Real estate as an asset class is one of the most stable forms of investing, which is why it attracts a large investor base of retirees and yield players. There are a number of listed real estate investment trusts which make real estate investments easy for the common man. Additionally, their structure is such that the REIT managers tend to carry out regular dividend payouts and provide a good yield to investors. As the demand for a REIT grows, its price goes up and the effective yield goes down, which is why it becomes important to identify undervalued REITs that have the potential to generate excellent future yields based on their current cash flows. One such high-potential REIT with excellent potential for future payouts is the recently listed Presidio Property Trust (SQFT, Financial).
What does Presidio do?
Founded in 1999 as NetREIT, Presidio has been active in the domain of real estate investing for over two decades. The company is headquartered in San Diego and looks for commercial real estate investment opportunities in relatively smaller and growing cities. Its investments are spread across cities such as Salt Lake City, Minneapolis, Kansas City, Columbus, Denver, Colorado Springs, San Diego and others. In terms of sectoral exposure, the company has invested in office spaces, industrial properties, strip malls,and model home residential properties with a combined area of 1,129,738 square feet. It has a total of 15 commercial properties with a book value of around $129 million and an additional 138 model homes as a part of a highly diversified portfolio. The company has a base of 23 employees and managed to raise close to $2.3 million in gross proceeds before expenses through its recent public offering.
Investment strategy
Presidio is smaller in portfolio size as compared to many REITs, which is why management has the ability to focus on a niche. They look to invest in high-quality commercial properties in regionally dominant markets, which are characterized by steady growth in population, a highly educated workforce, a high student population, stable health care systems, the presence of large corporate employers and, most importantly, a lower cost of living. Apart from population growth, such cities could also witness a potential influx of people from larger cities like New York for a better quality of life and possibly even the Covid-19 fears.
Currently, Presidio has most of its exposure in the states of North Dakota, Colorado and California. The attractive growth dynamics of these regions help the company maintain a high occupancy rate and also ensure minimal rental defaults. Its current occupancy rate is around 86% amidst a highly diversified tenant base of 227 individuals. The diversification is key as it significantly reduces the revenue concentration risk as no single tenant of Presidio represents more than 6% of its top line and its top 10 tenants represent about 29% of its revenue. The company has a short-term lease model, so its typical leasing tenure does not exceed five years. Management is targeting office, industrial and retail properties in the range of $10 million to $30 million, which places the company in a smaller niche and avoids competition from the larger REITs. Thus, it can be said that Presidio's overall investment strategy has a strong rationale and appears to have good future potential.
Model homes investments – a key differentiator
One of the main reasons why Presidio's management refers to its investment approach as contrarian in nature is its focus on model home investments. Model homes are basically single-family residential homes constructed by builders for the purpose of showcasing floor plans, elevations, optional features and workmanship while being in the process of marketing its project. In ordinary circumstances, a model home is held by the builder for at least three years before being listed for sale at a fair market value.
Presidio goes ahead and acquires model homes from builders at a deep discount over the fair market value and leases it back to the builder for the three-year marketing tenure, post which it has the option to sell the home at a significant premium. The company's model home leaseback agreements are triple-net, requiring the builder to pay all operating expenses, such as maintenance, real estate taxes and insurance. This is a win-win for the builder as it indicates an immediate cash inflow that can be used for continuing with his project, plus a reported sale on the project that helps it from a regulatory point of view as well as from the point of view of attracting new homeowners.
Presidio's mark-up is very high when it finally sells the model homes and the company claims to have sold 21 model homes in the first half of 2020 for around $8 million and a profit of a staggering $557,000. It made a similar profit of close to $1.2 million from the sale of 41 model homes in 2019. Presidio currently holds around 138 such model homes, which are mostly concentrated in Florida and Texas, and management is looking to diversify across more geographies amidst mid-sized, high-quality builders. The model home upside is a key differentiator for Presidio that distinguishes it from most other commercial REITs.
Final thoughts
Presidio's public offering was priced at $5 per share. It currently trades at a discounted price of $3.85 primarily because the market has been unaware of the company's dividend policy.
Management changed that today, declaring 10 cents per share of dividends for this quarter. Presidio generated close to $1.18 million in funds from operations during the first six months of 2020. If management is able to continue this payout on a quarter-on-quarter basis, it would result in a yield of over 10% at the current pricing. They have also looked to reduce its debt levels over the past two years through the sale of properties, which explains the slight dip in the total revenue. At $3.85 per share, Presidio is a highly discounted underdog within the REIT space that is poised for excellent growth as well as dividends in the future and appears to be a compelling investment proposition.
Disclosure: No positions.
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