I recently got burnt from a stock which I bought earlier in the year. I didn’t blog about this because at the time I thought it was somewhat too speculative and risky for this blog (and on hindsight wondered why I idiotically made the punt). The stock I bought was RNY Trust, a REIT with a portfolio of commercial office properties located in the New York Tri-State area.
The shares were bought at an average price of 12 cents and are now trading at 4 cents, a whopping 68% loss. The only silver lining is that I didn’t allocate too much capital to this investment.
I thought it would be helpful to write a post mortem so that I hopefully don’t repeat the mistakes.
RNY listed on the ASX two years prior to the GFC with an IPO price slightly above $1 and after the GFC its shares traded at a range of 75% to 90% discount to its IPO price. The share price never recovered as RNY had two anchors holding it down; first it’s gearing levels was a product of the pre-GFC era and far too high which meant that it could not afford to pay a dividend and secondly demand for its office properties which were located in the suburbs were falling. The trend with the millennials was that they preferred to work in CBD areas and that suburb offices were just not desirable.
When I acquired RNY Trust in April 2016, the share price had dropped about 50% from about 25 cents to 12 cents after the release of it’s FY2015 financial report in February 2016. The share price fell as a result of management writing down the value of the property portfolio by approximately 14%. The thing that interest me was that management was going to wind down the trust over a period of 18 to 24 months and with a reported NTA of 35 cents and the share price trading at 12 cents, it could be an opportunity to profit.
My main concern was whether the carrying values of the property reflected actual market values. I tried to mitigate this risk by performing some desktop research on comparable property sales and being quietly confident on the newly engaged valuers Cushman & Wakefield (C&W). I had assumed that the valuation was conservative as it had resulted in the write down of the carrying values and was performed with the knowledge that the assets would sold in the near future. Surely, the valuers would want to avoid looking silly or worse negligent if the actual transaction value were materially lower than their valuation.
Once I was comfortable with the carrying values of the portfolio, factoring in transaction and winding down costs for RNY, I figured that there was an adequate margin of safety at 12 cents. I had missed the forest for the trees. My margin of safety calculation was based on the assumption that the carrying values were good even though I knew that if the transaction value was 5% lower than the carrying value, this would wipe out my margin of safety.
For the period between the FY15 and the HY16 results, RNY announced a further write off to the carrying values by 4.7% after getting C&W to value the remaining properties (which were not valued by C&W in December 2015) and that RNY would step up a gear with the sale of the portfolio given pressure from its lenders (a covenant had been breached).
In response to the further write down, I recalibrated some of my transaction and winding down cost assumptions after speaking to management which enabled my calculations to still show a margin of safety albeit reduced.
RNY recently announced that they had received bids for 12 out of 19 assets of the trust and on average, it represented a 13% discount to the carrying value. The share price immediately fell more than 60%.
So what did I do wrong?
The first mistake was I did not fully understand the property market in the New York Tri-State area. Although the portfolio had an average occupancy was 72%, some of the properties had occupancy levels as low as 25%. This was a warning sign I ignored.
Another mistake was ignoring the level of gearing and putting too much confidence on the carrying value of the portfolio. Before I invested, I knew that a 5% drop in the carrying value would wipe out my margin of safety due to the high debt levels. After the HY16 write down, RNY was around 80% geared.
Finally, the last mistake was psychological. Even though management gave another warning in the HY16 report by further writing down the portfolio and knowing that a forced sale scenario may entice opportunistic buyers, I responded by changing my transaction and winding down cost assumptions rather than changing my stance, a classic consistency principle in psychology. The psychological bias is to remain consistent with an earlier decision or conclusion even in the face of contradicting information.
The low occupancy levels for some of the offices and high gearing levels should have been reason enough to stay away. Although I knew it was risky (risky enough not to blog about it) I still decided to punt anyway, which was stupid.