Modiv: Intriguing, High-Yielding, Small-Cap Net Lease REIT (NYSE:MDV)

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Thesis: Lots Of Potential But Cost of Capital Disadvantaged

Modiv Inc. (NYSE:MDV) is a diversified net lease real estate investment trust that recently made its debut as a public company. The name “Modiv” refers to both MOnthly DIVidends and MOre DIVersification, as MDV pays a monthly dividend and offers diversification across property types and tenant industries.

The company now known as Modiv began in 2006 as a commercial real estate crowdfunding platform called Rich Uncles. In 2015, Rich Uncles launched a non-traded REIT focused exclusively on net lease properties, making this fund its primary investment product. In 2018, MDV brought in Aaron Halfacre, former President of fellow real estate crowdfunding website Realty Mogul, as its new CEO.

Halfacre (whose name perfectly fits a real estate career) assembled a new management team, refreshed the board of directors, and steered the portfolio toward institutional-grade quality. In 2019, Rich Uncles’ two private REITs merged, and the combined fund internalized its management team. Finally, in 2021, the REIT changed its name to Modiv in preparation for the eventual IPO in February 2022.

Since then, MDV’s stock has sold off far more than the broader net lease REIT index (NETL):

ChartData by YCharts

Net asset value per share stood at $27.29 in Q3 2021, the last time management reported it. Assuming NAV per share has not changed dramatically since then, MDV is trading at around a 45% discount to NAV.

Moreover, in the Q1 2022 earnings press release, management issued AFFO per share guidance of $1.26 to $1.36 with a midpoint of $1.31. That puts MDV’s price-to-AFFO at 11.6x at the current stock price of $15.25.

MDV’s dividend yield is the highest of any internally managed net lease REIT at 7.5%. But the REIT does carry an above-average debt load, leaving little room to add more debt while keeping the dividend safe.

While intriguing as a high-yielding value stock with potential upside in the case of a revaluation toward the peer range of 13x to 18x, it’s difficult to determine what MDV’s fair value is. For now, MDV suffers from a cost of capital disadvantage that will force the REIT to rely on capital recycling, rather than raising new equity or debt capital, for growth.

For the brave (or speculative), MDV is an intriguing value play. But for the more cautious, the company also offers a preferred equity series that yields virtually the same as the common stock.

Overview of a Net Lease REIT Newcomer

As of March 31st, 2022, MDV owned 36 net lease properties across the United States. However, the second quarter so far has been an active one on the acquisition front, as MDV’s portfolio had swelled to 44 properties that are 100% occupied and leased to 29 different tenants. Around 55% of the portfolio is leased to investment grade credit rated tenants.

Modiv key portfolio metrics

MDV Q3 2021 Presentation

This illustrative breakdown from a September 2021 presentation is outdated, as the exposition of several properties in recent quarters, including three office properties in Q1 2022, has significantly changed the portfolio. Here’s the property type by annual base rent breakdown as of mid-May 2022:

  • Industrial: 46%
  • Office: 35%
  • Retail: 19%

Moreover, MDV’s top three tenant industries are now Automobile & Components (19% of ABR), Pharmacies (14%), and General Retail (11%).

Another significant alteration to the portfolio since September 2021 pertains to the weighted average remaining lease term. Back in Fall 2021, MDV had a WALT of under 6 years, while long-let (20–25-year term) acquisitions since then along with dispositions of properties with short remaining terms has resulted in a WALT of 10.6 years at the end of Q1 2022.

Modiv example properties

MDV Q3 2021 Presentation

Over the past several quarters, MDV has been focused on disposing of office and non-essential retail properties, with a particular focus on minimizing exposure to remaining lease terms of less than 5 years.

Though it is unclear how much of a hit MDV took from COVID-19 (since it occurred before MDV began making public filings), it is interesting to note that MDV’s NAV per share surged 30% from April 2020 to September 2021.

Modiv NAV per share

MDV Q3 2021 Presentation

That said, it is unclear how much NAV per share has fluctuated since then, because there has been a large amount of portfolio turnover. We see evidence of this portfolio turnover in MDV’s cash flows over the past year or so.

Here’s MDV’s fully diluted AFFO per share for the past five quarters:

  • Q1 2021: $0.25
  • Q2 2021: $0.34
  • Q3 2021: $0.44
  • Q4 2021: $0.27
  • Q1 2022: $0.29

In the second half of 2021, MDV sold several large properties, mostly in the office and non-essential retail spaces. The proceeds of these sales were mostly reinvested into acquisitions in the first half of 2022. As such, NAV per share is now probably as high or higher than it was in Q3 2021.

More good news in the midst of this elevated portfolio turnover is that weighted average shares outstanding have gradually declined over the past five quarters, with the exception of the first quarter of this year:

  • Q1 2021: 8.93 million
  • Q2 2021: 8.83 million
  • Q3 2021: 8.75 million
  • Q4 2021: 8.74 million
  • Q1 2022: 10.19 million

The significant bump in shares in the first quarter is associated with the issuance of operating partnership units as currency for the acquisition of a KIA auto dealership in Carson, California. This acquisitions immediately made KIA of Carson MDV’s largest tenant by annual base rent.

Modiv top tenants

MDV Q1 2022 Supplemental

Unfortunately, future dispositions of office assets will likely reduce the portfolio’s share of investment grade tenancy, as many of MDV’s office tenants are investment grade corporations like Costco (COST), Cummins (CMI), and Northrop Grumman (NOC).

Balance Sheet

Like the real estate portfolio, MDV’s balance sheet has undergone a fair amount of evolution in the last year as well.

Between Class C common stock, four classes of OP units, and preferred stock, equity makes up about 53% of total capitalization, while various forms of debt account for the rest.

Modiv total capitalization

MDV Q1 2022 Supplemental

The vast majority of debt (93%) is fixed rate, thereby mostly fixing MDV’s debt service costs in place in the midst of rising rates.

In addition to generating cash for reinvestment, dispositions in the second half of 2021 and early 2022 also allowed MDV to reduce debt.

Modiv leverage

MDV Q1 2022 Supplemental

The drop in real estate value comes from the disposition of four properties in February 2022. Most of the proceeds of this sale were used to pay down $25 million on the credit facility as well as to repay the associated mortgage loans.

Net debt to EBITDA declined from 8.4x in Q1 2021 to 5.2x in Q3 2021, then bounced back up to 6.8x in Q4 2021 and 6.7x in Q1 2022. However, this net leverage ratio is a bit deceiving, because total debt has decreased steadily from $191 million in Q1 2021 to $166 million in Q1 2022. But EBITDA has fluctuated due to the timing gap between dispositions and acquisitions.

Once disposition proceeds are reinvested, MDV’s net debt to EBITDA could realistically settle at around a 5.75x level, which would not be the lowest leverage in the net lease REIT sector but would also not be worrisomely high.

Bottom Line

In 2021, MDV brought in a total of $1.30 in AFFO per share while paying out $1.05 in dividends for a payout ratio of ~81%.

In 2022, management expects to generate around $1.31 in AFFO per share while paying out $1.15 in dividends, marking a payout ratio of 88%.

There are a lot of moving parts to MDV, and I prefer to wait until the portfolio comes closer to its “final form” before I develop a more solid thesis about the company, whether bullish or bearish.

But Modiv’s preferred equity is an interesting high-income opportunity.

Compared to the mere $1 million raised in its common stock IPO, MDV raised far more capital ($50 million) with its 7.375%-yielding Series A preferred equity (MDV.PA), which IPO’d on the NYSE in September 2021. The call date for this preferred series is not until September 2026, leaving over four years remaining until redemption even becomes possible.

Since MDV.PA is currently trading at a price of $24.36, the effective yield sits at 7.57%, slightly higher than MDV’s dividend yield of 7.54%. Though it should be noted that MDV.PA’s trading volume is very light, so anyone interested in buying or selling it should probably use limit orders.

For now, MDV is a hold for me, but MDV.PA looks attractive.

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