Real Estate Investment Trust company DDR (DDR 8.76, +0.80) trades +10.1% higher today after last night’s news that the company would spin off a portfolio of 50 assets into a separate publicly-traded REIT.
In a conference call last night, DDR detailed the news that it would spin off a portfolio of 50 assets, comprised of 38 Continental U.S. assets and the entirety of the Puerto Rico portfolio into a separate publicly-traded REIT to be named Retail Value Trust.
The properties were selected from the remaining company based on performance and growth characteristics, resulting in what the company feels will result in the creation of a high-quality, high-growth portfolio located entirely in the Continental U.S.
The New DDR expects to pursue a business strategy of maximizing earnings and NAV per share growth through releasing, redevelopment and opportunistic investment.
Commenting on the new spinco, DDR noted that RVT expects to focus on realizing value in its portfolio through operations and private market sales of its 38 Continental U.S. assets and all 12 of DDR's Puerto Rico assets with a combined gross book value of about $3 billion as of September 30, 2017. The Continental U.S. assets are characterized by stable cash flows and measurably higher quality and demographics than the $1.0 billion of assets DDR disposed so far in 2017. RVT will be externally managed by DDR for maximum cost efficiency.
RVT will be capitalized with committed mortgage financing of $1.35 billion expected to fund in early 2018. Proceeds are expected to be used to repay debt at DDR, positioning New DDR to achieve the previously stated goal of 6.0x Net Debt/Adjusted EBITDA in 2018.
DDR management also commented on dividend rates for the two companies. Put simply, the company does not anticipate any change in the DDR dividend rate as it prepares for the spin off. The expected minimum initial quarterly dividend at the New DDR is $0.10 (or $0.40 annually). The company noted that RVT will be focused on targeting a 100% payout ratio of AFFO, which should be augmented by payment of special dividends over time as assets are sold.
While the final dividend rates are yet to be set, though, the company noted that the combined dividends of the New DDR and RVT together will be below DDR’s current dividend rate as of today. As reasoning behind the lowered dividend payout ratio, management called attention to the desire to have a lower, more conservative payout ratio at the New DDR, an expected higher interest rate on the new RVT debt that is being used to retire lower rate existing DDR debt, and about $5 million of incremental public company costs results from the spin of RVT.
The spin is expected to occur sometime in mid-2018. The company has executed a commitment letter with Credit Suisse, JP Morgan and Wells Fargo for the $1.35 billion of mortgage to fund the overall transaction, a loan they expect to close sometime before February 15. They expect to use the proceeds from the mortgage financing as well as DDR's remaining previously announced disposition program, which together represent $1.8 billion of total proceeds to reduce DDR's debt by $1.7 billion with the balance related to debt extinguishment and transaction costs associated with this financing and the spin itself.
Lastly, they expect net corporate costs to increase only $5 million as a result of this transaction with G&A allocated roughly proportionately on the basis of each portfolio's GLA. RVT will ultimately effectively reimburse DDR for its management cost based on property and asset management fees that will be paid by RVT to New DDR.
The New DDR:
- Following the spin of RVT, New DDR will have 40% of its portfolio by property count anchored by specialty or a traditional grocer, a concentration that is equal to or higher than several other major shopping center REITs.
- New DDR will also be much more geographically concentrated than our portfolio is now, with nearly 70% of NOI coming from a dozen MSAs that represent some of the highest growth and highest income areas in the U.S., such as Los Angeles, Boston, New York, Washington DC, Miami, Charlotte, and Atlanta. While the portfolio is focused in a finite number of areas, there are certain markets in which DDR has a more limited exposure through the ownership of only one or two assets. The company would expect this distribution to be the case into the future.
- Management highlighted that DDR has proven it can operate assets efficiently, even when they have more limited presence, and they believe that some of the best investment opportunities are likely to arise in some less popular markets. One thing will always unite investments such as these, highly attractive demographics, demonstrable limitations to supply and resulting risk adjusted returns that, in the company's opinion are highly attractive to public market investors. They have curated New DDR to meet these requirements, with the end result being measurably higher same-store NOI growth and leasing spreads than the company as a whole. The company expect this level of improved growth going forward and estimate the same-store NOI growth for New DDR will be at least 1.5% in 2018.
- While the company expects debt-to-EBITDA to be roughly flat following the transaction and around 6.0x in 2018, their remaining unsecured debt will be tied to a pool of better faster-growing assets. Just as important, the use of mortgage proceeds to pay down existing DDR mortgages means that the company's exposure to secured debt will fall from 7% to 3%.
- Lastly, management noted that the fixed charge coverage ratio will increase to 3.0 times.
- While the combined RVT's portfolio leasing spreads were negative, this was caused entirely by Puerto Rico, spreads in the U.S. were positive 7% in 2017 to date.
- The company continues to believe the enormous population density surrounding these assets and the much lower supply of retail real estate per capita provides meaningful long-term support to the portfolio.
- The company noted that DDR has been a consistently active participant in the disposition market, selling an average of $500 million every six months. More importantly, this robust sales activity has been among assets that have measurably lower rents, lower occupancy levels, and lower household incomes than those the company is marketing for sale through RVT. And yet, the company has recently been selling these assets at cap rates in the mid to high 7% range, suggesting robust market demand for the RVT assets the company is marketing today.
- Whether it's high profile markets like Gresham Station in Portland, Oregon or Beaver Creek in Raleigh, the company strongly believes RVT's assets will be met with high demand in today's transaction market, enabling the company to efficiently and effectively execute on its maximization of value business plan.