imaginima
Equity Commonwealth (NYSE:EQC) is a real estate investment trust (“REIT”) vehicle whose trustees are led by the legendary real estate investor Sam Zell that currently trades at book value. It has been sitting almost entirely in cash for a couple of years after some exits pre-COVID as it looked for serious real estate investments that could add numbers to Sam’s legendary returns. Now with rates rising, that cash could find better uses in Sam Zell’s hands when real-estate markets have become better priced.
Due to the value you get by getting Sam Zell’s expertise without a premium on his vehicle, where something like that for Bill Ackman or Warren Buffett would be impossible, we think EQC could be attractive for investors.
Real Estate Challenges
It’s been good to have been out of the markets for a while. Major commercial real estate categories carries some risks. Office real estate is still quite uncertain due to the permanence of hybrid working, and there is a real risk that the current footprint constitutes an oversupply. Higher rates are creating an environment where investors are looking for bargains while sellers hang on to the hope of pre-scare valuations. Falling liquidity is creating uncertainty on the buyside with exit prices harder to determine.
The real estate market has slowed down to the detriment of savvy buyers like EQC for the time being, but once the new regime becomes accepted, in particular as higher CPI rates continue to create a basis for greater than expected rate hikes, the landscape is becoming fallow ground for Sam Zell and Co. to splash the EQC cash that they’ve been sitting on for years. Cap rates are going to have to rise at some point as lenders and buyers together crimp the market on uncertainties, and a high conviction investment will be able to create value in the current environment.
Opportunities are beginning to grow in retail, which has been working through its oversupply for a decade now. Industrial real estate, which has been difficult to develop on supply chain issues, might constitute an interesting opportunity as well on the basis that geopolitical tension is requiring shoring of inventory and government support of local production in a spiraling response to growing mercantilism. Multi-family might be the most attractive of all, with the housing shortage a secular concern, and latent demographic trends supporting demand for multi-family living. With security of rent-growth being a major factor for opening up financing options, things look really good.
Sam Zell and EQC
Sam Zell has an aggressive investment philosophy focusing on contrarianism but also defense against capital impairment, which any successful investor must do. He made his fortune investing in abandoned developments in the ’70s. The market may not be quite at that point now with a deleveraging rather unlikely, but with cap rates rising and more tightness on the financing side, markets have become more ripe for EQC to capitalize on. In a more ebullient market environment, the risk with EQC is that it is dead capital, and that it would get eroded away by opportunity cost and now inflation. With more possibility of a major allocation these risks have diminished, and the key question of value comes into play.
The cash balances are $2.7 billion in EQC, with the book value of assets being $3 billion thanks to some real estate assets still on the balance sheet. At a $3.1 billion market cap, there is essentially no premium associated with the headline investors’ expertise, which is on par with investors like Buffett. While some amount of money is going to go into compensation of the managers, at this point trading at cash value and net income positive, there really just isn’t any downside or unjustified premium. Dilution effects from equity compensation regimes don’t exceed 5% were share compensation plans to be awarded, and salaries are about $20 million a year which seems large but only if the vehicle sits and does nothing for another 10 years. With the share based compensation arrangements constituting the majority of the compensation right now and the plan subject to automatic cancellation in 2025, the risk of erosion of money is pretty low considering it trades at book value already.
Bottom Line
Ultimately, it comes down to if you think it is worth betting on a cash value company that is currently pricing Sam Zell’s involvement at no premium, so essentially for free. The downside is that the capital is dead for another 3 years, but with the market environment improving the chances of a high conviction opportunity, the outlook is better now than it used to be.
If you thought our angle on this company was interesting, you may want to check out our idea room, The Value Lab. We focus on long-only value ideas of interest to us, where we try to find international mispriced equities and target a portfolio yield of about 4%. We’ve done really well for ourselves over the last 5 years, but it took getting our hands dirty in international markets. If you are a value-investor, serious about protecting your wealth, our gang could help broaden your horizons and give some inspiration. Give our no-strings-attached free trial a try to see if it’s for you.
Be the first to comment