After my Initiating Coverage Report of Clipper Realty (NYSE:CLPR) and the 2nd quarter earnings release, I thought it would be worthwhile to do a follow-on article to support the thesis of undervaluation.
In this update, I will review the historical valuation and financial performance of Clipper, provide a detailed financial forecast and then proceed to examine different methods and perspectives to support the “undervalued” thesis:
1. Valuation Models Using Forward Trading Multiples of NOI, FFO, AFFO, and EBITDA
2. Valuation Estimates from Equity Research Analysts
3. Qualitative Indicators of an Undervalued Security:
- Initiation of a Share Repurchase Program
- Insider Purchase Activity
- Institutional Purchases
4. Current Share Price Implied Residential Rent/Vacancy Rates Assessment
Valuation Performance History
On 3/10/20, Clipper, like other Multifamily REITs, experienced a steep decline resulting from pandemic fears of long-term impacts to NYC and residential REITs (i.e., Clipper is the only pureplay NYC REIT).
Unlike other REITs, Clipper never fully recovered despite demonstrating extreme resiliency in its financial and operating metrics during and after the trough of the pandemic.
Since its April 2020 lows of $4.32, Clipper has risen 40%+ but remains ~50% or more below its 52-week high and NAV.
Source: Yahoo Finance – Clipper Realty
Examining Q1 and Q2 2020 Financial Performance
What actually happened to Clipper?
Despite COVID, in its Q1 and Q2 earnings calls, Clipper proceeded full steam ahead, achieving record top and bottom line numbers in BOTH quarters:
- Record revenues of $30.9MM and $30.7MM (+11.7% and +8.0% YoY) driven by rent growth from Flatbush Gardens and the Tribeca House properties and the re-leasing of renovated units at 10 West 65th St.
- Record NOI of $17.1MM of $17.3MM (+16.3% and 8.7% YoY)
… All the while maintaining strong positive AFFO cash flows and paying down debt.
Q3–Q4 2020 Forecasts
Below are my projections based on an asset-by-asset assessment of the Clipper portfolio from my prior Initiative Coverage report, an update from the Q2 Earnings Release & Call, and a conservative estimate for future increased residential vacancy rates (~10%) and “flattish” rent growth assumptions:
Source: Author Generated 2020 Financial Projections
This is slightly better than current quarterly consensus estimates:
Source: TD Ameritrade Consensus Quarterly Earnings for CLPR (9/18/20)
However, the real inflection point will be in Q1 2021 as all of the “office lease renewals” will come in full effect, the residential unit conversions/upgrades will be completed, and the remaining vacant retail spaces will likely be filled (refer to the Initiating Coverage Report).
My 2021 projections forecast significant growth on all relevant metrics (i.e., Rent Income, NOI, FFO, AFFO, EBITDA, and GAAP EPS).
Source: 2021 Financial Projections Created by Author
In valuing a Multifamily and Office Portfolio REIT, the most applicable methods are: NOI Capitalization, FFO and AFFO (and possibly EBITDA) trading multiples. I will examine all four below:
- Implied Share Price Based on NOI Capitalization Rates
In conducting the Net Operating Income (NOI) Valuation Methodology, I examined three sources for identifying the appropriate Capitalization Rates:
- CoStar database
- New York Sales Reports , Articles, General Research
- Implied Capitalization Rates based on current and historical prices
I first estimated a blended Capitalization Rate, (“Cap Rate”) of ~4.5% to ~5.5% accounting based on the proportionate mix of Residential, Office and Retail revenue contribution:
Source: Clipper June 2020 Presentation
I then applied the Cap Rates to the NOI to compute the Enterprise Value and deducted the Net Debt to compute the Market Capitalization and associated Implied Share Price.
As of 9/18/20, Clipper had Total Long-Term Debt of $1,079.7MM and Cash & Cash Equivalents (inclusive of restricted cash) of $116.3MM resulting in a Net Debt of $963.4MM.
I estimated an Implied Share Price (based on LTM 2021 NOI) between $11.14 and $18.47 per share.
Source: NOI Valuation Analysis Created by Author
- Implied Share Price Based on FFO Multiples
In applying the Funds from Operations (FFO) Valuation Methodology (which incorporates debt servicing), I identified historical P/FFO multiple ranges (accounting for the mix of Residential, Office and Retail).
I also examined two methods to determine the appropriate P/FFO trading multiple range:
b. Implied P/FFO for Clipper based on both current and historical prices.
I settled on a range of 13x-20x EV/2021 FFO.
I estimated an Implied Share Price (based on LTM 2021 FFO) between $9.15 and $14.08 per share.
Source: FFO Valuation Analysis Created by Author
- Implied Share Price Based on AFFO Multiples
The Adjusted Funds from Operations (AFFO) Valuation Method, in my opinion, is the most relevant for purposes of valuing a stabilized Multifamily REIT because it incorporates both debt servicing and maintenance capex requirements.
I identified historical EV/AFFO multiple ranges (accounting for Clipper’s mix of Residential, Office and Retail) using two methods:
- Comps for the Multifamily REITs with assets in NYC
- Implied EV/AFFO for the Company based on current and historical prices
I settled on a more conservative range of 13x-20x EV/2021 AFFO.
This is in line with recent overall AFFO multiple averages:
Based on the forecasted AFFO analysis below, I estimated an Implied Share Price (based on LTM 2021 AFFO) between $9.85 and $15.16 per share.
Source: AFFO Valuation Analysis Created by Author
- Implied Share Price Based on EBITDA Multiples
EBITDA is the least applicable valuation methodology, in my opinion, but important since it is used across many industries by some investors and also reported as a financial metric by Clipper.
I identified historical EV/Adjusted EBITDA multiple ranges (accounting for the mix of Residential, Office and Retail) as well as incorporating Clipper’s Net Debt.
I examined two methods:
- Trading Comps for the four aforementioned Multifamily REITs
- Implied EV/Adj. EBITDA for Clipper based on both current and historical prices and Net Debt.
I settled on a range of 6x-10x EV/2021 Adj. EBITDA
I estimated an Implied Share Price (based on Annualized Q4 2021 Adj. EBITDA) between $9.43 and $15.71 per share.
Source: Valuation Estimates Created by Author
Equity Research Analyst Valuation Estimates
Let’s see what the Equity Research Analysts think?
There are three equity research firms that cover Clipper and have issued price targets since the Covid-19 pandemic emerged:
- B.Riley Craig Kucera maintained a price target of $16/share on 8/20/20 after previously having attended Clipper’s NAREIT Conference: citing strength of cash rent collections in Q2 2020.
- JMP Securities maintains a Market Outperform as of 6/1/20 with a price target of $14/share.
- Raymond James Buck Horne maintained a Buy on 9/18/20 and a price target of $9/share.
The price targets range from $9 to $16 reflecting a ~45% to ~158% return (based on the closing price of $6.19 as of 9/18/20).
Summary of Valuation Estimates
Based on all the valuation estimates above, the common consensus valuation range is between $11-$14.5/share.
Source: Author Generated Valuation Chart
Additional Projects Excluded from Valuations
There are additional upside opportunities that would increase the valuation range from the above, and are mentioned in the Initiating Coverage Report. I have not incorporated these in my estimates because they are pending approvals, and are slated for completion in 2022, and are speculative as to the final economics:
- Flatbush Gardens 500k FAR sqft Residential Expansion
Application In Process (Estimated NOI contribution of ~$4.5MM in FY 2022)
- 1010 Pacific 119k sqft Residential Redevelopment
Development In Process (Estimated NOI contribution of ~$1.5MM in FY 2022)
- 10 West 53k sqft of Air Rights for Residential Expansion
Not in Process (Estimated NOI contribution of ~$1.5MM upon stabilization)
Collectively, all three initiatives may contribute an additional estimated ~$7.5MM in NOI upon stabilization representing a ~20% increase over FY 2022 NOI and shareholder value.
Other Indicators of a Potentially Undervalued Security:
Initiation of Share Repurchase Program
During the Q2 earnings call, Clipper announced, for the first time, that they were launching a $10MM share repurchase program; providing internal support that, at least from Clipper’s perspective, its shares are undervalued.
What do the people with the most information on the company think?
Clipper’s Insider Trading history shows positive support with Insider “Buys” occurring in the last year ranging between $5.73 to $10 per share by the CEO and two additional Directors of the Company:
- Chairman/CEO: David Bistricer
- 5/14/ 20 – 106,666 shares @ $5.73
- 12/17/19 – 199,380 shares @ $9.97
- 12/12/19 – 110,644 shares @ $9.98
2. Director/Co-Chairman: Sam Levinson
- 5/14/ 20 – 53,334 shares @ $5.73
- 12/17/19 – 11,500 shares @ $9.97
3. Director: Howard Lorber
- 12/16/19 – 134,560 shares @ $10
- 12/11/19 – 6,544 shares @ $9.3
Additionally, Clipper’s Insider ownership is also well above sector averages (i.e., >67% of the fully diluted shares outstanding and ~27% of Class A Shares) very much aligning management’s and shareholders’ interests.
What does the “Smart Money” think?
The majority of institutional funds have either initiated (8) or increased (44) their positions in Clipper vs. exited (5) or reduced (17) as of the end of Q2 2020:
Among the institutions showing strong positive interest are name brands such as: Blackrock, Brigade Capital Management, Forward Management, Geode, Goldman Sachs, and JP Morgan.
“Perceived” Headwinds & Mitigating Factors
In regards to Tribeca House, 61 plaintiffs (current and former tenants) filed a case alleging they were subject to rent stabilization laws and Clipper was incorrectly charging excessive amounts permitted under these laws because the buildings were receiving tax abatements under Real Property Tax Law 421-g. Clipper has not accounted for any liability in its books.
Regardless of the outcome, the case appears to be limited to ~61 plaintiffs seeking retroactive reimbursement of overage rents and attorney costs. Management does not believe the outcome will have any material impact on the business. I estimate liabilities could be in the high single-digit millions on a worst-case basis given the number of plaintiffs in questions, the years covered, the incremental rents covered and the costs of legal fee reimbursement.
NYC enacted a rent stabilization rule effective immediately in June 2019, which affects rents-stabilized apartments by slowing the rate of future rent growth (e.g., curtailing rent increases on legacy unit turns and limiting increases on “preferential unit renewals”). This primarily impacts the Flatbush Gardens complex.
- The rules do not reduce current rental revenues.
- The limitation on “preferential rent” increases applies only to “renewals” of a preferential unit and not “vacant” preferential units.
- Clipper maintains the ability to increase the rents up to the maximum legal limit, tempering slow preferential rent growth and renewal growth.
- The rule does not reduce Clipper’s ability to increase revenue on rent-stabilized units by eliminating vacancy bonuses & incentives and limiting capital expenditures on preferential units.
- Renewal growth on legacy units is not impacted by the rule, as these renewals, were already subject to the rent guideline board increases.
While the new law will “marginally” slow the rent growth trajectory of Flatbush Gardens, the property will remain a very significant part of Clipper’s portfolio and growth story, with the FAR expansion project and other rent growth opportunities proceeding full ahead.
Investors were “spooked” with visions of skyrocketing vacancies as residents engage in an urban mass exodus from NYC during the crisis (given its status, at one point as the epicenter of the pandemic). However, such fears never materialized in the Brooklyn area, and Clipper’s portfolio and operational efficiency has demonstrated quite the opposite as residents “hunkered” down with a reluctance to relocate. Clipper has proven resilient in maintaining occupancy rates almost in-line with historical pre-Covid-19 levels (i.e., >96%) through the trough of the crisis and thereafter upon re-opening:
Our residential properties were still over 96% leased and has stabilized at that level through July. Under difficult circumstances, our business has remained strong, we expect our properties – and the New York City markets remain desirable to a broad range of tenants and our operations to return to a more normal state over time.
Source: David Bistricer, CEO Clipper Realty – 2nd Qtr Earnings Call as of 8/11/20
While vacancies are on the rise in New York City, the share of vacancies has disproportionately been felt in Class C and Luxury Class A properties in the city central district/Manhattan. Suburban areas like Brooklyn cater to Class B or sub-Class A properties, and have experienced a positive migration inflow to help mitigate vacancies.
For purposes of the prior forecasts, I have assumed vacancy rates of 4% as of July and increasing to 10% by year end, to reflect an overly conservatifve and worst case scenario as I believe there are “some” valid concerns for an increase in short term vacancies in the Tribeca House (i.e., due to its strong affiliation with college students and the planned shutdown of schools at this time for the upcoming fall academic period).
According to the latest research from M.N.S Real Estate NYC, rents in the Flatbush area of Brooklyn (where the bulk of the residential real estate for Clipper is located) showed an increase with August YoY rents up 0.7% echoing positive rent growth for Clipper.
Markets are concerned about collection rates spiking, with visions of mass double-digit defaults, but Apartment REIT collections rates have been climbing (closing out August at 97.5% vs. its low of 97.1% in June) and with consist growth QoQ and MoM. The Company has already reserved ~$600k in bad debt collection from Q1 and Q2 reflecting 2-3% default/delinquency rates and will likely continue to add to the reserves in nominal amounts as the stimulus package affects wear off.
OFFICE: Clipper’s Office rents were no exception in terms of its resiliency and are supported by creditworthy clients (i.e., local government).
RETAIL: On its Q1 2020 earnings call, Clipper identified Retail collections as an area of both individual collaboration and negotiation. Given the absence on retail detail in their presentation (unlike past presentations), I suspect this may be the most “at risk” asset class in their portfolio. Despite this, the Retail segment accounts for only 5% of portfolio’s revenues. With prime locations and creditworthy brands (e.g., Starbucks, AT&T, Amish Market, Apple Bank and a new upcoming tenant of “7-Eleven”), I do not foresee any further delinquencies or vacancies, other than potentially a small tenant, “Equinox” (although, forbearance, deferment, and/or rent reductions will be likely throughout the year).
Many REITs are cash starved, but Clipper’s most recent Flatbush Gardens refinancing served a dual purpose of shoring up liquidity with cash (i.e., $116.3MM in cash and cash equivalents as of 6/30/20) to ride-out further pandemic outbreaks as well as to demonstrate the firm’s ability to raise capital at highly attractive rates in a capital-constrained environment. The firm, since inception, has and remains significantly AFFO cash flow positive.
Governor Cuomo, along with the Tri-State area, is committed to ensuring adequate protections are in place (e.g., mask orders, travel restrictions from other states, and social distancing enforcement). It is highly unlikely that NYC will revisit the same peak levels of infections and hospitalizations as witnessed in April. Should a resurgence arise, Clipper already has a proven history of surviving and thriving during such circumstances.
Could the Short Interest Potentially be Affecting Valuation?
Short interest, a headwind for any company, has been trending downwards since the Covid-19 pandemic began which bodes well near term.
As of 8/31/20, shorts represented only 2.02% of the total public float which is in-line with the median/average of the multifamily REIT peer group:
Source: Author Compilation
Implied Residential Rents/Vacancy Rates
So what does the current share price imply for residential rent/vacancy expectations in the future?
Let’s examine the following matrix which compares Residential Rent Reductions/Vacancy Rates vs 2021 AFFO Trading Multiples in deriving implied share prices (holding office and retail rents “as is” given the investment grade status of the clientele and long term contracts).
Source: Author Generated Share Price Sensitivity Analysis
Based on the above, the market is currently pricing in expectations of an ~25% to ~30% reduction in residential rents/increase in vacancies. To put this in perspective, currently, as of 8/11/20, vacancy rates are less than 4% and residential rents have continued to grow (driven by below market rents to begin with). Additionally, AFFO multiples historically (i.e., 2019) were ~18x.
To put it another way, because Clipper’s long term debts are all non-recourse loans, and given their $116.3MM cash & cash equivalents position, Clipper could literally walk away from any or all of their residential properties (should any be in distress) while still reaping the positive AFFO of its office rents, and still be worth more than it’s current market capitalization.
Clipper is a resilient low-risk undervalued pure-play New York City REIT with “growth stock” characteristics ready to set sail on a journey of NOI growth and share price appreciation. It has proven to be a-cyclical and Covid-19 fortified in financial performance-to-date.
Clipper’s shares are significantly undervalued as supported by:
- Four Multi-family REIT Valuation Methodologies
- 3 Equity Analyst price targets
- A Newly Initiated Share Repurchase Program
- Insider Trading Activity
- Institutional Capital Flows
- Implied Residential Rent Reduction/Vacancy Rate Expectations
It is my opinion that the share price of $6.19, as of 9/18/20, reflects a myopic view of a Multifamily REIT that has felt the worst of the pandemic, and befuddled by unwarranted fears of mass urban exodus wrongfully applied to the Brooklyn region.
As investors turn their gaze forward over the next three quarters, they will likely witness an upcoming “tsunami” of incremental NOI which has the potential for triple-digit returns with limited downside risk demonstrating that Clipper is far from underwater and instead, deeply undervalued.
Disclosure: I am/we are long CLPR. 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.
Additional disclosure: We pride ourselves on conducting extensive primary & secondary research, analyses, and/or interviews with Senior Management, Partners, and/or Customers in order to identify and vet undervalued investment opportunities. That said, we aren’t always right and these are just our humble opinions. Don’t get us wrong, we would love for you to follow us to show you the “hidden” gems we find, but we also always encourage everyone to do their own homework and research and as the saying goes….BUYER BEWARE. Happy investing!