CTO Realty: A small portfolio in all the right places (CTO)

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CTO Realty Growth, Inc. (NYSE: CTO) was founded in 1910 and is headquartered in Daytona Beach, Florida. Although they have a long operating history, it is a newly formed Real Estate Investment Trust (“REIT”), with conversion approved in 2020 and completion in 2021. In addition, its board of directors recently approved a 3 for 1 stock splitwhich entered into force on July 1, 2022.

Currently, the stock is trading at a post-split price of approximately $22/share, representing a forward adjusted funds from operations (“AFFO”) multiple of 12.50x. With just 22 commercial properties in its portfolio, the company is smaller than most competitors. While that may be enough for some to justify the lower multiple against its peers, which are trading at around 15x, there are clear upside opportunities in the CTO.

Attractive spreads between their in-place and leased occupancy levels at their largest properties provide an additional avenue for continued net operating income (“NOI”) growth. Additionally, contributions from their largest acquisition to date, Madison Yards, in Atlanta, GA, should begin to provide immediate benefits to rental income. As these gains are realized, ongoing share price buyback activities should preserve earnings that would otherwise have been diluted by future capital increases or common conversions.

With a dividend yield of nearly 7%, CTO offers investors the right combination of an above-average payout and upside potential for the stock price.

A small portfolio of properties but in all the right locations

CTO owns 22 retail properties, 14 of which are in some of the fastest growing submarkets in Florida, Texas and Atlanta. These properties are primarily focused on food-oriented and traditional/mixed-use properties.

CTO Company Website - Geographic Concentration Map

CTO Company Website – Geographic Concentration Map

In July 2022, the company completed its largest acquisition yet, the Madison Yards in Atlanta, GA for +$80 million. The building anchored Publix is ​​newly built, with an occupancy rate of 98%. Following the acquisition, Atlanta became the company’s largest portfolio market, representing approximately 23% of the company’s annualized base rent (“ABR”).

With an on-site occupancy rate of 96%, Madison Yards should contribute immediately to revenue growth. Additionally, there are 200 basis points (“basis points”) of opportunity in further launches later in the year. This should add attractive additional benefits in later periods.

July 2022 Investor Presentation - Overview of Newly Acquired Madison Yards Property

July 2022 Investor Presentation – Overview of Newly Acquired Madison Yards Property

In addition to its core real estate holdings, CTO also owns a 16% stake in Alpine Income Property Trust, Inc (PINE), a publicly traded pure play net rental REIT. CTO’s revenue benefits from both the dividend payout, which yields approximately +$2.5 million annually, and any resulting share price appreciation. In addition, the CTO receives management fees for his functions as an external manager.

In addition, CTO also has a portfolio of commercial loans and investments, in addition to underground mining interests in the State of Florida.

While the activity of these non-core investments is notable for reporting purposes, they still represent only a small portion of the company’s overall activity. In the first half of the year, for example, management fees and interest income accounted for just over 10% of total revenue. Future growth will therefore depend on the expansion of their core properties and not necessarily these other holdings, which primarily serve as sources of additional income.

Q2FY22 Form 10-Q - Summary of Total Income

Q2FY22 Form 10-Q – Summary of Total Income

Solid occupancy levels with plenty of rental opportunities

CTO’s top tenants include Fidelity, which is their largest by ABR with 6.7% of the total, and Ford Motor Credit (F), WeWork (WE) and General Dynamics (GD). Collectively, these four tenants represented just over 17.5% of total ABR as of the date of the most recent filing period. Of the four, WE is one of the most concerning, given their past history. But they are also ones that could easily be replaced in the future, if needed.

T2FY22 Investor Supplement - Partial Summary of Major Tenants

T2FY22 Investor Supplement – Partial Summary of Major Tenants

In total, the portfolio was 93.5% let at the end of the second quarter. While most properties were over 90% leased, a few were in the 80% range. Furthermore, while the rental occupancy rate is 93.5%, the economic occupancy rate, ie leases not yet started, is 91.3%. The more than 200 basis point spread between the two presents a favorable indication of cash rental growth as these leases come online.

In future periods, CTO will experience increased physical occupancy levels, particularly at certain properties, such as Ashford Lane in Atlanta, GA, where there is a 900 basis point gap between their rental rate and the rate actual startup. Gains in this property are expected to drive RNE growth over the next 18 months.

These future gains will build on the strength of the current period, which included double-digit year-over-year growth in the NOI, FFO and AFFO. NOI increased by 13%, excluding one-time items, while FFO and AFFO increased by 60% and 38%, respectively.

These gains are partly attributable to a combination of contractual rent increases and the effects of new leases coming online during the period. CTO also benefited from a favorable leasing environment which included the signing of over 40,000 square feet of new leases and renewals at slightly higher spreads than prior period rates.

A healthy turnover schedule also provides an attractive opportunity to reset rates closer to their current weighted average rate of $31.82/sq.ft. In 2023, for example, 25 leases expire at an average price/square foot of $22.62. Even at their current average renewal rate of $29.28, this still presents an attractive go-to-market opportunity.

T2FY22 Investor Supplement - Lease expiry schedule

T2FY22 Investor Supplement – Lease expiry schedule

In addition to the many internal growth opportunities, management still expects to opportunistically acquire additional properties to its portfolio. This is reflected in their full-year guidance, which has been revised up across the board due to their current year-to-date performance. Total acquisitions for the year are now expected to be +$250M at the low point, which would be +$50M higher than their prior guidance.

Release of T2FY22 Results - Revised Guidance for 2022

Release of T2FY22 Results – Revised Guidance for 2022

A flexible balance sheet with limited debt risks

For a smaller REIT, CTO has enough flexibility in its balance sheet to support additional expansion activity. Their net debt multiple is quite high, at 6.6x, but there are no significant short-term maturities and their exposure to floating rate debt is minimal. Additionally, at the end of the period, CTO had over $100 million in cash on hand, which is more than enough to cover its short and medium-term obligations.

T2FY22 Investor Supplement - Debt Maturity

T2FY22 Investor Supplement – Debt Maturity

For income investors, an investment in CTO comes with a quarterly payout that currently yields almost 7%. At an annual rate of $1.49/share, the payout is approximately 88% of the lower end of forward AFFOs. Although it’s on the high side, it’s still fully covered. In addition, the ratio should improve in future periods thanks to the growth of AFFOs. While investors are unlikely to see an increase in payout anytime soon, the current yield is still more attractive than what one could get in many other stock-based alternatives.

Current dividend and share price upside potential presents an attractive value proposition

CTO is a newly formed REIT that is smaller than most peers. Their core portfolio consists of just 22 properties and their current market cap is less than +$500 million. Low trading volume further constrains the stock to a narrow trading range. While this can be frustrating for those looking for an upside, some comfort can be found in the quarterly dividend payout, which is currently yielding almost 7% at the current price. Although the stocks have not yet experienced significant appreciation, this does not mean that they will remain in their current holding mode.

The recent large-scale acquisition of the Madison Yards property in Atlanta, GA is likely to provide accretive benefits in later periods. Attractive spreads between their in-place and leased occupancy levels at several of their key properties also provide an extended avenue for NOI growth, which is already in double digits. A healthy turnover schedule provides even more opportunities for rental growth.

These are just a few of the drivers likely to contribute to significant earnings growth in future periods. For those concerned about earnings dilution through common capital increases or conversions, the ongoing buyback activity should provide the necessary preventive safety net.

At an assumed future dividend yield of 6%, the shares would be worth approximately $25, which would represent a forward multiple of AFFOs of 14.6x. For a smaller REIT operating in some of the country’s fastest growing submarkets with plenty of organic growth opportunities, this is a reasonable multiple. With the potential for share price upside of more than 10%, in addition to an above-average dividend yield, there is an attractive value proposition in CTO for those looking for an alternative REIT for their portfolios at long term.

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