Establishing A Synthetic Real Estate Portfolio

Introduction

I am a 73 year old retired real estate lawyer who had sold most of his real estate holdings a few years ago. There are notable exceptions, such as the brownstone on the West Side of Manhattan, where I raised my family and although I put it for sale before Covid, no one seems to want to purchase it at a reasonable price. I have watched the decline in prices but am too old to start buying and managing properties myself. As an alternative, I have elected to create a synthetic real estate portfolio which I can invest in and monitor through the purchase of Reits and publicly held real estate companies. I had been successful in my real estate endeavors to the extent that I retired and went back to school taking undergraduate and graduate courses in art history and proceeded to build a moderately successful second career.

In buying real estate, I always tried to buy at reasonable prices but my timing was never even close to perfect. My money was made buying the right properties and sitting on them for a very long time. I was never fortunate to buy at the low or sell at the high. I did not buy to be safe but rather sought those locations where I believed there would be appreciation over time. This is different from buying stocks with the strong emphasis on impeccable timing and the agility to take profits and avoid loses.

I have now decided to once more invest in real estate, prices are certainly down, buy rather than own actual properties, I would do it through a small selected portfolio. I am not seeking a diversified or broad portfolio but rather a selection of securities which reflect my investment parameters. I am not as concerned about safety and comfort as I am about performance over time. I have selected four companies which encompass these needs. The firms I selected are not etched in stone and I have also set forth alternatives for those who would prefer other companies. In my selection there is a bias towards New York based real estate firms because that is what I know best. Some of my investments contain a great deal of risk and I am fine with that. These are all intended to be long term investments and I am prepared to see them play out over time.

Alexander’s Inc. (ALX)

I chose Alexander’s because it consists primarily of just two assets. A square block in Manhattan located between 58th and 59th Streets bounded by Lexington and Third Avenues, consisting of a large office tower built designed and net leased to Bloomberg News, surrounded by high quality retail names and the Rego Park Mall located in a very congested part of Queens. My information is taken directly from the lastest annual report which is available on their web site.

731 Lexington Avenue is net leased to Bloomberg with the primary term expiring in 2029 but with the tenant having several option renewals. The rent escalates every four year with an increase having occurred in January of this year. The tenant needs the space and with it’s continual expansion, now also occupies 150,000 square feet in other locations. The stores are basically solid but there are also weaker tenants. If you go to see the building, you should walk into Home Depot which has a small entrance but then opens up into gigantic space. The A & D Building is on one side and Bloomingdale’s flagship store is on the other. This is the kind of real estate I always wished to own and pass down to my grandchildren.

According to a recent press release, the $350,000,000 mortgage on the retail space came due this year and was successfully extended at the existing variable interest rate of 1.55% but ALX had to pay down $50,000,000 of the mortgage loan. They had the cash to do it. I have written about this before and I believe that the value of this square block exceeds substantially the market value of the entire company. In many ways this is an inflation protected bond.

The Rego Park Mall is in a very congested area of Queens and was intended for construction in three stages. Sites I and II are complete but site III is still an open parking lot. A large rental apartment house called the Alexander, tall and gleaming, was also built on the site and appears to be close to fully occupied. I have been to many Costco stores but the one here was among the largest I had ever seen. Like most malls, it is a victim of our times. According to the annual report, Sears vacated but 90% of the space was rented to IKEA, which will use it as its first urban concept store. Kohls went dark but still pays rent, while Century 21 is now closed forever. You basically get this mall for free and it does have value. You simply need to wait for it to stabilize. I have never been there without having to search for parking in the garage and being exposed to heavy foot traffic.

There is a third parcel which appears to have value but is probably a liability. ALX leases a 30.3 acre parcel in Paramus to IKEA which has the option in October 2021 to purchase the property or extend the lease at much higher terms. If they exercise the option to purchase, ALX will receive $7,000,000 in cash but incur a capital gain of $60,000,000. Maybe something will be worked out or maybe not. The annual report simply states the facts and gives no indications.

The annual dividend is $18 annually which produces a 7.16% return at its present price of $252. This dividend should increase due to the escalation of the Bloomberg rent and IKEA starting to pay rent on the space previously occupied by Sears.

I happen to like Alexander’s, because I can understand it, but an argument can be made for purchasing Boston Properties (BXP), S L Green (SLG) or Vornado (VNO) instead. All are high quality large commercial landlords in Manhattan and based on several metrics are even cheaper than Alexanders (which is majority owned, managed and controlled by VNO). In my mind the others are more like an index fund of NYC commercial real estate. As an aside, Empire State Realty (ESRT) appeals to me because these are older buildings in good locations which can charge substantially less rent because of their age. That 25% of its revenue comes from the Empire State Observatory scarred me away because of the decline in tourism and the opening of a new observatory at One Vanderbilt Place by S.L. Green (SLG).

Macerich (MAC)

According to its latest annual report, Macerich owns 47 regional shopping centers in densely populated markets throughout the United States. They are partners with Pennsylvania REIT (PEI) in the newly opened Fashion District in Philadelphia and in New York own Kings Plaza Shopping Center (purchased from Alexander’s in which partial consideration was paid in stock at $55/share but now worth $7.50) and Queens Center (which is absolutely massive and within 10 minutes of ALX’s Rego Park Mall). Time has not been kind to MAC. From a high of 90 in 2016, it now sells for $7.50. They have been always known as superb operators of high-end malls. With a reduced dividend at its present price, the yield is 7.98%. I am not investing all my money in MAC but I am prepared to take a chance that multi-channel marketing will survive and that all malls will not collapse. The price chart is simply ugly.

I am not prepared to invest in lesser quality firms such as Washington Prime Group (WPG) or Pennsylvania REIT (PEI), let alone CBL & Associates (CBL). I do understand that many buy the Preferred Shares for the allure of the anticipated dividends but I am a straight up equity real estate investor. I also understand those who will simply buy the best in class, namely, Simon Properties (SPG) but although greatly undervalued, it lacks the upside potential of Macerich, should there be a true recovery. I have also looked at Taubman (TCO) which pound for pound owns the best malls but with the merger litigation, I have elected not to participate. SPG has unlimited money and can drive Taubman through the mud for years.

Macerich just seems very cheap with all bad news already priced in. It could totally collapse and be worthless or it could hang in for a few more years, dying slowly, but I am prepared to believe that there is a possibility of a meaningful recovery. It will not happen quickly but will take many years but at this price I am prepared to wait. I also fully understand that they may lose properties along the way but I am also fine with that. I am not anticipating that it will recover to its old high of 90 as I think those pays are long gone. I am satisfied in knowing that there exists the possibility that it can increase several times in value over the next ten years and that is enough for me.

Cedar Realty Investors (CDR)

Cedar owns grocery anchored strip shopping centers in smaller communities. Their business model is referred to as “necessary retail”. They provide ordinary services in middle class communities. According to its web site, It has 55 properties with 8.3 million square feet of gross leasable space which is 82% grocery anchored (this is displayed in bold letters on its web site). Above is the tenant categories as set forth by management in their latest investor presentation. I am not sure which categories are immune from the internet but suspect that many will survive. Please note that these are centers where ordinary people come to shop for necessities.

Management has embarked on an ongoing strategy of selling inferior properties and investing the proceeds in better locations. This has been emphasized in the President’s letter in each of the past several annual reports. They have been doing this for several years but it has not helped the stock which presently sells for $.90/share and at roughly 23% of book value. I once did a rough analysis based on market caps and believe that the actual value of the centers is more like $4.00-$4.50/share which is slightly above its book value. This is still cheap enough. Even with the greatly reduced dividend it has a yield of 4.47%. The market has not been kind to Cedar which hit $8.00 in 2016 and has been as low as $.70 this year.

These sort of small town and suburban shopping centers were never considered exciting and dynamic. They were simply a place to earn a decent and supposedly safe return. They have always been mundane purveyors of necessary items. At these price levels I am prepared to buy and sit. I believe there will be stabilization, cash flow will become more robust and the dividend will increase over time. Some of the properties will do better than others and they might even lose a few but I can live with that and the risk is acceptable.

There are alternatives to CDR, namely Regency Centers (RCG), Federal Realty (FRT) and Urstadt Biddle Properties (UBA) which are of much higher quality and even pay better dividends. There is little question, that with the return to normalization, these REITs will increase in price but I believe that the “pop” in CDR will be more dramatic. Over the long term, I hope to earn multiples on my investment in CDR and to enjoy increased dividends for many years to come.

J.W. Mays Inc. (MAYS)

According to Wikipedia, Mays was founded by a Polish-Jewish immigrant named Joe Weinstein (who did speak at my elementary school graduation) in1927 as a discount department store in Downtown Brooklyn which eventually expanded throughout NYC and at its height had 5000 employees. After a Chapter 11 Bankruptcy in 1982, Mays finally gave up retail and became a real estate company in 1989, managing its former stores which were now leased to government agencies, health services, charities and secondary retail. The descendants of Joe Weinstein continue to manage the real estate in survival mode.

For many years, Downtown Brooklyn and its main commercial artery, Fulton Street, was in a steep decline. The great discount retail stores slowly but surely fell aside. Mays is not unique when you consider that Vornado, Alexander’s and Trinity Place Holdings (Sy Syms), experienced the same decline and transformation. Through many bad years, the family continued to manage the properties, more concerned with keeping tenants, who paid rent, then embarking on game changing growth plans. They were successful in keeping Mays alive and profitable during very tragic times. All they could think about was keeping their massive buildings partially rented.

The tide eventually changes and neighborhoods sometimes rise from the dead. Downtown Brooklyn rose as a Phoenix. It began with the slow and steady rise of the black middle class, spreading out from Bedford Stuyvesant and Ft. Greene and aided by the gentrification of this newly identified neighborhood, now known as Borum Hill, by those seeking cheaper housing than currently available in Brooklyn Heights, which had become expensive after many years of stagnation. This was a slow silent process which took place on multiple levels. Today the brownstones on the tree lined streets such as Pacific now sell for millions each, several major high rise residential towers have been constructed all over the neighborhood, running from Dumbo through Park Slope and retailing has found new vigor and prosperity. The streets are congested with traffic and the continual new construction only makes it worse.

Mays management is still in survival mode and probably regards the change in socio-economic status as temporary and passing. Three articles had been written on Seeking Alpha, in 2014 and 2016 some in extreme depth, about the value of the real estate owned by Mays, which varies from $67 to $105/share. There is even a detailed research report from 2014 projecting 2021 profits in excess of $10/share. Needless to say, nothing has changed and the increased rentals have not occurred. Insiders own 80% of the outstanding shares. Included in this is the 22.52% owned by the descendants of Sol Goldman, who had been an extremely successful real estate investor in NYC. To give you a fuller picture, the following is a list of the Members of the Board of Directors and their ages:

Robert J. Ecker 63

Mark S. Greenblatt 66

Steven Gurney-Goldman (Sol Goldman’s grandson) 29

John J. Pearl 85

Dean L. Ryder 74

Jack Schwartz 98 (not a typo)

Lloyd J. Shulman 78

The stock is languishing in the low 20s and is anything but liquid. According to Fidelity, 90 day average volume was 268 shares. Management will not change and when you buy the stock, you are buying a long term call on future change.

I looked for alternative investments to Mays and I found two companies which met the criteria. One is J.G. Boswell (OTCPK:BWEL), which is a large cotton and tomato farm in California with enormously valuable water rights and is controlled by the family of General J.G. Boswell. According to Fidelity, its average 90 day volume was 338 shares. People continually talk about when its intrinsic value will be brought to fruition to enrich its shareholders but it has not happened. At $540/share, its intrinsic value has been estimated from $800-$1500/share. Maui Land and Pineapple (MLP) owns valuable land in Hawaii and has been extremely slow in developing it. 62% of the stock is owned by Stephen Case who had owned AOL and he appears fully content to simply own the land. The stock sells for $11.67 and there have been fair market value estimates in the 20s. I prefer to own Mays because I understand its assets and can appreciate the mechanisms of value.

Conclusion

This is the kind of real estate portfolio, I would have acquired when buying actual real estate. I am not necessarily seeking the best and safest but rather that which over time has the possibility of showing strong appreciation. I am prepared to purchase and await the outcome over time. I have no desire to trade but rather prefer to watch and wait. It worked for me with actual real estate and it will work for me as my synthetic real estate portfolio.

Disclosure: I am/we are long ALX, MAC, CDR, MAYS, BWEL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

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