Modiv Inc.: High Cost of Funding Leaves Little Room for Expansion (NYSE: MDV)

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By Snehasish Chaudhuri, MBA (Finance).

Net Leasehold Real Estate Investment Trusts (“REITs”) generally rely on their ability to raise low-cost capital to fund their growth. Large cap REITs have an easier time in favorable macroeconomic conditions. The other On the other hand, small-cap REITs find it difficult to raise capital, especially when rising interest rates make it difficult for such REITs to raise additional capital, which is a prerequisite for the expansion of the capacity.

Modiv Inc. (New York stock market :VMD) is one such micro-cap Net Lease REIT that has a relatively high exposure to offices and retail and significantly higher debt. The covid-19 pandemic has had a negative impact on the office and retail real estate market. MDV was forced to liquidate some of its office properties and use these funds to repay its existing debt. However, MDV common stock has failed to attract investors, and the stock has seen a gradual decline since its initial listing nearly 9 months ago.

MDV leases its properties to creditworthy sole tenants on a net lease

Modiv Inc. holds a dominant position in the direct-to-consumer commercial real estate products industry. The Company invests, directly or indirectly, in income-producing properties located in the United States, which are leased to creditworthy sole tenants under long-term net leases. In a net lease system, tenants must pay a base monthly rent plus a portion of the property’s operating expenses, typically property taxes, insurance, and maintenance. As these assets are leased to a single tenant, they are generally of high quality and are leased by multinational corporations like Starbucks or McDonalds, who occupy these properties under a net lease agreement.

Modiv Inc. owns 44 net rental properties that are leased to approximately 30 customers, with long-term leases. These lease agreements generally include a clause of committed rent increases, which ensure a regular income. Nearly half of MDV’s properties are leased to companies operating in the retail, automotive and healthcare sectors. Approximately 55% of the portfolio is leased to high quality tenants such as Kia Corporation (KSE:000270.KS), Sutter Health, Costco Wholesale Corporation (COST), AvAir, FUJIFILM Holdings Corporation (OTCPK: FUJIY), 3M Company (MMM), Cummins Inc. (CMI), Northrop Grumman Corporation (NOC), Dollar General Corporation (CEO), etc.

Modiv Inc. rebalances its portfolio and reduces its existing debt

Modiv Inc. owns different types of assets in diversified real estate segments such as office, hotel and hospitality, retail, industrial and self-storage. However, since last year, it has started to reduce its office property portfolio and increase its industrial property portfolio. During this year, MDV has sold multi-office properties and office exposure within the total portfolio has fallen from 35% to 30% over the past year. On the other hand, MDV has acquired several industrial properties, including a KIA dealership, and industrial exposure as part of the total portfolio increased from 46% to 51%. The change in portfolio composition should improve occupancy and revenues for this net lease REIT.

Equities account for approximately 53% of the total Capital city, while various forms of debt make up the rest. Over 90% of the debt is fixed rate, which helps to support MDV’s debt servicing costs during a period of rising interest rates. Over the past few quarters, MDV has focused on disposing of non-core office and retail properties, with particular emphasis on minimizing exposure to assets with less than 5 years remaining lease. This allows MDV to reduce its existing debt. It also helps this REIT generate cash for reinvestment. However, the current level of high interest rates does not leave much room for Modiv Inc. to raise more capital. Thus, raising additional capital will come at a very high cost.

Modiv Inc.’s Price Growth and Dividend Yield Do Not Cause Optimism

Modiv Inc. was formerly known as RW Holdings NNN REIT, Inc. and was incorporated in May 2015. However, this net lease REIT was listed on the New York Stock Exchange (NYSE) just 9 months ago and started paying monthly dividends only from February 2022. The average yield so far has been 3.64 percent. Thus, it is not possible to make an investment decision based on its performance history.

However, the good thing is that MDV has checked in quarterly adjusted diluted funds from operations (AFFO) stable per share since 2021 – Q1 2021: $0.25, Q2 2021: $0.34, Q3 2021: $0.44, Q4 2021: $0.27, Q1 2022 : $0.29 and Q2 2022: $0.35. So far, dividends have been covered by its AFFO, and changes in the composition of its asset portfolio should improve occupancy and revenue, which in turn should have a positive impact on the AFFO.

Modiv Inc. has little price multiples now. A price-to-book (P/BV) ratio of 0.47 reflects a lack of confidence on the part of investors, despite the fact that it generates stable AFFOs. The price-to-cash-flow (P/CF) ratio of 6.27 and the price-to-sales (P/S) ratio of 1.92 also indicate that the value of the stock has less to do with the current financial parameters of VDM. Investors, it seems, are more concerned about the future growth of this net lease REIT.

When the stock was listed in February 2022, it recorded a daily high of $89.99. From the very beginning, the price is on gradual decline, and went down to a level of $10. The stock has been trading around $10 for over a month, and it looks like the price may be stabilizing here. But no conclusions can be drawn on its price movement, as current financial metrics are not reflected in its valuation.

Investment thesis

In my view, Modiv Inc. is taking the right steps in rebalancing its portfolio and reducing its debt exposure. It has a stable AFFO and generates a decent yield, although it’s too early to comment on its durability.

Despite all this, MDV’s common stock failed to attract investors. Investors might assume that rising interest rates will make it difficult for this REIT to raise additional capital, which is a prerequisite for expanding capacity. As MDV sells some of its office properties and pays off its existing debt, there are good reasons to suspect sources of future growth. All of these factors are unlikely to change anytime soon. I too am not optimistic that MDV will be able to escape this cycle and achieve a higher market valuation anytime soon, and suggest a hold or a sell.

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