Thorough and well researched write up! I'm still a little more conservative than your numbers on valuing their office assets but credit where it's due - you were basically spot on the pricing for the Mechanicsburg, PA sale in Q2 out of the "Other" bucket and my valuation estimate was ~40% lower than the price achieved! I hope you're right and I'm wrong - certainly was the case for $NLOP, which you knocked out of the park.
Connecting the dots indicates to me that the Level3 property in the "Other" segment has a short <1 year lease so I'd value that a lot lighter and on a price PSF basis than on a cap rate but doesn't move the needle on overall asset value.
Also of note is in an early presentation, management released fairly detailed tear sheets on each property including the area in acres and Floor Area Ratio (FAR) of each site they own. Due to the suburban nature of the office portfolio, site coverage and FARs tend to be low but locations tend to be pretty good. This supports the ability of alternative use value - as multifamily, mixed use, industrial - to limit downside for those offices that are hard to lease and / or obsolete (despite being broadly new and good quality, there are some real clangers in the portfolio as well).
The office market is far from out of the woods and real question marks remain around demand. However, the supply side of the equation is starting to heal as JLL Q2 research shows ground-breakings of new office projects are drying up and inventory removals continue to accelerate.
Great input, thanks! That's what I like about this situation: you can use figures more conservative than mine and still get a a value well above the trading price. I would not be as enthusiastic at $18-20 but down here, I think it's a steal.
What do you think about the new deal / new assets? It’s a low cap rate but it seems like a niche property type that doesn’t seem to be available at scale anywhere else in the public markets. I just can’t help but think they overpaid….
The price is full, but they're definitely paying for platform value here. Much easier to go from 50-100 properties in this niche than from 0-50 cobbling a portfolio together 1-5 properties at a time.
Peakstone has 3 problems.
1. Small size. Nobody cares because it's a $500mm market cap REIT.
2. High exposure to office.
3. High cost of capital, mostly because of 1 and 2. Issuing equity is not accretive.
This transaction, while technically sub-optimal compared to repurchases, helps directly to address the first two issues and indirectly with the third. I think investors cranky about the choice to acquire at mid-5 caps rather than buy back shares are missing the fact that the market has no appetite for Peakstone running higher leverage on its existing asset base. At 9/30 they were at 6x net debt to EBITDA. Let's say they bought back $100 million in shares at $13. Shares outstanding goes from 39.6mm to 31.9mm. NAV goes from maybe $32 (excluding capitalized overhead costs) to $36.60. Cool! But now net debt to EBITDA is a half turn higher and the market sees the leases getting shorter and leverage creeping higher. I just don't think shares would move that much.
Yeah, curious to see what the market thinks in the morning. My view (and maybe not an uncommon one) is that I can give it time and/or average down a bit as long as the dividend is safe. These are super low capex properties (on net leases, regardless) and I do think there’s an opportunity to re-rate the leases to market over time, although maybe not as much as management pitched. They’re not making any more of these assets, I just wonder about the cap rate being too tight but if they make the assets work for them and maintain the dividend the criteria that you describe this meeting makes total sense to me.
Thorough, i had independently reached very similar conclusion with asset-by-asset review. I am concerned these guys will consider themselves heroes if they start buying industrial at 6.5% caps rather than just starting with share buybacks. The market is valuing their office at around a 32% cap rate (assuming 5.8% for industrial) - less than HALF of just the contractual office NOI remaining. Anything other than buybacks is hugely dilutive. With a bomb-proof capital structure, $400MM of liquidity vs $520MM market cap, and a mere 35% dividend payout ratio, they're squandering a huge opportunity. Sure they could just wait until stock drifts back up, but if they were aggressive with buybacks, they could drive price back toward NAV quickly then acquire RE with OPs, issue stock, etc. They're being capital markets babies, and it's staring to seem like the direct listing has hurt them in terms of getting Wall Street coverage (and institutional shareholders) as well as strategic advice.
if reallocating at 30% caps to credit tenants doesn't work, the world has bigger issues. i don't agree on the market comment since market is currently rewarding low-quality office REITs with 7-8% implied cap rates. publics may have rallied right through private mkt cap rates, but REIT market overall has decent bid for office, whether warranted or not. totally agree on scale, however there's no fiscally responsible way to grow a REIT if equity is at 1/3 of NAV. to add $60MM of industrial NOI to get to 50/50 (absent big office sales), they'd have to buy +/- $1 billion of industrial - i don't see it happening. if they got the share price up through buybacks, at least then growth in scale would be a possibility rather than a pipe dream that doesn't pencil.
Can you throw out a few examples of office REITs trading at single digit cap rates? The ones I'm looking at trade between 12 and 15 caps. I'm looking at decidedly small and B grade comps, though. I haven't even looked at where Vornado and the like are trading.
I agree there's no way they buy $1 billion in industrial, but I think there is a good chance they sell office properties producing $40mm in NOI in coming years and recycle that into industrial. Selling $400mm in office and recycling into industrial is a lot more doable over time.
NLOP, ONL, etc. are of lower quality than PKST if that's where you're getting your 15% from The sector average for larger cap REITs is about 7.5% but I'm just using analyst reports, I don't really spend any time on those. In the stepchild category, HPP 9.4%, PDM 8.0%, PGRE 8.8%, HIW 8.0%, CIO 9.5% and even pre-BK OPI is just barely
10% (all very rough #s btw). However, all of these office REITs have mostly multi-tenant buildings and are therefore far more capex intensive than PKST and to my mind riskier. I know some are CBD, some have old-school trophy towers, etc etc, but there are no perfect comps.
net lease office REITs just aren't a category anymore. NLOP is not a horrible proxy, but it's 2-2.5x more expensive than PKST as a percentage of my NAV estimate. it demonstrates that liquidation is obviously a more efficient path to re-rating. i would give mgmt 10% of liq proceeds over $13/shr and let them make $100MM because as Gekko said, it's wreckable.
Incentives, incentives. Yes, it would be wonderful if management would buy back a ton of shares rather than make acquisitions. But the market won't reward them for that in the short term. While buybacks would be extremely accretive to net asset value per share, it would have a few negatives:
1. It would represent incremental allocation of capital toward offices. While I think this would work out reasonably well, the market does not. The market will not reward any company that plows funds into office assets now, even if it's a good move for the longer term.
2. Peakstone is too small to get a reasonable valuation. Buybacks would make it even smaller. In order to get a better cost of capital and some sell side coverage, Peakstone needs to be in growth mode.
So yes, the long-term optimal approach would be for Peakstone to return a ton of capital and buy back cheap shares. Failing that, I think the strategy of opportunistically selling stabilized offices, divesting from the "other" segment at any reasonable price, and directing investment toward industrial properties at market cap rates will result in a good outcome in time. Once industrial NOI exceeds office NOI, hopefully within 2 years, watch the stock re-rate quickly.
Any concern that the company will tap the $200 mil ATM program it disclosed in Aug'23? It would seem unnecessary given the balance sheet and cash flow but it is there.
Minimal. Having an ATM filed is standard for REITs. On the off chance that shares rocket to something approaching NAV and an equity raise would not be dilutive, they don't want to waste weeks getting offering docs ready and filed and potentially miss the window.
Management knows they need to build credibility with investors, and that selling shares at a 13% cap rate to buy assets at 6-7% cap rates would absolutely blow those efforts to pieces.
Quick update here after Q3 results, which were respectable. The company got a nice 10-year extension on an industrial asset, found a new tenant for a small office in Las Vegas, and sold 4 properties for a total of $40 million, $7 million more than where I had valued these properties.
A stabilized office property with a 5-year lease sold for a 6.7% cap rate, while a vacant office building sold for just $35/square foot. Goes to show the difference between a good building with a quality tenant and a commodity-grade, unadvantaged vacant building.
The composition of building-level NOI, excluding the non-core "other" category, remains 31% industrial and 69% office. On the call the company noted it had reached its leverage target of <6.0x net debt to net rents, and is closer to "going on offense" and targeting acquisitions in industrial.
Corporate overhead remains too high, but is trending in the right direction.
On the whole, I like the deal. I have commented more elsewhere on this thread, but I continue to look at this deal as a great step toward creating a better "story" for Peakstone. Fundamentals-based investors too often discount the value of a narrative, and markets love a narrative. "Deeply-discounted office REIT with a good industrial portfolio" is not a narrative the market appreciates. "The only way to access the attractive IOS asset class in public markets" IS a narrative that can work, assuming Peakstone can successfully transition the portfolio in coming quarters.
No concern for the CEO earning 7-8 million a year in total comp? How activist friendly is the governance structure? because anything besides for buybacks at these levels would be super destructive
Oh it's absolutely a concern. PKST's overhead is excessive. The legacy of being a private REIT. I think as time goes on and ownership concentrates in actual economic buyers (not those who had it pushed on them by wirehouse brokers) there will be pressure to improve performance and shrink overhead to more appropriate levels.
With all your conversations with these REITs, how many of them are aware of the offerings of IWG and are considering this option as long term leases expire/roll off?
I think IWG and similar are options for large multi-tenant buildings in dense metro areas. Your 5+ story buildings in central business districts, etc. Less viable for buildings like those that Peakstone has, which are mainly designed for single tenant occupancy and are located in suburban office parks mostly accessible by car.
Dave, Thanks for the great write-up. Would you pass on your opinion regarding the dividend, it's reliability/payout coverage, and any role it may play in protecting the downside potential of the stock price?
I should have discussed the dividend, which is currently 22.5 cents/quarterly for a 6.6% annual yield. The dividend payout is less than one-third of adjusted funds from operations, which is highly sustainable. (In reality, some cash flow will be used to reduce the mortgage balances in the "other segment" and so isn't truly cash flow. But the dividend remains very well covered.) As for downside protection, I do hope the strong yield puts a floor under shares. On the other hand, the dividend hasn't stopped shares from suffering badly over the last 12 months.
Thorough and well researched write up! I'm still a little more conservative than your numbers on valuing their office assets but credit where it's due - you were basically spot on the pricing for the Mechanicsburg, PA sale in Q2 out of the "Other" bucket and my valuation estimate was ~40% lower than the price achieved! I hope you're right and I'm wrong - certainly was the case for $NLOP, which you knocked out of the park.
Connecting the dots indicates to me that the Level3 property in the "Other" segment has a short <1 year lease so I'd value that a lot lighter and on a price PSF basis than on a cap rate but doesn't move the needle on overall asset value.
Also of note is in an early presentation, management released fairly detailed tear sheets on each property including the area in acres and Floor Area Ratio (FAR) of each site they own. Due to the suburban nature of the office portfolio, site coverage and FARs tend to be low but locations tend to be pretty good. This supports the ability of alternative use value - as multifamily, mixed use, industrial - to limit downside for those offices that are hard to lease and / or obsolete (despite being broadly new and good quality, there are some real clangers in the portfolio as well).
The office market is far from out of the woods and real question marks remain around demand. However, the supply side of the equation is starting to heal as JLL Q2 research shows ground-breakings of new office projects are drying up and inventory removals continue to accelerate.
JLL Report: https://www.us.jll.com/content/dam/jll-com/documents/pdf/research/americas/us/jll-us-office-market-dynamics-q2-2024.pdf
Great input, thanks! That's what I like about this situation: you can use figures more conservative than mine and still get a a value well above the trading price. I would not be as enthusiastic at $18-20 but down here, I think it's a steal.
What do you think about the new deal / new assets? It’s a low cap rate but it seems like a niche property type that doesn’t seem to be available at scale anywhere else in the public markets. I just can’t help but think they overpaid….
The price is full, but they're definitely paying for platform value here. Much easier to go from 50-100 properties in this niche than from 0-50 cobbling a portfolio together 1-5 properties at a time.
Peakstone has 3 problems.
1. Small size. Nobody cares because it's a $500mm market cap REIT.
2. High exposure to office.
3. High cost of capital, mostly because of 1 and 2. Issuing equity is not accretive.
This transaction, while technically sub-optimal compared to repurchases, helps directly to address the first two issues and indirectly with the third. I think investors cranky about the choice to acquire at mid-5 caps rather than buy back shares are missing the fact that the market has no appetite for Peakstone running higher leverage on its existing asset base. At 9/30 they were at 6x net debt to EBITDA. Let's say they bought back $100 million in shares at $13. Shares outstanding goes from 39.6mm to 31.9mm. NAV goes from maybe $32 (excluding capitalized overhead costs) to $36.60. Cool! But now net debt to EBITDA is a half turn higher and the market sees the leases getting shorter and leverage creeping higher. I just don't think shares would move that much.
Yeah, curious to see what the market thinks in the morning. My view (and maybe not an uncommon one) is that I can give it time and/or average down a bit as long as the dividend is safe. These are super low capex properties (on net leases, regardless) and I do think there’s an opportunity to re-rate the leases to market over time, although maybe not as much as management pitched. They’re not making any more of these assets, I just wonder about the cap rate being too tight but if they make the assets work for them and maintain the dividend the criteria that you describe this meeting makes total sense to me.
Thorough, i had independently reached very similar conclusion with asset-by-asset review. I am concerned these guys will consider themselves heroes if they start buying industrial at 6.5% caps rather than just starting with share buybacks. The market is valuing their office at around a 32% cap rate (assuming 5.8% for industrial) - less than HALF of just the contractual office NOI remaining. Anything other than buybacks is hugely dilutive. With a bomb-proof capital structure, $400MM of liquidity vs $520MM market cap, and a mere 35% dividend payout ratio, they're squandering a huge opportunity. Sure they could just wait until stock drifts back up, but if they were aggressive with buybacks, they could drive price back toward NAV quickly then acquire RE with OPs, issue stock, etc. They're being capital markets babies, and it's staring to seem like the direct listing has hurt them in terms of getting Wall Street coverage (and institutional shareholders) as well as strategic advice.
if reallocating at 30% caps to credit tenants doesn't work, the world has bigger issues. i don't agree on the market comment since market is currently rewarding low-quality office REITs with 7-8% implied cap rates. publics may have rallied right through private mkt cap rates, but REIT market overall has decent bid for office, whether warranted or not. totally agree on scale, however there's no fiscally responsible way to grow a REIT if equity is at 1/3 of NAV. to add $60MM of industrial NOI to get to 50/50 (absent big office sales), they'd have to buy +/- $1 billion of industrial - i don't see it happening. if they got the share price up through buybacks, at least then growth in scale would be a possibility rather than a pipe dream that doesn't pencil.
Can you throw out a few examples of office REITs trading at single digit cap rates? The ones I'm looking at trade between 12 and 15 caps. I'm looking at decidedly small and B grade comps, though. I haven't even looked at where Vornado and the like are trading.
I agree there's no way they buy $1 billion in industrial, but I think there is a good chance they sell office properties producing $40mm in NOI in coming years and recycle that into industrial. Selling $400mm in office and recycling into industrial is a lot more doable over time.
NLOP, ONL, etc. are of lower quality than PKST if that's where you're getting your 15% from The sector average for larger cap REITs is about 7.5% but I'm just using analyst reports, I don't really spend any time on those. In the stepchild category, HPP 9.4%, PDM 8.0%, PGRE 8.8%, HIW 8.0%, CIO 9.5% and even pre-BK OPI is just barely
10% (all very rough #s btw). However, all of these office REITs have mostly multi-tenant buildings and are therefore far more capex intensive than PKST and to my mind riskier. I know some are CBD, some have old-school trophy towers, etc etc, but there are no perfect comps.
net lease office REITs just aren't a category anymore. NLOP is not a horrible proxy, but it's 2-2.5x more expensive than PKST as a percentage of my NAV estimate. it demonstrates that liquidation is obviously a more efficient path to re-rating. i would give mgmt 10% of liq proceeds over $13/shr and let them make $100MM because as Gekko said, it's wreckable.
Incentives, incentives. Yes, it would be wonderful if management would buy back a ton of shares rather than make acquisitions. But the market won't reward them for that in the short term. While buybacks would be extremely accretive to net asset value per share, it would have a few negatives:
1. It would represent incremental allocation of capital toward offices. While I think this would work out reasonably well, the market does not. The market will not reward any company that plows funds into office assets now, even if it's a good move for the longer term.
2. Peakstone is too small to get a reasonable valuation. Buybacks would make it even smaller. In order to get a better cost of capital and some sell side coverage, Peakstone needs to be in growth mode.
So yes, the long-term optimal approach would be for Peakstone to return a ton of capital and buy back cheap shares. Failing that, I think the strategy of opportunistically selling stabilized offices, divesting from the "other" segment at any reasonable price, and directing investment toward industrial properties at market cap rates will result in a good outcome in time. Once industrial NOI exceeds office NOI, hopefully within 2 years, watch the stock re-rate quickly.
well they used $100MM for IOS deal at 5.2%. not nearly as good as buyback but will be the only public IOS play
Any concern that the company will tap the $200 mil ATM program it disclosed in Aug'23? It would seem unnecessary given the balance sheet and cash flow but it is there.
Minimal. Having an ATM filed is standard for REITs. On the off chance that shares rocket to something approaching NAV and an equity raise would not be dilutive, they don't want to waste weeks getting offering docs ready and filed and potentially miss the window.
Management knows they need to build credibility with investors, and that selling shares at a 13% cap rate to buy assets at 6-7% cap rates would absolutely blow those efforts to pieces.
Quick update here after Q3 results, which were respectable. The company got a nice 10-year extension on an industrial asset, found a new tenant for a small office in Las Vegas, and sold 4 properties for a total of $40 million, $7 million more than where I had valued these properties.
A stabilized office property with a 5-year lease sold for a 6.7% cap rate, while a vacant office building sold for just $35/square foot. Goes to show the difference between a good building with a quality tenant and a commodity-grade, unadvantaged vacant building.
The composition of building-level NOI, excluding the non-core "other" category, remains 31% industrial and 69% office. On the call the company noted it had reached its leverage target of <6.0x net debt to net rents, and is closer to "going on offense" and targeting acquisitions in industrial.
Corporate overhead remains too high, but is trending in the right direction.
I may be mistaken but 6.7% seems to be incorrect.
One stabilized office property totaling 99,200 square feet was sold for $19.5 million.
(Northrop Grumman just under 5 year WALT) .9% of total ABR @187m (Q2) = 1.683 / 19.5
~8.6% Cap Rate
why no buybacks? my full comment below
Thanks for the article. I am also invested in the name.
What are your thoughts on the earnings and the new deal announced today?
How does it affect your thesis and valuation?
On the whole, I like the deal. I have commented more elsewhere on this thread, but I continue to look at this deal as a great step toward creating a better "story" for Peakstone. Fundamentals-based investors too often discount the value of a narrative, and markets love a narrative. "Deeply-discounted office REIT with a good industrial portfolio" is not a narrative the market appreciates. "The only way to access the attractive IOS asset class in public markets" IS a narrative that can work, assuming Peakstone can successfully transition the portfolio in coming quarters.
No concern for the CEO earning 7-8 million a year in total comp? How activist friendly is the governance structure? because anything besides for buybacks at these levels would be super destructive
Oh it's absolutely a concern. PKST's overhead is excessive. The legacy of being a private REIT. I think as time goes on and ownership concentrates in actual economic buyers (not those who had it pushed on them by wirehouse brokers) there will be pressure to improve performance and shrink overhead to more appropriate levels.
Thanks for a stimulating piece. I spent some time on this and reached a different view.
https://focusedinvesting.substack.com/p/brief-look-at-peakstone-realty
With all your conversations with these REITs, how many of them are aware of the offerings of IWG and are considering this option as long term leases expire/roll off?
I think IWG and similar are options for large multi-tenant buildings in dense metro areas. Your 5+ story buildings in central business districts, etc. Less viable for buildings like those that Peakstone has, which are mainly designed for single tenant occupancy and are located in suburban office parks mostly accessible by car.
Dave, Thanks for the great write-up. Would you pass on your opinion regarding the dividend, it's reliability/payout coverage, and any role it may play in protecting the downside potential of the stock price?
I should have discussed the dividend, which is currently 22.5 cents/quarterly for a 6.6% annual yield. The dividend payout is less than one-third of adjusted funds from operations, which is highly sustainable. (In reality, some cash flow will be used to reduce the mortgage balances in the "other segment" and so isn't truly cash flow. But the dividend remains very well covered.) As for downside protection, I do hope the strong yield puts a floor under shares. On the other hand, the dividend hasn't stopped shares from suffering badly over the last 12 months.
what a treat to get this post just after mentioning REITs from your excellent value-stock-geek podcast.
also appreciate your retrospectives on harbor and p10, even though new thoughts always shinier for us huddled masses.
OffTopic : you mentioned magnate bios, check out the book\audiobook of 'Trust' by Hernan Diaz.
it's a romp through an (multi)imagined octopus persona mixed in with tricks of modern-day robber barons. historical fiction with high-level narrative.
https://en.wikipedia.org/wiki/Robber_baron_(industrialist)