As yields have sunk, I’ve been doing some due diligence on REITs I could use as yield generating for my portfolio. Mack-Cali came to my attention due to its relatively low forward P/FFO ratio of 11.6x. I wanted to publish my due diligence on Mack-Cali (CLI) and show why it is a REIT to avoid.

Mack-Cali is a REIT focused on an assortment of properties situated in the waterfront area of New Jersey and New York as well as other properties along the Northeast. The company has 71 real estate properties (41 office buildings, 22 multi-family properties, 4 retail properties, and three hotels). The company’s core asset is Harborside located in Jersey City. Harborside is a master-planned community with offices, luxury apartments, retail, and restaurants.

The company reports its revenues in two segments 1) Commercial Real Estate and 2) Multi-family and other services. Revenue is split roughly evenly between these two reporting segments. In 2019 and Q1 2020, the Commercial segment had revenues of $179 million and $40 million respectively. While Multi-family had revenues of $171 million and $43 million in 2019 and Q1 2020 respectively. The company has no single tenant that accounts for more than 10% of revenue.

Mack-Cali is undergoing a change in its strategic approach. The company has decided to sell the company’s entire suburban New Jersey office portfolio and focus all its resources on developing the Harborside property. Currently, the company has 34 office properties in the suburban portfolio for sale worth about $898.1 million. The company disclosed that it intends to use the sales proceeds to pay down its debt.

While I am generally on board with the company’s plan to refocus its strategic assets, the coronavirus pandemic will make it difficult to execute these sales. The current economic environment is just not conducive to real estate transactions and I don’t know if the company is getting the best price for its assets. In fact, the company had to recognize an unrealized loss of $45 million from these properties.

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Company Investor Presentation

Company Investor Presentation

Mack-Cali’s Q1 2020 results were stable despite the economic devastation brought about by the coronavirus pandemic. The company’s core office and multi-family properties were 81% leased and 95.7% leased respectively. Net income was negative for the quarter at a loss of -$39 million. Total revenues was $82 million in Q1 2020 vs $90 million in Q1 2019 however the decrease was due to the disposal of certain assets. Adjusting for this using same-store properties revenue was largely flat as it increased by 0.5%. Funds from operations for the quarter was $29.7 million vs $39.5 million in the same time last year.

The company’s management is in a battle for the future

Currently, Mack-Cali’s present management is embroiled in a battle for control of the company with Bow Street Capital. The hedge fund accuses current management of years of shoddy corporate governance and failed strategic initiatives that have resulted in poor shareholder returns. More worryingly, Bow Street has accused Chairman Mack of funneling value-enhancing deals to himself leaving out Mack-Cali shareholders. The company had an agreement with the Mack Family that allows then to appoint 3 directors to the board despite only owning 7.5% of the company as well as “not disadvantage Chairman Mack’s tax position”. This agreement has since been waived but does show a history of questionable corporate governance oversight.

Bow Street believes that Mack-Cali would best focus on its residential multi-family business as the company’s current strategy pursuing developing its commercial portfolio requires significant capital investment. The company is currently cash-flow constraint thus its strategy puts the dividend at risk as well as opens the outcome of shareholder dilution via an equity raise. Mack-Cali has been partnering up with other developers via JVs to develop its multi-family business which Bow Street believes is not maximizing the value of those assets. Bow Street wants to shift corporate strategy and install more oversight on the management

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Bow Street presentation

Bow Street presentation

From Mack-Cali management’s perspective, however, Bow Street has acted like an opportunistic disrupter. The company accuses Bow Street of wanting to profit at the expense of shareholders. In early 2019, Bow Street submitted, what management considered, a “low-ball” offer for Mack-Cali’s suburban and waterfront office assets. These happen to be the same assets that Bow Street wanted Mack-Cali to dispose of. The company has accused Bow Street of utilizing this proxy fight to deploy several underhanded tactics to profit.

Company Investor Presentation

Valuation and Conclusion

Looking through both sides’ arguments, I believe both have significant points. Mack-Cali management has significantly underperformed its benchmarks and has engaged in questionable corporate governance practices. It will be hard for the company to execute its ambitious Harborside development as it is over-levered. The company has a Net debt to adjusted EBITDA for Q1 2020 of 11.5x compared to 9.5x for the same time last quarter indicating that the company may not be earning enough cash to cover its debts. Mack-Cali’s dividend payout ratio is 60.3% indicating that if this trend continues the dividend could be at risk.

On the other hand, it is also hard to put my trust into Bow Street which acts out of its own interests and not necessarily other shareholders. A hedge fund using its influence to extract value at the expense of minority shareholders is not entirely unheard of. Especially since Bow Street actually tried to purchase assets from the company directly. While Mack-Cali certainly has valuable assets, the high leverage and proxy fight ensures that these may not be fully maximized. The company currently has a dividend yield of 5.6% which I don’t think fully reflects the risk of the stock, especially as a minority shareholder. Mack-Cali is a stock to avoid.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don’t know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.