I'm just going to dive in here.
Interest rates have gone up very quickly. Long term bonds have sold off in the new year and look to continue to sell off for the foreseeable future as demand for government debt goes down.
As a result, cap rates have already gone up and will likely continue to stay elevated.
Although all of commercial real estate has struggled over the past 2-3 years, the office sector has had it the worst. It's quite possible that office assets have been permanently (or at least for the next 5-10 years) been impaired.
The going-in cap rate for many office buildings is in the 8% - 10% cap rate range. Stabilized occupancy for these assets are in the 70% - 75% range across the country. Some markets are seeing tenants downsize in size and those vacancy rates could even go higher.
That being said, there could be value in the office sector. However, SQFT, in my opinion is not that value.
This company owns 12 office/retail properties and a model home triple net rental business. The model home business has promise, but the offices do not.
On the model home side, they buy properties from developers and lease it back to developers to showcase to prospective buyers. They get a fixed rental amount on a triple net basis and then end up selling the property to someone when the project is complete. It's a nice business and a growing business.
The office side is heavily impaired though. Here are their properties:
Property Name |
| Acquired | Location | Type | Reported Asset Value (as of 9.30.23) | MTG Principal | Interest | Maturity | LTV |
Genesis Plaza |
| May-11 | Fargo, ND | Office | $8,923,571.00 | $9,260,159.00 | 4.74% | 7/6/2024 | 104% |
Dakota Center |
| Dec-14 | Centennial, CO | Office | $8,565,680.00 | $7,471,082.00 | 4.34% | 1/5/2025 | 87% |
Grand Pacific Center |
| Dec-14 | Colorado Springs, CO | Retail | $8,969,912.00 | $7,910,038.00 | 4.28% | 1/5/2025 | 88% |
Arapahoe Center |
| Aug-15 | Colorado Springs, CO | Retail | $2,273,906.00 | $1,603,836.00 | 3.94% | 1/5/2025 | 71% |
Union Town Center |
| Aug-15 | Westminster, CO | Office | $7,754,915.00 | $6,074,444.00 | 4.77% | 9/5/2025 | 78% |
West Fargo Industrial |
| Aug-10 | San Diego, CA | Office | $7,697,493.00 | $5,967,580.00 | 4.71% | 9/6/2025 | 78% |
300 NP |
| Dec-15 | Highlands Ranch, CO | Office | $19,274,869.00 | $17,022,587.00 | 4.92% | 1/5/2026 | 88% |
Research Parkway |
| Aug-15 | Fargo, ND | Industrial | $6,874,243.00 | $3,942,804.00 | 6.70% | 8/5/2029 | 57% |
One Park Center |
| Aug-21 | Houston, TX | Retail | $4,715,201.00 | $3,589,108.00 | 4.35% | 4/6/2032 | 76% |
Shea Center II |
| Dec-21 | Baltimore, MD | Office | $8,522,343.00 | $5,670,000.00 | 4.67% | 4/6/2032 | 67% |
Mandolin |
| May-14 | Bismarck, ND | Office | $6,084,032.00 | $3,806,187.00 | 6.35% | 5/5/2033 | 63% |
Baltimore |
| Aug-15 | Fargo, ND | Office | $2,801,682.00 | $0.00 |
|
| 0% |
As you'll see, all of their properties except one that is unencumbered and three others, are above 70% LTV. Unfortunately, many of the near-term maturities have LTVs of nearly 85% - 100%...yikes!
When these loans come due, SQFT will either have to sell at a loss or cash-in refinance to keep the assets.
Excluding the value of the model home division, they have about $20MM in equity above their debt levels. Seems okay, right? Not so fast. I believe the reported value of the assets are significantly over stated. If you take the current rent per square foot and current occupancy levels, multiplied by a standard office expense ratio of 50% and adjust valued based on a market based 7% - 9% cap rate you get a drastically different figure. See below:
Square Footage | Current Rent PSF | Current Base Rent | Percent Occupied (as of 06.30.23) | EGI | Expense Ratio | NOI | Cap Rate | In-Place Value | Equity |
119,434.00 | $14.09 | $1,682,825.06 | 58% | $976,038.53 | 50% | $488,019.27 | 9% | $5,422,436.30 | ($3,837,722.70) |
79,023.00 | $13.75 | $1,086,566.25 | 88% | $956,178.30 | 50% | $478,089.15 | 9% | $5,312,101.67 | ($2,158,980.33) |
44,042.00 | $25.22 | $1,110,739.24 | 80% | $888,591.39 | 45% | $488,725.27 | 7% | $6,981,789.51 | ($928,248.49) |
10,700.00 | $23.53 | $251,771.00 | 100% | $251,771.00 | 45% | $138,474.05 | 8% | $1,730,925.63 | $127,089.63 |
69,174.00 | $20.35 | $1,407,690.90 | 82% | $1,154,306.54 | 50% | $577,153.27 | 9% | $6,412,814.10 | $338,370.10 |
57,807.00 | $26.26 | $1,518,011.82 | 96% | $1,457,291.35 | 50% | $728,645.67 | 9% | $8,096,063.04 | $2,128,483.04 |
121,306.00 | $19.40 | $2,353,336.40 | 62% | $1,459,068.57 | 50% | $729,534.28 | 9% | $8,105,936.49 | ($8,916,650.51) |
150,099.00 | $6.80 | $1,020,673.20 | 98% | $1,000,259.74 | 40% | $600,155.84 | 8% | $7,501,948.02 | $3,559,144.02 |
10,500.00 | $31.37 | $329,385.00 | 100% | $329,385.00 | 45% | $181,161.75 | 8% | $2,264,521.88 | ($1,324,586.13) |
31,752.00 | $21.93 | $696,321.36 | 100% | $696,321.36 | 50% | $348,160.68 | 9% | $3,868,452.00 | ($1,801,548.00) |
93,153.00 | $13.90 | $1,294,826.70 | 56% | $725,102.95 | 50% | $362,551.48 | 9% | $4,028,349.73 | $222,162.73 |
34,517.00 | $16.72 | $577,124.24 | 64% | $369,359.51 | 50% | $184,679.76 | 9% | $2,051,997.30 | $2,051,997.30 |
Once you adjust the value to true market prices, you get -$10,000,000 in equity on their non-model home business. Not great!
Now, you could argue that they'll just refinance their assets instead of selling them at a loss. I wouldn't recommend that. Check out the required cash-in refinance amount they'd need to get a new loan at a more respectable market-based rate and amortization schedule:
New Loan Interest | DSCR | New MTG (1.30x DSCR, 25-year amort.) | Cash-in (out) |
6.75% | 0.64 | $4,527,828.13 | ($4,732,330.87) |
6.75% | 0.77 | $4,435,696.80 | ($3,035,385.20) |
6.75% | 0.75 | $4,534,378.36 | ($3,375,659.64) |
6.75% | 1.04 | $1,284,758.08 | ($319,077.92) |
6.75% | 1.15 | $5,354,810.72 | ($719,633.28) |
6.75% | 1.47 | $6,760,352.71 | $792,772.71 |
6.75% | 0.52 | $6,768,597.21 | ($10,253,989.79) |
6.75% | 1.84 | $5,568,227.90 | $1,625,423.90 |
6.75% | 0.61 | $1,680,813.28 | ($1,908,294.72) |
6.75% | 0.74 | $3,230,224.35 | ($2,439,775.65) |
6.75% | 1.15 | $3,363,741.72 | ($442,445.28) |
6.75% |
| $1,713,453.24 | $1,713,453.24 |
Those DSCRs should be in the 1.20x - 1.30x range. At the higher rate of 6.75%, they come in much lower than needed. There is almost no chance they'll be able to refinance their 2024 & 2025 maturities close to the outstanding balance. Adding these figures up and you'll get to a whopping $23MM in impairment.
So where are they getting this cash from?
Well, they have about $7MM in cash, but they also have a nice model home business and shares of CDT from a SPAC they sponsored. Let's see what those are worth.
In terms of the model home business, they state they have about $15MM in equity there. I think that is a fair estimate and could potentially grow.
They also own 4MM shares of CDT. The CDT SPAC lock-out period ends in March. I envision SQFT will likely sell their shares at that point in time. CDT trades at $2.88, but the volume is basically non-existent. When SQFT looks to sell their shares, I can't imagine they'll be able to do so at that price. Here is a break down of SQFT's value based on different CDT prices.
Stock Ownership | 4,015,250.00 |
CDT Share Px | Value |
$1.00 | $4,015,250.00 |
$1.25 | $5,019,062.50 |
$1.50 | $6,022,875.00 |
$1.75 | $7,026,687.50 |
$2.00 | $8,030,500.00 |
$2.25 | $9,034,312.50 |
$2.50 | $10,038,125.00 |
$2.75 | $11,041,937.50 |
$3.00 | $12,045,750.00 |
$3.25 | $13,049,562.50 |
$3.50 | $14,053,375.00 |
$3.75 | $15,057,187.50 |
$4.00 | $16,061,000.00 |
$4.25 | $17,064,812.50 |
$4.50 | $18,068,625.00 |
$4.75 | $19,072,437.50 |
$5.00 | $20,076,250.00 |
If CDT jumps to $5 and SQFT can liquidate their shares then there is definitely value in owning SQFT. However, at $2.88 a share with no volume and a forced seller in SQFT, I think CDT will trade closer to $1.50 - $2 by the time SQFT sells out.
So, let's assume they'll generate about $8MM from the sale. So putting it all together, we have an office/retail portfolio worth about -$10,000,000 + $7,000,000 in cash + $15,000,000 in model homes + $8,000,000 in CDT stock. That brings us to $20,000,000 in value.
However, aside from the near-term maturities that SQFT has to address and potentially raise cash for, the lease rollover risk on an individual property level is also very bad.
Lease Rollover | ||||
Year | Leases | SF | Rental From Lease | |
2022 | 3 | 62868 | 1084714 | 9.84% |
2023 | 56 | 137273 | 1902590 | 17.26% |
2024 | 20 | 58699 | 1010993 | 9.17% |
2025 | 23 | 130463 | 2084009 | 18.91% |
2026 | 20 | 148168 | 2447014 | 22.20% |
2027 | 15 | 48202 | 843371 | 7.65% |
After | 19 | 97588 | 1650373 | 14.97% |
156 | 683261 | 11023064 | 100.00% |
A number of tenants have already vacated some properties (Genesis Plaza). I expect that trend to continue into 2024 and 2025. That will only further impair the properties further.
Now, at $1.15 a share and 13,000,000 shares outstanding, you might think shares are undervalued. Stock price implied value at roughly $15MM with my estimate of roughly $20MM. But, the capital structure points to a different picture.
SQFT has $14MM worth of preferred equity outstanding that pays over 9%. Though the preferred shares are not debt technically, they are a large overhang on the equity value. Additionally, there are over 14MM warrants outstanding that convert to roughly 1.4MM shares on a cashless basis.
So, putting it all together, with the warrant dilution and preferred equity overhang, there is essentially $5MM left over for equity value. That would imply about 50% - 70% downside.
Prior to a company announced buyback in November, shares were trading in the $0.50 range. The company should use their cash primarily to pay down the preferred equity investment, not the common stock. However, if they do use their cash to pay down the common stock, power to them but they can't avoid the impairment they'll face when they have to refinance or sell their investments within the next 12 months.
I have a modest short position here and hope to cover in the $0.75-$0.90 range.
FYI - this is a very illiquid stock. Whether you are long or short, be sure to position modestly given the volatility inherent in micro caps.