A Closer Look at the Green REIT IPO

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Red or Green REIT?!

Green REIT (GRN:ID) is Ireland’s first real estate investment trust. And the first ISE main market listing in over 5 years (a shock for the somnolent exchange staff, I’m sure). In fact, the IPO was so unprecedented, even the Minister for Finance turned up – here’s his speech! Not to mention the press, who fell on the story like a pack of dogs. But really, what do you expect? If there’s one thing that unites people, it’s a fervent desire for property to increase in value. Which is particularly true of Ireland, especially now – we blew the bubble we had, and Lord we so desperately want it back…


Yes, bored real estate agents want to treat buyers like scum & regain the respect they deserve. Mortgage holders just want to return to break-even, so they can finally relax & enjoy those gigantic monthly mortgage payments for the next 20 years. Old tyme reporters are sick of being forced to write real (i.e. non-property & interior design) stories, while their ad departments are tired of calling ’round begging for business. The banks dread visiting their own bank manager (NAMA & the Dept. of Finance) – while acting the gombeen with recalcitrant borrowers is somewhat problematic when they were reduced to beggary themselves not so long ago. As for the politicians, they just want to close their eyes & wake up when everything’s alright again…and then take all the credit! Finally, we have the poor old taxpayer…he just dreams of getting back to the good old days.


Because property solves all problems – doesn’t it?!

But I have to confess, I’m more than a little fascinated by the Green REIT IPO. Is it me, or did we just hit an inflection point? Could this be a new zeitgeist we’re witnessing? Well, if the collective national psyche could will it, Ireland’s certainly right about bloody due now… Oh boy, that’s a huge subject to tackle – for the moment, why don’t we take a closer look at:


Company: Green REIT
Ticker: GRN:ID (or GRN:LN)
Mkt Cap: EUR 381.3 mio
Price: EUR 1.23

As I mentioned, Green REIT’s the first ever Irish REIT. Unlike most REITs, it’s not a conversion of an existing property company. It’s actually a cash blind pool, and it will be externally managed. This is pure circumstance – existing Irish property companies have mostly remained private, and/or they’ve been wiped out in the past few years. Obviously, the management team will be of prime importance for investors here. Let’s walk through the basics:


IPO Details: 300 mio shares issued at EUR 1.00 per share in July, well in excess of the EUR 200 m placing target. Management has subscribed for an additional 10 mio shares. IPO expenses should total about EUR 10.8 m.

Investment Focus: Green REIT will concentrate on Dublin-based commercial property. Up to 15% of the portfolio may be invested in development projects, and vacant property purchases are also possible – I suspect joint venture (JV) investments are more likely at this point. The company will focus on both income & capital growth – to be delivered via opportunistic investment, active property management & the prudent use of debt. Management’s indicated an expected pre-tax return of 10-15% pa for shareholders.

Leverage: The company’s loan-to-value ratio will be limited to 35% for the moment – implying a potential EUR 460 m balance sheet total. Once all concerned get comfortable with that ratio, I’d expect it will be quickly raised to the max. REIT limit of 50%. [This REIT leverage limit & the requirement to dividend the majority of income should ensure Green REIT remains a fairly conventional & conservative vehicle]. Eventually, when property lust’s rampant again – as it surely will – investors should ponder if JVs (or other investment structures) might enable/permit a higher degree of effective leverage.

Fees: Base management fee set at 1% of EPRA NAV per annum (0.5% ’til 50% of NAV is invested), plus a performance fee which is 20% of the excess shareholder return over a 10% annual return hurdle (with a high watermark provision). Including some additional listed plc expense, an approx. 1.07% total (base) expense ratio’s implied. This may actually prove a far better deal than internal management, where there’s no particular limit on expense.


[Two fee issues to monitor: i) Capitalizing (& amortizing) IPO expenses as a balance sheet 'asset' is a nice gimmick for investment managers to collect additional fees - however, it's far less prevalent these days & actually may not even be permissible any longer, and ii) if the company invests in JVs which are also managed by the investment manager (or a related party), shareholders should ensure two layers of fees aren't imposed].

Shareholders: From day one, the IPO was embraced by international institutions. Pimco (via LVS II) acted as a cornerstone investor, taking a 9.99% stake & agreeing (potential) co-investment rights with the company. Other large/well-known investors include Paulson & Co (12.9%), Blackrock (9.6%) & Ameriprise Financial (8.1%, via Threadneedle Investments). Investec Asset Management took a surprisingly large 12.9% stake, but they were co-lead manager & presumably they also wanted a substantial allocation for their private clients. Other institutions accounted for a further 10% in aggregate.
Since the IPO, we’ve also seen Franklin Templeton aggressively build its stake from 3.6% to 9.3% – no doubt inspired by the success of Michael Hasenstab’s ‘Erin go bond’ strategy. And Marketfield Asset Management just popped up out of nowhere, declaring a 9.7% stake. Finally, management has a 3.2% stake (via GP Holdings). [Investors who'd prefer to see a larger stake should realize management already has significant Irish (& UK) exposure, in terms of assets owned and/or managed].

Management: Green REIT will be managed by Green Property REIT Ventures - a sub. of Green Property Ventures, an asset management business set up by Green Property in 2008. Management includes key members of the original (listed) Green Property management team – most specifically, Stephen Vernon – and ex-Gunne Commercial (now CBRE) staff, inc. Pat Gunne.


I’d tend to discount Gunne – if I recall, Gunne Commercial was cheer-leading the Irish market & valuations right ’til the bitter end. But Vernon’s definitely a man to jump into bed with… His property development, investment & management skills propelled Green Property from a tiny EUR 24 m listed company to a EUR 1 billion property behemoth by 2002. At that point, he led a successful LBO of the company. From his appointment as MD in 1993, up to & including the buy-out in 2002, a total shareholder return of almost 750% was generated. Granted, the buyout probably demanded a de-leveraging strategy anyway – but I think it’s fair to credit Vernon as one of the few Irishmen who saw disaster coming & neatly side-stepped it by aggressively selling down most of Green Property’s UK & Irish portfolio. Since 2008, he’s focused more on (distressed) asset management, with Green Property Ventures amassing EUR 1.4 billion of property assets under management.

In my opinion, this offers a v reassuring pedigree for investors.

Net Asset Value (NAV): After expenses, NAV should be around EUR 299.2 m – or EUR 0.965 per share.


Ouch, everything was looking hunky-dory…’til that last little factoid! So, the company’s now trading at a bloody 27.5% premium to NAV, and the burning question must be: Does Green REIT still present opportunities? I phrase the question deliberately – because when you consider buying a stock, there’s actually two opportunities you need to analyze. First, you have the business opportunity – what type of business is the company involved in, and what are the potential risks & rewards of that exposure? And second, you have the investing opportunity – what’s your estimated intrinsic value for the company, and where’s that stand in relation to the market price?


Obviously, if you consider both opportunities equally attractive, you may have an outstanding low-risk/high-reward investment on your hands. Unfortunately, one opportunity’s usually far more attractive than the other… And all too often, you’ll have to evaluate conflicting merits: a) a great business opportunity, but a poor investing opportunity – the curse of the growth investor, or b) a great investing opportunity, but a poor business opportunity – the downfall of the value investor. This is the exactly the situation an investor now faces with Green REIT…


Let’s examine the business opportunity first. C’mon, you really don’t need me to lay out the bull case – the Green REIT team, plus a growing number of brokers & investors, will be happy to do that for you! But here’s a small reminder: Irish commercial property has now collapsed 65%+ from its peak!? Seeing that, you either envisage huge potential upside (and an Irish economy that’s painfully, but successfully, adjusting), and perhaps you’re already investing in/considering Green REIT – or you’re horrified by such a disaster (and Ireland’s economy & Debt/GDP ratio), and wouldn’t touch Green REIT even if it was the last damn stock on earth… I prefer to focus on the risks myself – the upside usually takes care of itself:


- We’ve only finally seen a tentative stabilisation/rise in values this year. Logic would (hopefully) argue the decline’s over, but it’s far too early to arrive at any kind of definitive conclusion. Could another leg down be lying in wait?


- A recent rise in rents might be similarly deceptive, and may simply reflect increased tenant demand due to a marked aversion to buy & occupy property. Rent increases could end up being offset by a reversal in yields.


- The Dublin office vacancy rate only recently dropped below 20% – that’s a lot of supply still on tap. Vacant purchase, refurbishment and/or development don’t look like the most promising strategies at this point.


- A 65%+ decline doesn’t automatically imply Irish property’s now cheap – it may simply be an unwinding of ridiculous boom-time valuations. Prime yields are now ’round 6.5% in Dublin…which doesn’t scream value to me on an absolute basis, or a relative basis vs. the risks & rewards elsewhere in Europe.


- Remember, NAMA took on a colossal EUR 74 bio+ of loans! This is a purely nominal value, of course – market value of those loans (and/or collateral) was clearly far lower, but that’s still a hell of a property overhang…


- The Irish banks continue to record write-downs – who knows when (or if) they’ll end up with any surplus equity. Meanwhile, you’ll see precious little new lending from them, while international banks will be slow to take up the slack. At this point, the risk appetite of banks (or even borrowers) is still debatable anyway. And property prices can’t rally without credit expansion – even if opportunistic equity investors are available, they need leveraged buyers to produce decent exits. We may see flat prices for (some) years to come…


- Oh, and have I mentioned the Irish economy, austerity & the Debt/GDP ratio? Fortunately, Ireland may be the sole economy in Europe that’s capable of producing a competitive devaluation (via labour & other input prices). Which provides a road-map out of the current mess – but it doesn’t necessarily promise a speedy recovery in property prices.


Now, you need to weigh/discount these potential risks accordingly, and also evaluate them vs. the potential rewards. Despite the laundry list above, regular readers know I’ve actually been consistently bullish on Ireland – note the substantial over-weighting of the Irish equity market in my portfolio. So let’s presume, for the sake of argument, a similar bullishness re Irish property.


Now we must also consider the investing opportunity…and there’s no escaping this damn 27% NAV premium! I can pretty much guarantee it will evaporate in due course – and more property IPOs will simply accelerate the process. That’s not to say you can’t ultimately profit from a rising NAV. But if you’re dying to access this business opportunity right now, and the premium gets wiped out, are you ready to sacrifice perhaps two years (or more) of your returns?! The usual solution to this dilemma is to look elsewhere – i.e. can you find a better investing opportunity that offers (roughly) the same exposure?

Er well, unfortunately not..!


Aha, this may well explain Green REIT’s NAV premium! [Plus the aggressive post-IPO buying by institutions & frustrated PIs]. To illustrate, let’s explore all possible opportunities:

WK Nowlan & Willett Companies are tipped to launch a EUR 300 m REIT IPO in October – again, a blind pool. This could be a v interesting alternative/switch from Green REIT, but you first need to ask: Will the IPO go ahead, what’s the track record of the promoters, and what are your actual chances of being allocated stock in the IPO?


On the listed front, your choices are (more) problematic. Donegal Investment Group (DCP:ID) is arguably a cheap Irish property play, but I’d ultimately tag it as an exceptional agri-business opportunity. Abbey plc (ABBY:ID) is now essentially a UK company, with less than 10% of its net assets in Ireland – however, the company has EUR 75 m of cash/investments & zero debt, so Irish (residential) exposure could be scaled up easily. Kennedy-Wilson Holdings (KW:US) isn’t much better – it offers a 15% exposure to Ireland, and is priced at a spectacular 2.1 times book! [So, rumours of a spin-out/IPO of its Irish property interests sound like fantasy - KW can't hope to achieve the same premium as it already commands]. And that’s about it, folks..!


But while I’m at it, I may as well throw out some (real) dark horses: Readers know I regularly despair of TVC Holdings’ (TVCH:ID) investment inactivity. But I recently wondered if they might be tempted to jump into the property game instead, notwithstanding a lack of expertise. With TVC trading at a 20%+ discount to NAV, vs. the 27% premium Green REIT’s been awarded, they might be a lot more tempted now..?! Next – I’ve hailed John Gallagher as one of the few other people who called the top of the Irish market, and actually acted on it. He’s now Chairman of IFG Group (IFP:ID) – not an ideal property investment vehicle, but arguably in the investment game already (pensions & IFA business). Obviously an experienced team would be required to support any kind of substantial business, but fund seeding from their own IFA client base could give them a decent head start.


Our final dark horse is more like the living dead – but zombies are v popular these days – Balmoral International Land Holdings. Existing shareholder value has been decimated here, but if we actually see sustained positive investor sentiment, it’s not inconceivable Balmoral might try to raise new funds/re-list – stranger things have happened! Unfortunately, at this point, Irish assets have now declined to just 29% of its portfolio.


Surveying all of these, Green REIT’s attractions might seem even more obvious! But personally, I’d recommend some simple (though possibly more challenging) alternatives for you to consider vs. Green REIT:


- If you’re bullish on Irish property, in all likelihood this should also imply a bullish outlook for the Irish equity market (which should be much less dependent on credit expansion). So why not just buy equities instead?! See The Great Irish Share Valuation Project for this year, starting here & finishing here. Not a stock-picker? Just buy a diversified portfolio of Irish equities – I’ve written about this closed-end fund before, the New Ireland Fund (IRL:US). It trades on a 13.0% discount to NAV – so buying Green REIT instead is essentially a bet you’ll manage to beat a 40 percentage point+ spread in favour of IRL! Now that’s a bloody tough bet…


- Now, let’s progress this train of thought to its logical extreme. If you believe in an Irish property market recovery, surely you must also believe in the future well-being of the Irish banks? Of course, they’re far more leveraged than the average property company – but when investors turn bullish, that’s exactly what they’re looking for, isn’t it?! Of course, I’m obviously not suggesting Allied Irish Banks (ALBK:ID) – God forbid! You might consider Permanent TSB Group Holdings (IPM:ID), but Bank of Ireland (BKIR:ID) is the safer & more obvious choice.


- To a fair degree, property is property, no matter where it is – so why Ireland at all? There’s plenty more listed property companies which offer attractive exposure elsewhere in Europe & the UK. Most offer (fairly) comparable yields (vs. Dublin), similar risks & rewards in terms of income & capital growth, and a low/reasonable amount of leverage – but they’re still sporting substantial NAV discounts. Putting some time & energy into exploring the UK/European property sector could really pay off! You’re sure to find business opportunities that are (on average) comparable to that offered by the Irish property market, and many are still investing opportunities that are priced at a 50 percentage point+ discount vs. Green REIT. To me, that looks like a damn compelling relative value bet to make…


OK, Green REIT’s pockets are full of cash, it’s got zero debt, and it currently enjoys unique status as an Irish property pure play. However, while there’s really no other acceptable listed substitute available right now, there’s still plenty of other attractive alternatives to choose from. Therefore, despite its strong attributes, the best multiple I’d award the company is a 1.0 Price/Book Fair Value. This implies a EUR 0.965 price target, and Downside Potential of (22)% for Green REIT.

• Green REIT (GRN:ID): EUR 1.23
• Market Cap: EUR 381.3 mio
  
• Price/Book: 1.27
  

• Tgt Price/Book: 1.00
• Tgt Mkt Cap: EUR 299.2 mio
• Tgt Fair Value: EUR 0.965
• Downside Potential: (22)%