, and (2) dividend yield. As it is true that the company may appear very cheap relative to its sector valuations, we also need to bear in mind that with interest rates this high, investors wouldn’t accept dividend yields below 5%.
Valuation (Seeking Alpha)
The other valuation metric we will use is the EV/Net income. Indeed, the company has plenty of excess cash we want to take into account in the valuation - hence using EV instead of the market cap. Then we use net income because there are significant minority interests associated with the public company, and they reduce proportionately any profits after taxes. We find that the current EV/Net income multiple based on 2023 results is around 10.8x. If compared with the sector’s median of 26.5x, we believe there is a good margin of safety. A multiple around 13x would be considered reasonable also in light of the dividend yield. This implies a fair price per share of $30 with an upside potential of around 30%.
Conclusion
The RMR is a manager of publicly traded REITs that has experienced steady income and revenues despite the depressed performance of the RE market. Their business model allows for much more stability even in periods of high uncertainty thanks to the structure of the fees they collect from the managed companies. We believe the stock of RMR is undervalued by around 30% and a fair price should be around $30 per share.
For further details see:
The RMR Group: Steady Income Despite Headwinds In The RE Market