RE: RE: Property appraisals,1:3 rollback “Dante:
WRK bought the property AFTER the $8 million in improvements were made, so at most $4 million in improvements came after the purchase and thus could have increased the appraised value subsequent to the purchase.. Anyhow WRK says that they did not pay any of the total of $12 million.”
According to the wording of the 2005 Q3 report and Nov. 9, 2005 news release, the $8-million new exterior facade and interior renovations would have to have been completed in a month or less – not very likely, to say the least, although, technically, the December 8, 2008 news release confusingly implies that that's the case. If the minimum case of $4-million, some of the improvements could have increased the appraisal.
There's still an ROE calculation that ignores millions in fees paid to extend a lease for a period starting almost a decade in the future. IMO, a calculation of the returns attributable to this property should recognize this outlay.
I'd also question the suitability of highlighting the equity available in the property based on a recent snapshot appraisal as:
I)The 72% leverage utilized by Whiterock creates large double digit swings in NAV per unit for tiny 50-75bps moves in cap rates. Any REIT management team can take second tier real estate, with its higher cap rates, and apply outsize leverage to produce high returns in the short run. The market knows this, despite WRK management's distracting “implied return on equity” advertisements. IOWs, the market will discount the equity and NAV of a REIT in some proportion to its leverage – in good times and bad.
“In October and November 2005, Whiterock acquired six primarily government occupied office buildings in Quebec City, Quebec, and an industrial building in Mississauga, Ontario. These properties produce a 14% return on equity and are leveraged at 72% with long-term fixed rate financing.” September 30, 2005, Third Quarter Report
II) WRK's brief history for the property indicates that is was renovated in 1990 and again in 2005 (or that $12-million figure over the past three years if you prefer), which implies that the building experiences real depreciation, i.e., significant components of the building will predictably fall in value. Considering that WRK paid $47.9-million and $12-million went into the building since the acquisition (or very near the acquisition date), these “renovations” to remedy the declining guts and exterior of the building are a large percentage of the acquisition/book cost. Hopefully, the lease extension puts the financial responsibility for these recurring expenses on the tenant until 2030, preventing any future impact on the “implied” ROE.
“You seem to feel that WRK management should not be trusted; can you elaborate further?”
It's long, but here are a few;)
1)Thirty-five days after being compensated for his management company's (Whiterock Capital) internalization, Underwood decides it's time to ditch the long term organic and external growth strategy he has espoused from day one and sell. He fails and the total cost for this managerial excellence is $5.6-million. It's hard not to see this as an attempt by management to make a quick buck after cashing in. It seems that for him, the problem was that he was paid in units, and the solution was to get those units sold at a premium. Anyone who believed and invested in the long term strategy and objectives for the tiny company was left to wonder just what the company got for the $5.6-million adventure in enriching Underwood.
“On December 12, 2006, the Trust issued, through its subsidiary Whiterock Limited Partnership
("Whiterock LP") 286,671 LP Class C Units valued at $3.5 million to a company controlled by the
Officers in connection with the internalization of the management function and the acquisition of the
Agreements, and the Officers became employees of a subsidiary of the Trust.” p. 18, June 30, 2007 FS
“On January 16, 2007, Whiterock announced that it had commenced a process to review its strategic
alternatives and to solicit proposals to acquire or merge with Whiterock (the “Process”), in an effort to
continue to enhance its unit value.” p.19
“On July 18, 2007, Whiterock announced that it had completed the Process, and determined that having
management continue to operate the business is the best means to build and deliver value to
Unitholders. As a result, the Special Committee of Trustees was disbanded. Whiterock expensed $2.1
million of costs, primarily for legal, special committee and independent trustee fees and due diligence
costs relating to the process, in the six months ended June 30, 2007.” p.19
2)Then there was the “Whiterock Advisors” cc that clearly perturbed Underwood. Here's the exchange:
Shant Poladian from Canaccord
Q. My next question deals with an article I saw in “real estate alert” a couple of weeks ago. An entity called Whiterock Advisors has been formed? Is management or the trustees principal investors in that vehicle? Potentially vending in 80% of 655 Bay? Could you comment on that as well?
A. Underwood: That's classic misreporting. Ummm, none of that's true. What we've said, and continue to say, is that, ah, now that we're a fully integrated platform, we are looking to, um, attract international capital that would like to invest alongside the REIT to acquire , um, assets in primary markets like 655 Bay. The reason that makes sense for the REIT to do that is because with a 20% investment and 80% from an institutional partner we can receive management fees for 100% of the asset and produce very attractive returns in lower quality, in lower cap rate assets in primary markets. That's certainly our desire to move in that direction. But doing something like that is a 12 month prospect. We're headed that way.
Q. But has there been this Whiterock Advisor entity formed? Do you know, er...?
A. Underwood: No, there's no entity formed; however, we're marketing, out talking, to institutional investors.
Q. Okay. And that wouldn't be something that you as management or the board would be equity investors in?
A. Underwood: That's a premature discussion.
Poladian: Okay, thanks.
A premature discussion? Unitholders spent millions to "internalize" the management, painfully watched Underwood fail miserably at a sale attempt, and now learn that Underwood considered using WRK assets to generate income for a personal investment. Happy days are here again! He should have preemptively ruled out any personal investment.
3)The use of wildly unrealistic 6-7% cap rates in the MD&A's NAV estimates. When much higher quality RE assets trade publicly in the 6-7% range, why does management persist with this pretense?
4)Touting on conference calls the fully integrated RE platform, yet it fails even to lease up a half vacant warehouse in Saskatchewan. And, instead, issues a second mortgage at over 100% LTV while guaranteeing the first, all in exchange for an option to acquire the SK property at market value from the third party that has WRK's cash and guarantee. Hardly inspiring stuff. And something that a real RE platform would undoubtedly do in-house.
5)Underwood buys an $80-million portfolio in the overheated Alberta RE market at a 7% cap rate. And, by my rough calculations, at nearly 86% D/GBV. The vendors of the $80-million AB portfolio took back a private placement of $11.4-million in units and $11.4-million in converts, but received the rest through cash and, of course, WRK assuming their mortgages. As far as I can tell, that (the units) was all of the equity in the deal. I'm not done looking at the deal, but Leben REIT was a highly levered REIT destined to implode with only $15-million in equity, yet they managed to sell to WRK at a 7% cap rate. To cap it off, there does not seem to be any significant weighting of investment grade tenants in the Leben portfolio.
The credit facility used to help finance this acquisition: “Security for the facility will be comprised of mortgages on new and existing property and include second mortgages on the properties located at 655 Bay Street, Toronto and 2450 Girouard, Saint-Hyacinthe.” - WRK news release July 20,2008.
Increasing the debt on your best assets to buy much lower quality, overpriced material AND give away almost 10% of the REIT with options for more is not an exercise in value creation.
“ They seem to have a lot of solid leases; do you feel otherwise?”
They do, but they are diluting the base of solid leases away. Three properties with solid leases went as part of the sale fiasco and the Leben acquisition dilutes the quality and duration further. Underwood should have held the “equity” in his best assets as a reserve against a weakening economy, not gamble it in on a second class investment in an overheated one.