Podcast #82: Ari Lazar on $KW
Ari Lazar, senior analyst at RGA, discusses his investment thesis for KW.
You can find my Twitter thread on KW here, and please follow the podcast on Spotify, iTunes, or most other podcast players, as well as on YouTube if you prefer video! And please be sure to rate / review the podcast if you enjoy it, or subscribe to this Substack (it’s free!) to get all new podcasts and transcripts delivered right to your inbox!
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Transcript beings below
Andrew Walker: All right. Hello and welcome to the Yet Another Value Podcast. I'm your host, Andrew Walker. With me today, I'm excited to have Ari Lazar. Ari is a Senior Analyst at RGA Investment Advisors.
Ari, how's it going?
Ari Lazar: It's going pretty good. Thanks for having me.
Andrew: Hey, thanks for coming on. Let me start this podcast the way I do every podcast. First, just a disclaimer to remind everyone that nothing on this podcast is investing advice. Everyone should do their own due diligence. I know Ari's going to have a position in the stock we're going to talk about today.
The second way I start this podcast is with a pitch for you, my guest. You work with friend of the podcast, one of my friends, Elliot Turner. Anyone who's good enough for working with Elliott is good enough for me. That's about as good as a recommendation as it gets. We've also talked several times. I find you to be a shark investor. We're fellow back holders of the Angie's List Back Holder Club, so we really got to watch out for each other. I'm just excited to have you on. That out the way, let's turn to the stock we're going to talk about. The company, it's Keller Williams. The ticker is KW, and I'll just flip it over to you. What's so interesting about Keller Williams?
Ari: It's actually called Kennedy Wilson, sorry.
Andrew: Oh, my God. I think I saw a KW, and in my head, I think of stocks in their ticker, not the company, which I know is probably bad, but I think I was-- Kennedy Wilson, I've looked at these guys forever. I tweeted out the [inaudible] to prove I looked at it. My bad. Go ahead.
Ari: Oh, no problem at all. Yeah, I make those kind of mistakes all the time. Kennedy Wilson, they are a real estate investment firm. They are not structured as a REIT which we should definitely talk about down the road. What they do is they invest in multifamily properties. They invest in offices, and to a smaller degree, retail and commercial infrastructure, which is mostly e-commerce infrastructure. They also have one hotel, currently, although they are in the process of developing another one. I think they actually might have just acquired another one. Multi-family is their main focus. They are based in the US, however, they have a lot of European investments. Geographically speaking, they're high court in California. They've got investments in California, the Pacific Northwest, so I think like Seattle, Portland, Oregon area. They have the Mountain Stage, which is a huge focus of their portfolio right now, so think Colorado, Boise, Idaho, Utah. On the European side, most of their investments are in the UK and in Ireland, London, and Dublin-based for majority of those.
Andrew: Cool. Lots of different stuffs to talk about. I just want to start. Again, Elliot's been on the podcast, you and I have talked before. KW is a little bit different than what I feel like you guys normally look at... Oh, of course, my light shuts off as we're doing this.
But KW is a little bit different than what I feel like you guys normally look at. Most of the stuff we've talked about, Angie's List, which is a burgeoning marketplace, IAC. Elliot will talk here about Roku, these types of thing which are more internet-scale businesses, whereas it's an interesting sum of the parts story. But, it's real estate, they've got a burgeoning as a manager. But what particularly attracted you to KW? And then I'm going to use that to transition into a couple other things about sum of the parts
Ari: Yeah, absolutely. So with RGA, definitely talking about Angie gets a lot more attention on Twitter and I feel like maybe those are the most interesting to some degree, stocks, but we are generalists and we focus across the entire spectrum. There's a lot less to talk about maybe are less internet-related or tech-related positions, but we have those and KW is a great example. At RGA our three focuses are quality, growth, some form of growth [unintelligible], and reasonable valuation. Kennedy Wilson checks all three of those boxes. And so, we're fascinated with it. The thing that makes us most excited not only is that we think it's an incredibly high-quality real estate business with high-quality assets, really well-managed and it's really run by McMorrow and the whole team in such a value investor way. I don't know how they find these yields, but you're always seeing them-- if you look at the last five or six press releases, they've had and it's like, "We just bought an asset for a 7.5 cap rate. We just sold an asset that's very similar for a 3 cap rate", and it's like they get it. They're value investors themselves so we relate to that. And then KW, we like to think of it-- they were in a growth gutter, or no longer, but since between 2017 and Q2 of 2021, they were in a growth gutter. And we should definitely talk about this more, but we're very fascinating with our frame markets. We saw that turning that they were returning to growth. And that got the understanding that put that very much in our radar. It got us excited. And is part of the reason I wrote it up on our last letter and that we're so excited about it, and why I'm here talking about it.
Andrew: Perfect. And I'll include RGA's Q3 letter in the show notes. The back half of the letter is all KW all the time so people can definitely dive into that. I guess the best place to start, so there's gonna be a lot of questions, you know I put all my questions out on Twitter, there were lots of questions and responses there. But I think the best way because again, this is a company that mainly owns their real estate and they have a burgeoning asset management business. And valuing an asset management business is a lot different than valuing a real estate business. But I think the best way to start would be, let's go through the different sum of the parts here, start doing an overall value framework which I think will get people to why you're excited about it. And then we can go to some of the pushback. So [crosstalk] people can look at my Twitter thing. The company is really helpful and that for years, because I've got notes on these guys from 2017, 2018, they've always published a basic, "Here's each of our parts, you can make your own assumption but here's how much income each of our parts do." But let's just go through it. Let's do a sum of the parts on KW.
Ari: Perfect. Yeah, so I think, right before we get into this, it's really important to give maybe a little history of the company. [crosstalk] I think that that would fit really well right here. So it started in the wake of the 1987 market crash. I think in 1988, McMorrow kind of started that. He purchased an auction company. An auction company was important because they have relationships with banks, and he wanted the best deal to get from banks, defaulted real estate. The name of the auction company was Kennedy Wilson but that's not part of the business anymore. So he had been focused mostly on initially in US real estate. Somebody on Twitter asked they did dabble in Japan,
they're not involved there anymore. I don't think they've been involved there since 2015.
Andrew: Yeah, I was surprised when someone asked because I've loosely followed this for a couple years, and I don't remember a lot of Japan talk on this.
Ari: No, I had to look that up because I heard that at one point, but yeah, that wasn't something I read anything about. Okay, so then in Europe and this is a really fascinating part of their story, they started investing in Europe I think around 2014, I might be a year or two off there, but they took a minority investment and that grew the way public entity KWE [crosstalk] Europe. And then in 2017 right in the heart of Brexit, true value timing guys, they came in and they bought the remaining 75% of the KWE that they did not own of the European assets. Took that under KW.
Andrew: Ari, can I pause there for one second?
Ari: Yeah, sure.
Andrew: Because again, I've loosely followed this for years and I remember when KW took over KWE. And I also remember a lot of KWE shareholders saying, "This is ridiculous. You're taking us literally out at the bottom" which, you know, as a KWE shareholder we love. But it does remind me a little bit-- I don't know if you ever looked at Brookfield Asset Management, but, you know, one of the issues with Brookfield Asset Management is they are great at creating value but if you invest in anything at Brookfield aside from Brookfield Asset Management, they've got a bunch of malls publicly traded, right? Then covid hits and the malls are trading for pennies on the dollar. And sure enough, a month later Brookfield steps in and buys all of the malls for minority shareholders in basically a compulsory bid. Takes them all out at the bottom. I think they're going to create a lot of value there. And I think one of the pushbacks with KW would be, and we can also talk about Fairfax involvement here because Fairfax has been kind of involved [unintelligible]. But when you look at that KWE deal, I say, "Oh, well, if I'm on the KW side, I'm really happy about this." But if I'm a KW minority shareholder, I'm looking at the deal and saying, "Why couldn't that happen to me a couple years from now? Where I don't know, KW, you know,
goes private right before there's a big trend. Are they really going to be looking out for minority shareholders? Does that make sense?
Ari: Well, I believe that they will because if you look at the stakeholders, yes, at one point I don't think-- I don't know what was going through their heads as that structure emerged, having a portion of minority interest in KWE, they were minority shareholders when they bought it. So they bought it, I mean, it shared a name. I think it's maybe a little different than some of the Brookfield stuff. But in terms of what the stakeholders look like today, you have shareholders. Kennedy Wilson, I believe close to 10% is held by the CEO himself.
Andrew: That's right.
Ari: It's a huge portion of his wealth. Then Fairfax, one of their asset management partners owns 9% of the company so they're very tied in that sense.
You can tell they're big fan of the business. So you have the shareholders, you have the investors that are investing in the asset management platforms and there really aren't any other vehicles out there that would be at risk of something like that so I wouldn't really be worried about that. I don't think they were really thinking, "Let's go screw our European investors," I think they were thinking, "We have a chance to buy this asset. We already own a minority of it. Let's buy it for what we can get it for today." And that's what they do. And I would not want to be on the other side of any of their deals, to be honest. So yeah, I'm a shareholder because I want to be on their side of all the deals.
Andrew: Perfect. Perfect. So I think the KWE deal happen in 2017, so what do you think is from 2017 to today?
Ari: Yeah, so they had been aggressively growing their NOI, their balance sheet. Everything had been aggressively growing from when they went public in the wake of '08 until 2017. And then out of that, that is when two things happen; number one, they had to digest that. That was a huge acquisition for them. [crosstalk] They were digesting that. They had to divest some things they didn't love. They had to change things around. They had to make it fit them. And number 2, KW is always thinking about mid to long-term decisions on where they want their capital, where they want their properties to be. They were heavily invested in California, they still are. But [unintelligible] way more [unintelligible]. In 2017 two things happened; They simultaneously decided they wanted to cut their California exposure and that they want to increase their Mountain State exposure. And there are many reasons for that. Some of the reasons being like, you have really high taxes in California, very high valuations at that time, there still are, you're looking at 3 cap rates across the board.
Ari: And just general, they didn't see much upside and they wanted to turn those assets over so they've been selling those assets since about 2017. They've been buying for much, much more attractive cap rates. I mean, they were like the first big player to get into Boise, Idaho. They like to compete where REITs are not playing, they like to be the only ones there. And I think you're just starting to see REITs come into the Mountain States which are still pretty fragmented. And I mean, there's a chart of the write-up, but like, four of the six fastest-growing states are Mountain States [crosstalk] in terms of population. Especially with covid trends, work from home, people want more outdoor space, people want cheaper real estate. You have those populations growing like wild. And I mean, the real estate can barely keep up. There's so many projected shortfalls in real estate which is all really attracted. You have similar things happening in Dublin from Brexit. They're still very invested in the UK, but they've been focusing more on Dublin. And Dublin is interesting because out of Brexit you have-- London is no longer going to be part of the EU, and if a company wants to have an office in the English-speaking city in the EU, that was London, that's going to be Dublin. Dublin's a very popular tax haven. I believe Google might be headquartered there, I'm not sure about that, but I think so. I think a lot of companies are. [crosstalk] I mean, a lot of companies are headquartered there. So Dublin is growing very quickly, lots of projected shortfalls in housing is in Dublin. And they find that dynamic very attractive both for office and multi-family. Before we end finally into the sum parts very soon, what's been happening is since 2017, Andrew, we call the growth gutter, they've been net sellers of real estate because they're selling their California property. Yeah, they're investing in the Mountain States, they're continuing to invest in the Seattle area there but mostly focused on the Mountain States, focused on Dublin. And you go from a company that's like growing their NOI very consistently, very quickly, like mid-double digits, some years, high double digits close to triple digits, and then bam NOI right after that acquisition starts going down and that there's net sales every year. And then kind of right when that trend was like about to reverse [unintelligible] The largest asset that KW owns is the Shelbourne, it's a hotel. It is where the Irish Constitution was signed. It is extremely iconic, extremely high-end. There's all sorts of ghost stories. I can't think of a better hotel to own on the planet. I mean, I'm sure there's things equally as good but not many. And the earnings profile on that asset got obliterated during covid, it still hasn't recovered. Its started to recover but nowhere near the pre-covid levels. It will recover when covid's not an issue. There's no doubt in my mind that it will be back to at least where it was, if not more. And so that wasn't good for growing NOI despite that NOI hung in there in 2020 [unintelligible] from 2019. Now, we're back to the point where they're growing NOI on Q2 and the earnings-- there was a large amount of urgency for management. IR communicated to me that they intend to be met and [unintelligible] going forward. You're seeing a lot of press releases on acquisitions. They made a really interesting acquisition in California right adjacent to a property they own housing on a campus. I don't remember the name of the university. They have synergies with amenities. They're going to develop more land there. They're going to take over a lot of the university's housing which I'm very excited about because they have the adjacent asset. They already have a team, should be a great deal for them. And then I guess something that they're always thinking about on top of all this. I mean, this is net buyers net sellers, on top of all this minus covid which is obviously a really rough year, within their disclosures you can break out what their same property growth is. Historically, they've averaged mid-single digits, and their strategy for this is to be doing, I guess, constant improvements. They're the dog-friendly multi-family apartments. They're the ones with the pool, the gym. They want to be the ones that you pay a little bit more for but get a lot more out of them. They want to constantly be making it better and raising the price that you're more than willing to pay. And so they're able to do that. And they've been doing that and I think they'll continue to do that. So these are the growth tailwinds. And then we should definitely talk about their affordable housing which is probably one of my favorites sub-segments. We should talk about that when we talk about REIT structure. But anyways, let's get into the sum of parts now.
Andrew: Let's do it. Let's do it. So people can see my tweet, it's the second or third tweet in the things I put out. They literally give you "Hey, here's our net operating income broken down by--", you know because if you've got net operating income from a hotel versus an apartment building, you're going to value those very differently. They literally give you, "Here's our net operating income from hotels, multi-family office all that. Here's our cost basis for all of our development programs. Here's how much we're getting as--". So they give you the parts. So let's walk through the parts and come up with kind of how you think about the value for KW.
Ari: Perfect. So the first segment, let's start with is their mature income-earning real estate. So, the way that I think about valuing that is with a cap rate. Multi-family's a larger segment. I think that a 4 cap rate is conservative yet fair. Think we were working with a slightly higher cap right there in the RGA write-up, but I'm pretty comfortable. I mean, they're there in California which probably has the cap rates in the 3s based on my conversations with professionals there. I've heard even lower but I don't believe it. [crosstalk] Mountain states where they have both California Mountain states or like I think about--California's about a quarter of the multifamily, Mountain States are about a third. Then the Seattle-Portland area, talking to real estate professionals, I definitely have heard below 4 across the board there, that's about a third. And then Dublin is the rest. And Dublin I've heard below 4 as well, minimum because definitely population growth is not being offset by housing growth. So I think 4 is really fair. And some contest, one of my buddies who's a real estate investor, all he focuses on it's like investing in real estate and a lot of
multi-family, and he was telling his team was looking at a deal in the heart of covid at a vacant dorm room for our college of [unintelligible] sure was going to survive the pandemic at a 4.25 or 4.5 cap rate. And that's like what the market is. --
Andrew: Ari, Ari, I think we're losing you. I'm just going to pause it real quick. All right, we had a little bit of technical difficulties, but we're back. Ari was just going through his friend was bidding for. I believe it was a college mixed-use facility at like a 4.2 or 4.5 cap rate kind of during the heart of COVID, but please continue.
Ari: Yeah, I think it was like an unoccupied dorm for a college that was closed for covid, wasn't sure if it was going to reopen. And that dorm was sold or was going to sell for like a 4.25 or 4.5 cap rate. And so if that's where the market is on, then that makes me pretty comfortable with the 4 cap rate in the multifamily. And on top of that, a lot of people on Twitter asked about inflation. And in fact, what happens if cap rates will worsen and I think that using the valuation assumptions I'm using, I think I'm building a lot of [unintelligible] for that.
Andrew: Yep. So just quickly, so right now let's say he was saying buy something at a 5 cap rate. That's a 5% yield it's equivalent to paying 20 times earnings for something. People worry inflation goes up, a 5-cap rate becomes a 10-cap rate so, in effect, you're multiple went from 12 to 10. Your value got cut in half. That's what people worry about because cap rates and yields are very closely connected to each other. So that's perfect. So, yeah, multi-family 4% cap rate. I think that makes all the sense in the world. What else is in the sum of the parts?
Ari: One quick point on the inflation as well. I think that's something that makes us comfortable with it being, yeah, I mean, interest rates move, cap rates move a little that's fine. We built that into our underwriting valuation assumptions. But if there's like a true inflation motion, I would love to be owning real properties on real estate because those assets will be just fine. Their real assets will grow, the valuation will grow with inflation because people need to buy housing, so yeah. Anyways, next point on the sum of the parts is office. It's the second-largest segment. And within the office segment, I'm working with a much higher cap rate. I think it's like the thing I'm using about a 5 1/2 cap rate, which I think is generally considered, based on my conversations in the industry standard, may be a little conservative.
Ari: However, I think they have very high-quality assets. Here, I got a spreadsheet on the side here that [crosstalk]
Andrew: That's a real pro move on a podcast. Pull up the Excel spreadsheet.
Ari: Yeah, well, here we go. About 30% of their office assets are in the US so about half of that's in California, and half of that's in Seattle. Their Seattle assets-- they're renting to like really, really high Costco, Amazon. They're renting to amazing companies that need headquarter offices. They're headquartered there. Those are really good office assets. They're California assets, they own their own headquarters. They know the area very well because their headquarters are there. They're laid there. They've some really interesting assets that have to do with research labs. Obviously, not something that can be work from home. [crosstalk] You need to go in and get your hands dirty in the scientific experiments. So the US office assets, I'm confident are very high quality. So then in Ireland, they have about a quarter. That is a very hot growing office market with Brexit's fallout with a lot of companies needing to put headquarters there not to mention the tax havens and whatnot. So Dublin is a booming city right now, great place to be in offices there. Well, others like less than 10% so that's not even worth discussing. And then the UK's about 40%. Within the UK, their office assets are largely in the London area. There's some spread out, but largely in the London area. And this is the other side of the coin of that Brexit scenario. However, London is still a first-class city. The economy there is still plenty strong, plenty of jobs, plenty of people go into offices. And across the board, they're like in the mid 90% in their office occupancy. That dipped a tiny bit I think with covid, but not too different than pre-covid, didn't dip too much. And they have offices that are rented out and that are occupied. Now, what's really interesting about some dynamics in at least the British or the UK office markets is that your typical leases there are extremely friendly towards the owner of the real estate where you have all these options to increase the rent if market rates have gone up. But if rates have gone down, the rate doesn't change. So that's really friendly. Second of all, the typical leases there are, I think like over 10 years, maybe like 14, 15 years, 12 years something like that, the typical leases are like that. And so, what really affects your cap rate in the London office market really is how many years are left on the lease. If you have a lease with a few years left, you're going to look at a mid to high single-digit cap rate because you have to find a new tenant to sign a really unfriendly lease and whatnot. Now, on the flip side of that, if you're a patient investor you know the area, you've got boots on the ground, a phrase that KW uses quite a bit, they have that and they know how to find tenants there. They have people that they've been renting to, and they know the market very well. Now, what they do is they arbitrage this like any great value investor. In Q2, there was a press release of them buying an office asset in the UK area for like a 7.7 cap rate and then selling a different one for a 3.5 cap rate. I would not be surprised if the term of years remaining on the lease for that 7.7 cap rate we're just a couple of years and the 3.5 cap rate was something that just got renewed.
Ari: So they're the ones who don't go do that work. They'll get their hands dirty and that's why I'm confident in a 5.5 cap rate. I think that their average duration in those assets are definitely somewhere in the middle there. And I think 5.5 cap rate makes sense. That was a long answer to that one but [crosstalk] interesting stuff. Perfect.
Andrew: Look, I don't disagree with you, and actually one of the things because I've been following this for a while, you can go to their 10-K and it's not for their actual producing assets, but it's for their development assets. And they give you, "Hey, here's the range of cap rates that were using to think about our development assets". And the numbers you just gave me are square in the middle of what they use. We just did multi and office. That's 340, 350 of Annualized Net Operating Income [crosstalk] I've got their NOI at 4.10 or so for the developed stuff so I don't think we need to go through the rest of it. We've covered by far the majority here. But so what you're seeing is multi at 4%, office at 5 1/2%. That produces, I don't know, 9 billion or so, a value in total for the developing segment. Am I kind of doing that math right?
Ari: Yeah. Well, actually, let me correct myself here. I think I'm working with a 5 cap rate for the office.
Ari: So yes, but I actually--
Andrew: What's a half percent among friends?
Ari: No, that's actually a big deal with this stuff. But yeah, I know I'm working with a 5 cap right there. But I don't think 5.5 is crazy, I don't think 4.5 is crazy. I think it's the range that works.
Andrew: But let me ask you another question here. And this is something I always worry about when I look at these and actually will come into another question I have on net asset value later. But you just said, "Oh, I said 5 1/2% cap rate. I'm actually using 5% cap rate." And, you know, one of the things I worry about is when you look at real estate, when you get to these small of cap rates, right? 4 versus 4.25 versus 3.75, like a small change in cap rate makes such a difference in the valuation, right? Because [crosstalk] going from 5 to 4, that's literally 20% boost to your property and it's not that big a change. So I worry, I start getting into my head about, "Hey, am I just garbage in garbage out in this?" Right? Where, "Oh, I had it at 5.5 but I thought that was conservative. So why not 5.25?", and I do that and all a sudden my value's 10% higher. And you know, what was a hold or kind of fairly valued becomes really undervalued. Do you worry about that here?
Ari: Yeah. So I think that that's when it comes to margin of safety being the keyword. You have your assumptions, you get to a value and if the value I'm coming out with is 48% above current market price then I'm not terribly worried about a half a turn, or a turn on those things. And I think that what it really comes down to is, yeah, if you're going to pitch something arguing, that it's a [unintelligible] because it's 1% undervalued but then you make that quarter-turn, half-turn and that makes a difference then you're really just probably not playing the right game. And I think there's so much more to this story here than just what does the valuation come out to. And I have a valuation background, I worked as a valuation analyst for about 3 years before switching over to the buy-side. And I think that it's so easy to get lost in the weeds here and it's really important to have an opinion on these things. I think it's more important to have a reasonable range. And when things get interesting or when you have like this, this is my range of outcomes and it's priced here, but it's like worth here. So if it's priced here but it's worth here, that's when things get interesting. And if they're doing things to add value on top of that, that's when it gives you a more margin of safety. And I think it's something like, why growth is important? Because it can bail you out of problems like that.
Andrew: Okay, so we just did their operating net income-producing assets, you know, we said 4% cap rate on multi, 5% on office. The other stuff is small, you can play around with it. But probably comes out of the 410 million in NOI that I think their run rating right now probably comes out to 9 billion or so of value. Let's switch to the development assets. They've got, I think it's about $1.5 billion of book value and development assets. In my head it just to make this conversation pretty quickly, I've always just valued those at book when I look at them. I think you could make an argument they're worth more than book. I'm sure there's an argument they're worth less. But how are you looking at that 1.5 billion of assets?
Ari: So in Q2 of 2021, the company came out with some new disclosures here that really helped clarify that picture. What they did was they told investors exactly how much NOI they were expecting, the stabilized outcome to be, and which year they would hit their [unintelligible]. So they actually fed it to you on a platter exactly when it's going to hit, how much it's going to hit. And so it actually made it, for me, if finally made it so I could value it in that sense, away from cost basis. We just talked about what sort of cap we're going to be using for their assets. Yeah, I come out to about 9 billion in value for their global portfolio. And then when you look at what I think these assets will be because I think the assets that they're developing are just as high quality as the ones that they have so I'm using that same cap rate. However, on the average time until that those earnings are going to hit their stabilized profile is actually like, almost exactly two years. So I discounted, I took that value of slap on that cap, right? And then it's two years from now. I used a 10% discount rate--
Andrew: That's way too hot for real estate though I guess it's development real estate.
Ari: Yeah, you know, I'm trying to-- what if there's a delay, as probably too. But yeah, I think that's conservative. And I think that there's plenty of upsides there and I think that yeah, I'm really trying to work with assumptions that make it really hard to lose here. And-- [crosstalk]
Andrew: Not to be a 10-K junkie, but I think if you go to page, I'm looking at right now, page 89 of their of their 10-K, they actually give you how they discount their development assets and it is lower than 10%. So, conservative.
Ari: Yeah, their mindset for when they do development since they're trying to work back from between I think it's like something in like 6-7% yield range is what they target with their development. So, yeah--
Andrew: I said about a billion and a half book value here, when you do your math what valuation do you get for that?
Ari: Yes. So I'm about 1.7 billion with that.
Andrew: Okay, so that would add another $200 million dollars or so in value. There's 150 million shares outstanding or so I believe, so there's yeah still 150 million shares if I'm right. So that would create about a dollar or so of extra value over the book value I was talking about. Unless you've got anything else on development, I want to turn to the most interesting segment to me.
Ari: Yeah, I think it's great. I mean, I think before we go there, we don't have to get into the nitty-gritty of how they're being valued. But I think it's worth just briefly discussing their other assets.
Ari: So they have retail which a lot of those retail assets are things that are, like, kind of attached. So you've got a hotel and a retail shop. [crosstalk] You've got like an office building and some retail on the first floor.
Andrew: And that's important. I'll jump ahead of you. That's important because you know, when a lot of people think retail they think, "Oh the old strip center off the interstate that maybe doesn't get a lot of traffic" which you know, those have a very questionable future. I think the future for retail, you know, the Starbucks at the bottom of the office building or something. Maybe if it's not a Starbucks, maybe if it's a retailer it's got a little bit more questionable future. But I think there's absolutely value there just because there's so much foot traffic going by. Sorry to jump in, but please--
Ari: No problem. I thought that was a great point. And I think that's really interesting because they're very versatile. They're not, "Oh, we can't touch it because there's a dollar retail income". They're versatile. They make it work. And they've actually droughts that time period from 2017 to Q2. They were actually not only selling assets in California, but they were selling down their hotel and retail assets which was a really lucky move going into covid, but they actually had a strategic imperative to get into more multi-family. Office is important too but really focus on multi-family. So there's that. It's probably one of my favorite segments, the commercial encompasses retail. They have industrial assets under that. Their industrial assets, 100% occupied. They are e-commerce infrastructure. They recently like bought an airport in Brighton, UK. And they're going to take a lot of the land there build like shipping warehouse for like logistics. And I think that it's a brilliant play. And the final segment which we already discussed is a hotel, and I think that is worth talking about valuation because it's really hard to value. It's the largest asset, so it's important. The way that I think about valuation there is it's really hard to use NOI. And would I really triangulate it how to think about the value there is I looked at price per key transactions or like price per room of a hotel.
Ari: I saw inferior hotels or heard accounts of hotels that are just not as upscale, not as desired, not as iconic, not as historical. I mean, literally, the Irish Constitution was signed in a room there. And like the highest number I saw for inferior assets was a million a room. So, I just use that to get to the value there. And I think that's a probe-your-way to think about that. And that transaction happened in a post-covid world so that that is a reasonable one.
Andrew: Just to back you up because it sounds silly to say, "Oh, the Irish Constitution was sold here". But people do pay up for trophy assets like that. Right? I don't have a ton of them off the top of my head, but you think back to something like the Waldorf Astoria in New York, you know, a couple years ago it went for record-breaking sums because that was the hotel that every president stayed at when they came, right? They don't stay there anymore because the Chinese bought it and there's national security concerns. But like that type of self-buying the trophy asset that resonates across the world, there's real value there because tourist are always going to want to go there. And people respond to that real value where they put lower cap rates on it and people compete a little bit more aggressively to buy it. So I think that's definitely there. Okay, so I think we've covered the development assets, you know, 1.5 of book, you think they're probably worth 200 million over book. We've covered the NOI probably 9 billion of value there. Let's talk about the thing that I think, you know, at the asset management stream, right? So that's asset management stream to simplify, this is "Hey, we run funds. Third parties give us money. We take management incentives, right? The classic private equity model, the classic hedge fund model, the classic real estate model. They've got, off the top of my head, I think it's $4 billion in assets under third-party assets and management. You can correct me if I'm wrong, but--
Ari: It's 4 1/2 but, yeah. 4 1/2.
Andrew: As of the Q3 presentation, the run rate $33 million in asset management fees, $ 67 million in incentive fees for a total of 100 million run rate in fees. You look at the valuations that some asset managers trade at, go look at the stock price of KKR, Blackstone, any of these they've all done extremely well because people look at these fees as high margin and very sticky. These are obviously not earnings. So I've said a lot, I've rambled a lot. I'll toss it over to you. How do you look at that valuation?
Ari: Sure. So, I think that before I get into getting into the value. I think it's worth discussing the business and how important it is. So KW they are experts at finding cheap real estate, high-quality real estate, and they're great value investments. And that has become recognized by large institutions, insurance providers. Actually, from a recent press release, Goldman Sachs has just invested alongside them in something. So that was nice at Goldman Sachs Asset Management, I think, so that was great to see the traction there. So Fairfax owns 9% of KW stock, they are clearly huge fans of this. They outsource their real estate or a portion, or all of them, not sure, their real estate investment to KW. Actually, what happens is this allows KW to have more capital to play with, invest in larger deals. keep a portion on the balance sheet but then also have charged fees on the additional part so it's a [crosstalk] beautiful business. And I think that it in some ways, it's more interesting than when you have a company that just manages assets because KW's bread and butter is to operate this business. And it kind of reminds me of digital bridge or what used to be calm capital, doing the sort of two-step approach with digital asset management and digital assets, and you have the core competencies. And I think it's a really interesting-- another player doing this as well that I find [unintelligible]. They have the ability to know what they want to buy, know what they want to keep a lot of, know what they want to keep less of, balance their portfolios geographically how they want. They have the ability to-- if they need to raise capital quickly, sell it into their funds. It gives them flexibility. They have the ability to do specific asset types for partners. They're partnered specifically with the Singapore Sovereign Wealth Fund to do the e-commerce industrial investing. So that's something they're doing alongside an amazing partner. And it's amazing to be [unintelligible] cost of capital because they're able to do these deals, not have to front the cash and it's like, they can play in bigger ponds. It also allows them to get their name out there more get [crosstalk] reputations with developers, be able to commit more business to developers, and have better relationships. And that's been really key to them to keeping their development on schedule. So it all kind of-- it makes their core business a better business, and their core business makes their asset management a better business. And what I find really fascinating as well is, I might be butchering the-- AXA or axa, they have their own segment for this but despite that, they invest with Kennedy Wilson and which I think speaks volumes to how high-quality Kennedy Wilson is at this.
Ari: And yeah, so now into the valuation of it. They have a lot more committed capital than they've been able to deploy. A huge source of this had actually been their debt platform. They started investing in debt pretty recently within like the last year or two.
Andrew: If I remember correctly, Fairfax gave them to $2 billion dollars at like pretty much the height of covid, right? It was like May 2020. They gave them $2 billion dollars to go out and land which speaks to the relationship because, you know, $2 billion was [crosstalk] pretty precious then.
Ari: Between the fees they got, the yield on these on debt which is about 6%, and I mean, the fees on which like they're putting up 5-10% of the capital so they're charging fees on much more. They're getting [unintelligible] IRR on this debt platform. But the most beautiful part on why they're in a whole nother league on these debt investments, they're not doing diligence on the borrower. They're doing diligence on the value of the property they're underwriting. They're not looking at the borrower which almost every other lender on the planet is like. And the reason they can do this is because they'll make even more money if the debt defaults because then they get to acquire the property way cheaper [crosstalk] than they bought it in the market.
Andrew: [unintelligible] loans own. I've heard this story before. Okay, so $100 million dollars in fees. Let's try to figure out how to value that.
Ari: Sure. The fees are very lumpy. Sometimes you get a big incentive from performance, sometimes you don't. But in general, based on my conversations with the company, they kind of described to me that they think the best way to think about it is assets under management, their revenue in the--should average out to about 1% their fee there. So then on that, they expect their EBITDA margins to be 50% and I believe that's relatively consistent with historic figures, and they're still growing very rapidly. They've been growing and are on pace to growing if you just look at the capital commitments by like about 20% per year, I think that's a pretty reasonable growth rate to expect from them for the next few years. And so, therefore, they'll be at 5 billion by the end of this year. And I think, yeah, that grows 20% here for a couple years. So I think that the way that I think about valuation is 1% of AUM as revenue, 50% of that in EBITDA. And then I don't know if the constant moves since I have pulled this in September, but I looked at where the Ford comps of similar businesses that are pure plays, that are asset managers, that are growing at like, anywhere in the ballpark like at 20-ish% or less. And that came out to mid [unintelligible] multiple. And I think that using that multiple for KW and I'm working with Ford numbers here just to be as transparent as possible, I'm using 13x forward EBITDA. And I think that's pretty conservative. I think it's an unbelievably stable business. High, extremely sticky. I mean, it ties so well into their core business. And like what I was-- that portion of the business makes their core business better and the core business and competencies make them better at the asset management. I mean, maybe you could argue there's a premium that should be there, but I didn't [unintelligible] I guess.
Andrew: You know, I can't remember if it was this investor day or the last investor day, but Apollo's investor day either this one or the last one, does a lot of work on-- it's got some slides that really lay out "Hey, here's how we think about valuing both our asset management fee stream, the management fee stream, and the incentive fee stream." So you know, actually, I think your multiples are a little bit lower than they would but it's also you know, they're the hairdresser telling you need a haircut, right? [crosstalk] But I think they would probably push you that you're a little conservative. And you know, 13x even offer something at least on the asset management side that should be very steady. It shouldn't be cyclical, it's probably a little light. But let's put it all together, so 9 billion of dollars in value ish for the developed net operating producing assets, 1.5-1.7 billion for the kind of lease-up, development assets. And I think if I'm doing my math right, you were saying about 700 million of value for the combined asset management and incentive fee business [crosstalk]
Ari: --actually, because I think they had a lot of performance fees [crosstalk] I'm working with just the 1% of AUM [crosstalk]
Andrew: Okay, so you're adding value. But if I put that all together, I mean, I think, I get a value per share, you know, take out they've got 6 billion of net debt that's attributable to them. Take that all, I think I'm getting a value per share over $30 per share. Am I thinking about that correctly?
Ari: It's exactly where I am. A little bit over 30--
Andrew: And so, right now as we talk, the stock's in the low 20s if I remember. So we're talking, as you said, about a 50%-ish discount. So here's the pushback I want to provide, so I tweeted this out. I have heard real estate company trading at a discount to NAV forever, right? Howard Hughes. Everybody always likes to go argue, "Go look at the Howard Hughes comps". The ones I really think about which are not perfect comps here are Vornado and SL green which are both all-New York office-based. So again, not perfect comps, but both of them, you know, SL green attacks their share count. They buy back so many shares. Vornado actually has said, if I remember correctly, Steve Roth icon of real estate he says, "Hey, we don't believe in buying back our shares because we actually think even if our shares are at a 50% discount, the returns we can get from going and developing the next big skyscraper in New York actually create more value than buying back our shares at discounts NAV", which he walks through the math. And I had always kind of disagreed with him. But increasingly, I think he might be right. But, you know, both of 'em, I chewed out the chart that showed Vornado stock price versus their estimate of NAV. Right? So both of them always say, "We trade at a discount's NAV". Why is KW different than these guys, right? You say they trade at a discount's NAV. Why shouldn't they? Everyone else does. What's special about these guys?
Ari: Yes, so I think that what makes them-- they're totally trading at a discount. And I think that that discount should probably-- I expect it to shrink if not disappear in the foreseeable future for a couple of reasons; The first is that, if you look at NOI growth and a lot of how multiples work and all forms of applying multiple [unintelligible] for investment reasons is you have to look at the growth. And the growth and multiple are tied at the head. And so from basically when they went public until 2017, KW, the stock performed excellently. I definitely think the multiple got a little out of hand in 2013 and '14, but it corresponded with a couple of years where they were growing at almost 100% year-over-year growth. A lot of that was from that acquisitions, but they were growing very quickly. And I think that as long as KW can show consistent growth and keep growing, they'll get their multiple back and they'll close that discount. And a big focus on the letter or in our commentary is about why I think they're exiting the growth gutter. So on one hand, you're coming out of covid where they have a lot of assets that were impaired from that. Plus, you've got tailwinds to the Mountain States, accelerating population shift towards the Mountain States. So that's a tailwind. They consistently grow their same property like the same property rent mid-single digit. So there's a tailwind there. The company has told me they're aiming for net acquisitions and I definitely
seem to think they're on that path from a few press releases I've seen over the last couple months. And I mean they are developing like--so they have about $400 million in NOI. Over the next 3-4 years, they're going to add 100 million in development on top of 400 million. That's 25% growth from developing alone. I mean, like you've got upside from covid. McMorrow, the CEO, came out pretty confident that they're going to grow 10- 15% for the next couple years and grow NOI that much. And I do think that once they return to growth and show consistent growth, not to mention their asset fee-bearing capital segments growing at 20%, and that's really high. margin, you're going to really start seeing that accumulate on the bottom line more and more. So I think that there's a lot of reasons why you could see multiples, I guess, converge more with NAV going forward. And on top of that, I think unlike a lot of other real estate [unintelligible] I've looked at a few, I haven't looked at a ton. I'm not a specialist. But KW stood out to me when I was researching it because unlike at least three or four other ones, they have such transparent disclosure. I understand exactly what
they own. I feel like I can value it. And I feel like other companies trade at a NAV that's blurry because you don't know exactly what they own [crosstalk]
Andrew: It's what I said at the beginning, right? They might just give you an NOI and you've got to guess how much of it is hotel versus [crosstalk] versus multi-family. In this case, they give you every component of the NOI.
Ari: So I'm a lot more comfortable with the NAV here than other real estate companies.
Andrew: Let me ask you one of my favorite things financial [crosstalk] , right? You mentioned at the beginning KW is not a REIT which is a little surprising to me. Right. We estimated their value at, I don't know before debt it was like $11 billion of enterprise value and of that 9 billion or so was net operating producing properties, right? Like properties, that are cash flowing right now. Those are exactly what are meant to be inside of REITs, right? Big multi-family that produces consistent cash flow. Strikes me as inefficient that it's not a REIT right now. So, how do you think about the company and being a REIT going forward? Because if I remember correctly, I could be wrong, but I think in 2018, there was even a push for them to consider becoming a REIT. I can't remember for sure. But how do you think about REIT, financial engineering? Because another Financial engineering they could do, they've got a burgeoning asset management business, they've got a lot of income-producing things. They could split them, right? They could spin off the asset manager and the properties and do some financial engineer that way which I've seen companies do pretty successfully before. But REIT, financial engineering, everything. What do you think about KW and those terms?
Ari: Yeah. I don't think they're interested in the financial engineering. Like I explained before, the aspects of the fee-bearing versus the property-owning that make the other one a better business is so valuable. Why would they want to ruin that? And yeah, it becomes easier for a Wall Street analyst to figure it out but McMorrow's a very long-term thinker. We at RGA, we invest 5 plus year outlooks so I'm not concerned with that. Maybe this is not the right stock for investors who are expecting something like that. But yeah, I don't really think there would be any-- it wouldn't make sense to me for them to do that spin-off nor do I think they have any interest in it. [crosstalk] Oh sorry, go ahead.
Andrew: Oh no, I hear you but I do think the tax efficiency of splitting the net operating producing assets into a REIT structure and then spinning out the asset manager, I do think there are efficiency arguments there.
Ari: So KW is actually one of the most
tax-efficient businesses I've ever studied. With 1031s they are able to offset a lot. I don't know how much but well over half historically of the dividend payouts have been offset as 1031 rollovers--
Andrew: Return of Capital, yeah.
Ari: Yeah, Return of Capital. So they're not paying that much in taxes. They're really tax-efficient. Some other things that they do to be tax-efficient, so I mentioned earlier, the formal housing think it's like 10, 15% of either the I don't remember if that's 10,15 % of the multi-family or of the total NOI, I think it's total NOI but I'd have to double-check. What they do is they go out and they get a permit to develop multi-family housing. They developed the housing. They then get reimbursed the entire development expense in tax credits. So they are building in that and growing in that as fast as possible, as fast as they can get credits. It's helpful for the world, the world needs more affordable housing. They make good returns off of it. Their return profile that is extremely, extremely positive. And how do you even calculate the IRR in something with functionally zero upfront cost because it's all reimbursed in the tax credit?
Andrew: Yep, yep.
Ari: So they're really tax-efficient in that sense. And then when it comes to not being a REIT I think it's really important, an edge for them because they're not [unintelligible] to having to pay a certain portion of net income. They can focus on growth priorities. They can do share buybacks. In 2018, I think the company bought about 10% of the flow back because they had the capital and that was the top priority. They're always discussing and figuring out and acting on "What is the best use of our capital?" Right now, the next couple years, it's the development pipeline to grow NOI by 25% from that alone. After that, they're going to have a lot of capital to work with. And it's really messy when you look through their GAP financial statements as it is with all real estate companies. When they buy or sell real estate, it gets into the cash flow operations [crosstalk] something's hit-- It's all messy. But, like, they have a lot of things that they're using cash for, a lot of cash for the next couple years that 3, 4 years from now, that's going to be fair game for an aggressive buy back for dividend or what I almost prefer, they find more opportunities to keep that double-digit growth going on NOI level. And they pay a 4% dividend, that dividend has grown at a double-digit [unintelligible] for as far as I could go back into data. I also have another way to value this company with just a simple DDM and I get to similar value of north of 30 a share. And I think that you can really count on them to grow dividends at 10% for a very long time. They've done it and they will continue to do it, and that's a priority for that. Now they balance that with growing. Their philosophy, it's really similar to how I like to and how RGA likes the philosophy we like in companies where you balance finding great value and growth. They're balancing everything really well, I think. And so I'm very happy that they're not a REIT. And I think that something they talk a lot about is they like to play where the big REITs are not playing. They like to look for the opportunities where no one else is looking which is why they're the largest holders in Boise, Idaho multi-family assets. And I think that that's huge and then that's a big deal on. They're gonna have so much flexibility with that. I think they're gonna add a lot of value from owning that today. And something they've said, it makes it really hard to grow these Mountain State. To grow in the Mountain States, you got two options; You can purchase your way in really, really aggressive cap rates, or you can have boots on the ground and you can already know the developers and that's that's where they are right now in a really hot quick-growing market that I think has many years of growth. Sorry, I went on a tangent.
Andrew: No, no, no that's great though I feel like you're bordering on besmirching Boise, Idaho. And the Yet Another Value podcast fans from Boise, Idaho are not gonna standby for that. We're approaching over an hour, I believe. So I want to wrap this up but I want to do one more question and then maybe get your final thoughts. I'm sure you saw it on Twitter. It comes in two forms and it matched my priors, right? Where KW had this slide in their proxy statement that said, "Hey, we've outperformed our peers, we've outperformed the indexes over the past I think it was 10 years and 3 years or something which didn't really match my priors. You know, I remember looking at this in 2017 or 2018 on the heels of the KWE thing and it's kind of been 'meh' since then. And you know, a lot of people I think a direct quote was this belongs in the Mount Rushmore values traps like there's good assets, there's good management, but the markets just never going to care. And that also kind of rolls into the management team gets paid really well and they kind of get paid really whether the stock does 'bleh' or the stock does pretty well or something. So maybe they don't super care. You know, it's the old private equity. They care about if their funds are doing well or not because that's where all their care is. They might not care as much about their stock because their care is more directly in their stock. But I'll just toss all of that I just push, talked about over to you.
Ari: Yeah, so McMorrow the CEO, he's one if not the largest holders of the stock
close to 10% of the company. I think he's highly aligned incentives in the long run. to make the stock work. And the dividend payment, he gets a lot of that. So he's got the balance of both of those. I think that the first thing that came to my mind when I started looking at this and open the chart was, this looks like a value trap. I think that this company just went through between 2017 and Q2 2021 went through a very numerically messy transformation. A very necessary long-term-oriented transformation. And this management is very long-term oriented. They were selling off a lot of assets. They were moving geographies. They started a lot of development projects. They were very focused on planting a lot of seeds and it led. You can look at this and like, if you take a step back with that in mind, and again, I want to reference if you get a chance to look at our commentary I have a chart in there that I really like that's about--
Andrew: It will be in the show notes to remind listeners. Go ahead.
Ari: Perfect. Yeah, in that chart it shows the correlation between NOI growth and that acquisitions. And starting in 2017, when they made the biggest acquisition I think they've ever made at least as far as I could tell, was that KWE buying 75% of that. They had a lot to digest there and on top of that, you start divesting California, you start divesting retail, you're selling your hotels and then you're buying some Mountain State, you're starting a lot of developments. And, yeah, that was really messy for the stock performance. But if you zoom out the stock has done really, really well. If you go back to when they [unintelligible] It's done really well and I don't have the numbers all the time I had. I'm not surprised, I saw that thing you posted. I don't know who they indexed, I maybe scratched my head at that three years as well. It has not been a fantastic three-year performer. I think that this is the moment that they get out of the growth gutter. This is when the growth comes back and this is when the story [unintelligible]. If you zoom out enough and if you're patient and you're a long-term investor, I'm confident that management will do what they've been doing since they IPO this. And they clearly had a lot of value leading up to that. And I think that the value trap might have been there for a few years, I think the value traps over. And yeah, I really do think that the market will start to care once they've grown NOI for a couple years. On top of all this, they've started cleaning up. They used to offer a lot more services like a lot more subdivisions. And they've been cutting those aggressively.
Ari: They're just trying to simplify the business. And I think that that's a huge reaction to that as well. And something that I like too.
Andrew: Yeah, my old model had a lot of different segments they have. And to your point on, you know, sometimes the best opportunity is this stock is flat for 5 years because they're going through a messy change or something. But, 5 years ago, it was fairly valued and you know, intrinsic value has increased by 10% per year for 5 years so fast forward today the stock's flat but now it's 50% undervalued. And as you say you're kind of catching that curve right before it spikes up. We've talked a lot about Kennedy Wilson. I want to give you last thoughts. Is there anything you think we should hit a little harder? Anything we didn't cover that you think is important to the story or anything?
Ari: Yeah, I think we hit most of the interesting points. I read through the Twitter questions, there are a lot of good ones there. Is there anything we missed from those Twitter threads?
Andrew: I think we really covered everything. Most of them were pay, incentives, interest rate risk, inflation risk, and I think we did a nice job of at least touching on everything. You know, the two out there ones that I had kind of thought in my mind was a lot of their assets are in Dublin, and with tax reform coming do companies stop headquartering in Dublin? But that might be a little too galaxy brain for this podcast. And then rent control risk is a big topic for some of my friends who invest in New York real estate. I don't think they've got a lot of rent control risk because I don't think the Mountain States are where they're going to be putting out rent control. But that's an interesting out there [unintelligible] always kind of thought where I was trying to think of some off-the-cuff shelf to throw at you, but I don't know. Anything else you want to talk about?
Ari: No, I mean not seeing any evidence of rent control in the Mountain States these days. That's for sure. But yeah, I think that's it. And I want to just encourage anyone who's listening if they want to discuss KW if there's a question they have I haven't answered. Reach out to me on Twitter. I'm @pommelhorse9. I was a gymnast in high school [crosstalk]
Andrew: That's awesome. Can you do the T? The iron--
Ari: The cross? Yeah, I could. Now, I don't know. I haven't touched a ring set since the pandemic but I definitely could back in the day.
Andrew: That's pretty cool. It's pretty cool. Cool. Well, hey Ari, this has been great. Thank you so much for coming on. I think in the next few months we're gonna have to have you back on to talk about Angie, and we're just back holding all the way through, man. I still love that company. I know the stock price is telling me I'm wrong every day but I [crosstalk]
Ari: Always happy to talk Angie. Always happy to talk Angie.
Andrew: Well, hey, I appreciate you coming on. Everything we talked about it's going to be in the show notes. If you want to reach out to Ari, read the Q3 letter and everything. And Ari, thank you so much for coming on.
Ari: Thank you. Take care.