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The following segment was excerpted from this fund letter.
Radius Global Infrastructure (NASDAQ:RADI)
Radius has performed about as I would have expected since we’ve owned it – rent growth has increased from around 2% initially to 4.3% last quarter, as the company is benefiting from its predominantly inflation-linked escalators. Radius has also deployed almost $700mm (including all corporate SG&A costs) into acquisitions at a fully burdened going-in cap rate of 5.6%.
When I initially bought shares and interest rates were very low, I estimated fair value for Radius’s assets was probably somewhere around a cap rate of 4% given low churn, inflation-linked escalators, and their triple net cost structure. With rates higher now, I’d say fair value would be lower, maybe around a cap rate of 5%. With 2-3% rent growth and 50% LTV debt at a cost of 6%, that would generate 8-10% IRRs at a constant multiple.
I initially bought shares at a going-in cap rate of ~5% during a period of lower rates. I earlier said I overpaid for Radius, even though we bought shares at what I still believe was a discount to fair value at that time. I say this for two reasons. The first is because increases in interest rates would quickly lower my fair value estimates, and I would expect higher rates at some point so shouldn’t have anchored to the low prevailing rates at the time. The second is that Radius is exactly the kind of stock that will be volatile – it’s small, has significant hedge fund ownership, has leverage, and requires funding for its growth program. With these stocks, you can almost always afford to be patient and purchase shares at discounted valuations. If I had exercised some patience, we would have been able to buy a lot of stock at a large, obvious discount to the value of the real estate this year when the stock price was low.
As I write this, Radius trades at a cap rate of ~5.6%. If we just owned the portfolio of assets and cash flowed them, the results would be very likely to be good over time. We do, however, need to include the impact of the asset-purchasing platform.
The full SG&A burden for the company runs at $50mm / year. Radius has been buying $400-500mm of real estate per year at going-in cap rates in the mid 6%’s, excluding this $50mm of SG&A spend. When fair values were around 4%, the accretion math was clear – $400mm spent at cap rates of 6.5% yields $26mm in rent, which is worth $650mm at a cap rate of 4%, so the $250mm in value creation dwarfs the $50mm of SG&A expense.
However, with fair values now at cap rates of roughly 5%, the math gets a little tighter. I am hoping to see going-in cap rates on acquisitions going up along with higher rates, but last quarter cap rates went down to 5.8%. If you run the same math with $400mm spent at 5.8% with fair value at 5%, then the value creation net of SG&A rounds to $0.
When I initially bought Radius, I had such a scenario where they don’t create any incremental value with acquisitions in mind. The whole reason for Radius to be public is for it to be able to finance growth accretively. If it is unable to do so, it is very likely that they will sell the company to a private buyer. Rumors of a sale have already started, but we’ll have to wait and see if anything comes of them.
The scenario where we would lose is if Radius is buying assets at barely any spread to fair value, the corporate level SG&A is higher than this meager value creation, and the company remains public so that the asset-purchasing platform bleeds money out of the returns from the underlying real estate. Although this could happen, I believe shareholders would force the company’s hand into a sale in this scenario, which should give us upside from today’s levels.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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