I don’t often go back and look at my old blog posts. When reading my posts from several years ago, I wince a bit as I see how far I’ve come as an investor since. That’s not to say I am not proud of these writings. There are a lot of them 8 years in, though that output has slowed as I have taken on the role of a business owner and a pretty typical American family man. In particular, I am proud of a few pieces of analysis that I believe really captured some kind of value that was being missed by the market.
One of these is New England Realty Associates LP, ticker NEN. In a 2015 blog post, I laid out how the market was missing the value contained in New England Realty Associates LP’s somewhat complicated structure. For several reasons, “NERA” units screened poorly, and the substantial value of its equity-accounted real estate investments were not reflected in the financial statements. (Digging into the accounting for consolidated investments with minority interests and equity-accounted investments is one of my favorite mental puzzles. What can I say, we value dorks are a special type.) Despite significant growth in net asset value, NERA units actually trade lower than they did at the time of my post.
I’m going to keep this post on the short side, because I doubt anyone really wants to read a property-level analysis of NERA’s holdings. So here are the basics:
NERA owns 25 apartment complexes containing 2,892 units, all in the Boston metro area. NERA also owns 19 condo units, plus a smattering of commercial properties. Finally, NERA holds 40-50% interests in a further 7 apartment complexes containing 688 units, plus a parking lot.
In 2019, NERA’s wholly-owned assets produced $60.5 million in rental and sundry income (laundry rooms, etc.) Cash property operating expenses, including management fees, were $28.5 million leaving net operating income of $32 million. This compares favorably to $23.5 million in 2015.
NERA reported equity income of $1.7 million from its 40-50% owned investments. However, this figure materially underestimates the net operating income these properties produce. Here is a look at the underlying net operating income of these properties, and the percentage of this NOI (and the associated debt) attributable to NERA.
NERA’s equity-accounted properties produced net operating income attributable to NERA of $5.6 million in 2019 and $71.1 million in mortgage debt.
Summing up, NERA earned net operating income of $37.6 million in 2019. The balance sheet shows $299.8 million in debt. Adding the portion of NERA’s investment property debt attributable to the partnership brings the total to $370.9 million. There is no excess cash to speak of.
Today, NERA’s enterprise value is $458.7 million. On $37.6 million in trailing net operating income, this implies a cap rate of 8.2%. I challenge anyone to find a collection of investment-grade properties in the Boston area that can be purchased at a yield anywhere close. Just as a valuation exercise, here is what NERA’s equity value looks like under a variety of cap rate assumptions.
Clearly, I think there is plenty of upside to the current unit trading price in the low $40s. This is a good quality portfolio, and it is reasonably financed. Using a 5% cap rate valuation, loan-to-value is only 49%.
Now, there is a very obvious and legitimate caveat to all of this: COVID-19. The effects of the virus and the ongoing economic shutdown will absolutely have an effect on NERA’s tenants and their ability to pay their rent in a timely fashion. Occupancy may fall and cash collection may slow. But for anyone who believes the economy will eventually recover and that the Boston metro will continue to experience tight housing conditions, I think it’s very difficult to lose with New England Realty Associates LP at current prices. NERA pays a modest dividend and buys back a small number of units annually. The stock is unlikely to double in the short-term. On the other hand, I have a hard time seeing how an investment like this could be permanently impaired under all but the worst economic circumstances.
One last consideration. NERA is majority-owned and controlled by the estate of Harold Brown, the company’s founder. Mr. Brown passed away in February, 2019. By all accounts Mr. Brown was an extraordinary man. It seems the most likely scenario is business as usual for NERA, but the potential sale of the company could provide a catalyst.
Alluvial Capital Management, LLC does not hold units of New England Realty Associates LP for clients. David Waters does own units of New England Realty Associates LP personally. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at firstname.lastname@example.org.