Modiv Industrial: “Too F***ing Cheap”

Following the high inflation and subsequent rises in interest rates in 2022, global REITs have struggled, with the Iran war beating an already beaten down asset class further with more inflation and rate rise worries. However, like any bombed out sector I’m seeing a lot of opportunities, especially seeing a large disconnect between public valuations and private transactions. REITs like $PKST, $CHCT, $ALEX and $NSR.ax have all been taken out at a premium recently by firms like Blackstone and Brookfield who believe the companies to be undervalued. Between patience and pocketing the dividends, a rerating, or a takeover there are plenty of ways to win currently in REIT-land, so I want to introduce you all to an attractive and overlooked opportunity in the sector in Modiv Industrial $MDV.

Modiv is an internally managed REIT focused on triple net industrial manufacturing properties. Put simply, they own factories where things are made and lease them out on long term triple net leases, meaning that the tenants pay expenses like property taxes, insurance and maintenance. Modiv has had a rough time as a publicly listed entity. After going public in February 2022 with a direct listing at NAV ($25) the stock immediately plummeted to around $17 as private investors flocked to the exit and the stock got caught up in the rate rise based selling in the broader market. Since then, the stock has gone basically nowhere, currently trading at $15 (having paid around $5 of dividends in the time since). This poor performance has come in spite of steadily improving underlying fundamentals which have left the company far more attractive now than when they first listed.

When Modiv first listed they owned a variety of different assets including offices and retail assets. However, the last few years has been spent focusing on monetising their lower quality assets and focusing on becoming a pure play manufacturing REIT. Additionally, the quality of the leases has significantly improved. When Modiv first listed their portfolio the weighted average lease term (WALT) was around 6 years, which has grown to a whopping 14 years currently. The tenant quality has improved as well, with the EBITDAR

Rent coverage for the portfolio rising from around 3x to currently sitting at 10x. Some other highlights of the current portfolio include a 2.5% average annual rent escalation across the portfolio, getting 100% of their debt to fixed rates, and cutting expenses from $17m in 2022 to $12m this year. While the stock price may not reflect it, the company is in a far better place than when they started.

With all of this in mind I want to take a look at the valuation. Against a market cap of $156m, last quarters AFFO (adjusted funds from operations) was $3.2m when adjusted for stock based comp, or $12.8m annualised for an attractive 8% yield. Looking through the adjustments I don’t see any egregious adjustments that would make us disregard their AFFO number. Modiv is currently paying this all out in $12m annualised dividends for an 8% yield at current price. Moving to the balance sheet, management states their NAV per share at $22.2 vs a share price of $15.13 for a 46% premium. They do hold a fair amount of debt at $260m vs $470m of assets, however they have no maturities until 2028, and at a 4.15% cost of debt aren’t looking at any crazy increases in financing costs when the debt matures. I don’t like to put out target prices, but it’s very easy to see why the company is attractive with a growing (due to contractual rent escalators) 8% yield and at a 32% discount to NAV.

Modiv has been led by CEO Aaron Halfacre since 2019 and he is a very interesting character. Unlike many REIT’s, Modiv is internally managed and Halfacre takes a base salary of only $250k a year, with another $130k of cash bonuses. Meanwhile Halfacre owns $2m of stock in the company, with many other members of management owning large chunks of stock too. In a recent press release Halfacre described the stock price as being “too fucking low”, and he has put his money where his mouth is, buying stock on market personally and instituting a share buyback program for the company. Halfacre talks incredibly frankly about the stock, but also clearly articulates his vision for the company and their strategy to get there. I would highly recommend reading their recent strategic update for anybody who wants more information, but for those who can’t be bothered, I’ll summarise and provide my thoughts.

As I said prior, Halfacre believes the Modiv share price to be “Way too fucking low”. Halfacre has spent the last 5 years doing everything in his power to make the company more investible, and basically believes that within the next 2 years they will have pulled every lever available to them. They plan to continue selling non-core assets and assets that they can get good prices on to improve the balance sheet and reinvest in attractive properties. They also plan on retiring their expensive (7.3% yield) preferred stock, and have gotten permission from their lenders to do that. He talks candidly about their refusal to issue new stock for acquisitions while their share price is so low, which removes one of the largest fears for any REIT investor. The most interesting development however is the potential for a sale. In the most recent 4th quarter update Halfacre stated that Modiv had “received multiple inquiries of interest, including two unsolicited offers”. While those offers were turned down, Halfacre has stated that they are open to offers that they deem attractive, quote: “if you want to lay us, you better pay us”. More importantly he has stated unequivocally that if their share price is still languishing in the next year or two as they complete their initiatives that he will initiate a formal sale process.

The question I always like to ask in my writeups is ‘why is it so cheap?’ The main reason why I believe this mispricing exists is due to the lack of liquidity and attention to the stock. The average volume is only around $750k per day, which would lock out a lot of potential institutional buyers. There isn’t a huge amount of discussion about it on twitter and I’ve only seen one writeup of it on substack by a small account. Furthermore, the broader REIT sector is incredibly out of favour currently so we have an unfollowed microcap in an unloved sector. As far as the actual risks go, the biggest one is that the company doesn’t rerate, and nobody comes biting on the sale. The company would continue plodding along and this idea would have mediocre returns, though it isn’t the worst scenario as you would still receive an 8% dividend, but it wouldn’t be ideal.

Tenant concentration could be seen as a risk with 25% of their rent coming from two tenants in Fujifilm and Northrop Grumman, however both of these companies are large, publicly listed blue chips on long leases with a long track record of profitability so I don’t see this as a huge risk. Another risk is that the Iran war leads to a sustained spike in inflation and corresponding rate hikes. This would hurt both in the eventual refinancing of their debt and also likely driving their valuation down. Altogether, I see these risks as reasonable considering the potential upside here in a takeover or rerating.

At the end of the day, Modiv is exactly the kind of setup that gets me excited. You have an improved business with better tenants, longer leases, fixed rate debt and lower costs being run by a good, well aligned CEO. You’re getting paid an 8% dividend to wait with a catalyst in the form of a formal sale process if nothing moves in the next year or two. While there are always going to be risks, the risk/return here seems heavily skewed to the upside. I have been steadily building a position and at the time of writing have a 5% position.