Pair Trade in Regency Centers: Short REG and Long REG Preferred

This is really interesting - Zero Hedge has an annotated critique of an RBC research report on Regency Centers (REG), the shopping center REIT.

One funny comment in the report is that REG is "well positioned to recapture much of the lost NOI from the recession" once real estate "regains its footing" (p16). Their thesis is that leases expiring in 2010-2012 are going to roll over at higher rates. Uhh... you can consider me in strong disagreement with that.

Another howler is that "the development pipeline is heavily concentrated in strong long term markets" such as California, Nevada, and Florida. I just double-checked whether this report was written in 2005.

REG has a dividend yield of 5.6%, but in the most recent quarter the dividend payout was 193% of diluted funds from operations.

MRQ net operating income was $76mm and YTD NOI is $159mm, which annualizes to right about $300mm.

Let's talk capital structure. Total debt is about $2 billion. So the cap rate through the debt is 15%, which is solid coverage. REG debt due 2012 yields about 6%.

There are three series of cumulative preferred stock (REG-C, REG-D, and REG-E) which rank equally and total $275 million. All yield about 8.5%.

Market cap is $2.98B, for a total enterprise value of $5.2B. Cap rate through the entire enterprise (NOI/EV) is 5.8%. That is weak for a bunch of shopping centers in California, Texas, and Florida.

I guess my key disconnect with RBC is they expect NOI growth and I would consider them lucky just to maintain present levels. I am personally taking the opposite tack of RBC and shorting REG. I am also buying REG-E as a hedge.

With a cap rate of 8% and generously assuming they maintain $300mm NOI, the enterprise value is $3.75B. That leaves only $1.475B in equity, which would price the shares at $18. The pref is about fairly priced, so I'm looking for a 50% downside on the short, with a positive carry thanks to the yield on the pref. (And the carry will get better when they are forced to cut the dividend.)