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American Real Estate, Russian Prices

Twenty years ago, a close relative bought several apartments in a residential suburb of Moscow.

Russia was undergoing a severe crisis then. The state had just defaulted on its debt and the ruble collapsed amid total economic chaos. Countless banks and corporations were forced out of business, while former KGB directors were going hand in hand with oligarchs to plunder the country.

To cut a long story short, you couldn’t make it worse even if you tried – though Russians’ creativity is limitless whenever it comes to design inventive recipes for disaster.

Questioned by anxious business partners about his venture, my relative maintained that he couldn’t care less about short-term distress. In average, he was paying three years of net cash-flows to acquire these ideally located properties, so he figured the macro picture might as well take care of itself at some point in the future.

Needless to say, twenty years later this bold investment operation has proven incredibly successful.

History does not repeat, but it does rhyme. A minor difference though: Today these kind of deals – real estate selling for three years of net cash-flows – spring up at investors’ fingertip in the safest jurisdiction in the world – the United States – and within an asset class that until very recently kept being perceived as the ultimate safe haven – commercial real estate.

One such idea would be Washington Prime Group, a listed real estate investment trust spun-off from Simon Property Group four years ago. Here the long thesis is remarkably straightforward: Maximum pessimism, distorted perception, strategic assets, sound balance sheet, excellent management, trading at three times FFO, 17% dividend yield, and a 50% discount – at least – on private market value.

Led by one of the finest professionals in the industry – Lou Conforti, whose unconventional, cow-boy like earnings call will make you burst into laughter – WPG owns 57 million square feet in so-called class B malls. Naturally, these unsexy properties sometimes sitting in the midst of sparingly populated areas are loathed by investors, as an alleged “retail apocalypse” inflamed by the rise of e-commerce rages over North America and eats mall-owners’ lunches.

Yet the facts speak otherwise in the case of WPG. Occupation rates, sales and base rent per square feet remain stable – the latter even increases once the properties get refitted. The portfolio of tenants is well-diversified – the largest weighs 3,2% of rent revenue – and no major lease expiration looms in the five-years horizon.

Lou Conforti has shown in a compelling presentation that class B malls are in fact highly desirable properties, as they often stand out as the main magnet for community life, in particular in rural or semi-rural counties. In that respect, they’re prime targets for profitable redevelopments, for instance into remodeled shopping venues, food courts, theaters or gyms – among other options.

Management claims that said redevelopments yield returns north of 8% to 10%. If proven true, the departure of anchors such as Sears or Macy’s represents an opportunity rather than a risk.

Washington’s sound balance sheet and flexible indebtedness give plenty of leeway, as a thoughtful capital allocation – demonstrated by recent acquisitions and dispositions – remains aggressively oriented towards investments in properties.

At this price, should some major issue arise for good, a distribution cut by half would still imply a dividend yield of 9%. We’ve seen worse, especially in this era of anemic long-term rates. As about private market value, assigning a cap rate twice higher than current practice and a discount of 50% on base rent – better safe than sorry after all – still yields a considerable margin of safety.

To cut a long story short, you couldn’t make it crazier even if you tried.

(Long WPG at an average price of $5,60 a share.)

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