Luxor Capital Loves REITs

 | Jan 14, 2013 | 11:30 AM EST
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Luxor Capital, a hedge fund managed by Christian Leone, has reported that it now owns 15 million shares of American Realty Capital Trust (ARCT). This gives it 9.5% of the total shares outstanding, up from a position of 10 million shares reported to the SEC filing in early October. We can conclude that Luxor has increased its stake by 50% in the last three months. According to our database of 13F filings, the fund had initiated its position in American Realty between July and September 2012. American Realty Capital Trust is a real estate investment trust that owns commercial real estate property. Luxor apparently loves investing in REITs (these companies receive special tax treatment as long as they distribute 90% of their taxable income, as defined by the IRS, to shareholders). About a month ago a filing reported that the fund had a large position in CommonWealth REIT (CWH), so Leone and his team seem to like the space.

Income investors are often interested in REITs because of the requirement that they distribute cash to shareholders results in substantial dividend yields. American Realty went public in March 2012 (the stock is up 20% since shortly after its initial public offering, beating the market thanks to a strong rally year to date), and has made monthly dividend payments since that time. Recently, these payments have been a steady $0.06 per share, which annualizes to $0.72 cents, or a 5.7% yield based on the current market price of $12.59.

When analyzing REITs, it is more useful to consider funds from operations (FFO) and adjusted funds from operations (AFFO) and their respective multiples than to look at financial metrics derived from earnings. Funds from operations were $30 million in the third quarter of 2012, which reflects 73% growth from the same period in the previous year. Most of this is depreciation, which is subtracted to reach conventional earnings numbers but as a non-cash charge is often added back when analyzing the cash flow of a business. In the case of real estate, depreciation can be a particularly appropriate add-back as real estate values often increase over time rather than decrease with use, as is the case with equipment.

Adjusted funds from operations were considerably higher than straight FFO in the third quarter 2011, so the growth rate there has been only 33%, but even that is still a solid figure. If we annualize the $30 million in FFO we get $120 million, and the $2 billion market cap results in a price-to-FFO multiple of 17. American Realty was growing its FFO from a low base, and so the growth rates it has been seeing are probably not sustainable, but the dividend yield is quite good and the performance in terms of funds from operations is impressive as well.

American Realty's prospects, and much of the return an investor would get from investing in the stock, depend on the commercial real estate business. That is something of a risk. However, funds from operations have been growing nicely in the past few quarters and the company has made consistent dividend payments, at least during the short time that it has been public. The yield on the stock based on the current price -- and assuming that the dividend payments will not decrease -- is attractive compared to yields on bonds, and certainly compared to the rates that can be earned on bank deposits. Income investors familiar with the nature of REITs (if not, look for an introduction as these stocks are generally an excellent sources of yield) should consider American Realty further.

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