As I come across various stocks, particularly in the dividend sector, I’ll find myself staring at a situation that may either prove to be a multi-bagger in the making that pays a generous dividend — or a company headed for bankruptcy. These are the kinds of speculative plays that can turbocharge a portfolio. If you are right even 1 in 5 tries, you will wipe out whatever you lost in the 4 bad choices and make a sizable profit to boot.
Northstar Realty Finance Corp. (NYSE:NRF) is one such play. This REIT invests in the real estate debt business, acquiring, originating and structuring debt investments secured primarily by income-producing real estate properties; the real estate securities business, which invests in commercial real estate debt securities, including commercial mortgage-backed securities, REIT unsecured debt, and credit tenant loans; and the net-lease properties business, which acquires properties that are primarily net-leased to corporate tenants.
The company has been aggressively investing in each of these areas. As of earlier this month, NRF held $376 million of investment-grade CDO bonds at a $258 million discount to par. It is doing AAA-rated loan originations in CMBS investing. And it also has a commercial real estate portfolio consisting of $404 million of suburban office retail and industrial properties, plus $552 million of health-care properties. The lease portfolio is 94% leased, with a 6.4-year weighted average in lease terms. The health-care portfolio is 100% leased.
So why is the stock at $5.50? You may recognize that these are the types of investments that were a large part of the financial crisis, so the market is very skittish about them.
Things have changed quite a bit in the world of real estate securitization, and people have learned their lessons about the underlying value of properties. Northstar’s primary concern is the cash flow generated by its properties, which needs to be enough to to pay the interest on the credit NRF draws down to purchase these debt investments as well as produce dividends for shareholders. Given that NRF just raised its dividend again, management certainly seems confident of the company’s cash flow. In addition, the bonds NRF holds are at a huge discount to par, so there’s potential for big gains there.
The risk of this investment is that the value of the underlying properties may not be what they’re projected to be; that their AAA ratings may not be accurate (I remain suspicious of the rating agencies, which were a major reason for the collapse of the derivatives market); that tenants could default on their lease payments; and that when leases expire, tenants may not renew.
That might not sound like a lot of risk, but it is. That’s why the stock is at $5.50. That’s also why the common dividend is at 9.5%. It doesn’t take too many mistakes to cause the whole thing to collapse — that’s the downside of being leveraged.
But here’s why this play may appeal to some investors. If Northstar has played its cards properly — and its expertise suggests that’s the case — then this may be an extremely undervalued REIT with the possibility to return three or four times your investment, in addition to the dividend.
Those who don’t want to take on so much risk may want to consider the company’s Series A and B Preferred shares. Series A trades at only 2% below par, which suggests that the market believes the company is stable, and also pays an 8.9% dividend. Series B trades at an 8% discount to par, with an 8.95% dividend. Since common dividends get suspended before preferreds , you’ll be in a better position, with less stock price volatility.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
