With Industrial Assets In High Demand, 55M SF Warehouse Portfolio Targeted By Activist Investor

Billions of dollars have been raised this year to scoop up assets in the red-hot industrial real estate market, and the competition is pushing up pricing to record levels — and creating more pressure to sell.

With investment giants such as Blackstone, Starwood and Equity Commonwealth bidding up the price of large industrial portfolios, one well-known activist investor is betting that the assets of some publicly traded industrial REITs may be worth more on the private market. 

Land & Buildings, an activist investment firm led by Jonathan Litt, earlier this year took a stake in Monmouth Real Estate Investment Corp. and pushed for changes ahead of its $4B sale last month to Industrial Logistics Property Trust. With that process behind him, Litt is now setting his sights on another industrial REIT: Lexington Realty Trust. 

“Once [Monmouth] was done, we were looking for another place to buy industrial in the public markets, and we realized Lexington, which was this mixed bag of assets, had gotten to a sufficient critical mass of warehouse properties, and it looked to us to be materially undervalued," Litt told Bisnow this week. 

Litt's activist investing strategy involves taking a stake in a public company he sees as undervalued and then pressuring it to make changes, typically either a leadership shake-up or a sale. He said he began to focus on industrial REITs around three years ago because of the strong leasing demand the sector has enjoyed from e-commerce companies.

The e-commerce growth was accelerated by the coronavirus pandemic as more shoppers turned to online deliveries, and Amazon and other providers raced to grow their distribution networks. Rising leasing demand has led to skyrocketing industrial property prices, with the U.S. market experiencing year-over-year growth of 18.9% in October, according to Real Capital Analytics. 

Litt's first industrial target was Liberty Property Trust. Land & Buildings invested in the REIT and pressured the company in a public letter in July 2019 before it was acquired by Prologis for $12.6B later that year. Then he took a similar strategy with Monmouth, issuing an open letter in January. He exited that investment this summer after it had reached a deal with Equity Commonwealth, though that merger ultimately fell through before Monmouth reached another deal to sell to ILPT. 

This summer, Land & Buildings bought a 0.7% stake in Lexington Realty Trust and then met with its management team and board, the REIT revealed in an October letter to shareholders. 

That letter, which came before Litt had made public statements about the company, revealed that he was pushing for changes at Lexington, including board refreshment, CEO succession and an evaluation of strategic alternatives, such as a sale. Litt then released a letter and presentation to Lexington shareholders on Nov. 15, arguing that the company has underperformed its peers and blaming its management and board for the poor performance. 

The activist investor's letter outlined several potential options for paths forward that could improve the company's performance, including adding new board members, naming a new CEO and selling its assets and returning capital to shareholders. The letter said Land & Buildings intends to nominate new board members, including Litt himself, ahead of the REIT's 2022 annual meeting. 

Lexington Realty Trust disputes Litt's characterization that it has underperformed, and independent analysts say some of the metrics he presented comparing its long-term performance to other industrial REITs are misleading.

Lexington has transformed its portfolio over the last several years from having a mix of property types to focus solely on industrial assets. Its portfolio shifted from around 30% industrial at the end of 2015 to 95% industrial last quarter, and it is planning to sell off its remaining office assets. 

The REIT's industrial portfolio consists of 121 assets totaling 54.9M SF, according to its Oct. 6 letter. It is spread across more than two dozen states, and its largest markets by percentage of rent collected are Memphis, Houston, Greenville, South Carolina, Atlanta and Dallas, according to investor filings. 

"The Company’s successful transformation into a leading single-industrial REIT with a portfolio of high-quality primarily single-tenant, net-leased properties has created a strong platform for enhanced financial performance and value creation," a Lexington spokesperson wrote in a statement to Bisnow. "With our portfolio transformation substantially complete, we are poised to deliver even stronger financial performance by executing our disciplined, multi-channel growth strategy and releasing our properties at attractive spreads."

The REIT presented performance metrics since October 2018, when its portfolio surpassed 50% industrial, showing that it has delivered shareholder returns of 82%, 31 percentage points higher than its peer group of single-tenant industrial net-lease REITs. 

Litt said Lexington focuses on the 2018 comparison because that is one of the only time windows that shows it outperforming its peers. He found significant underperformance when comparing it to other industrial REITs and to its proxy peers, the companies that it defines as its competitors in investor filings, going back to 2003, when its current CEO, T. Wilson Eglin, assumed the role.

While its portfolio transition may make those long-term comparisons less relevant, Litt also looked back one year and found that it underperformed industrial peers by 13% and its proxy peers by 20%. 

Sheila McGrath, a senior managing director at Evercore ISI who covers the REIT as an independent analyst, said she has a favorable view of Lexington Realty Trust given its shift to industrial, and her metrics show it has outperformed its peer group. She said comparisons with industrial REITs going back to 2003 don't make sense because it has only become an industrial-focused REIT in the last few years. 

"My view is that the decision to go industrial has been a good one for the company and its shareholders," McGrath said. "We think over time, when they’re done with asset sales, they’ll be pure-play industrial and will be even more desirable."

J.P. Morgan Executive Director Anthony Paolone, another analyst who covers the REIT, said that while there are multiple ways to compare historical stock performance data, he thinks the main issue at hand now is whether Lexington's current stock price values it at less than what its portfolio would be worth on the private market.

"The real thrust to me is that over the course of 2021 you’ve seen a significant revaluation higher of industrial assets of all flavors," Paolone said. "You’ve seen cap rates compress a lot over the course of this year, and you’ve seen some M&A in the space as a result. The question becomes: here’s a company that has largely transformed over the last few years into mostly an industrial portfolio at this point — and look at where some of the private market bids are for portfolios, so is there a better place for this portfolio perhaps to maximize the stock?"

The company's stock price, with the ticker LXP, closed Thursday at $15.11 per share. Paolone's analysis has pegged the firm's net asset value, or NAV — an estimation of the private market value of its portfolio — at $16.16 per share. This means that if it were to sell to a private investor at that NAV estimate, LXP current shareholders would realize a gain of more than $1 per share.

In a report released Nov. 19, Paolone said that the recent involvement of Land & Buildings creates the prospect that the REIT could be sold to the private market, and that could create another $1 to $2 per share of upside from his current price target. 

"The market has just seen so much money flowing into the space so quickly over the course of this year, that could the real number be $17 or perhaps maybe even higher than that? It’s possible," he said of Lexington's NAV. "That’s one of the reasons this conversation is happening, because you’ve just seen so much money that maybe the reality is it’s a bigger number than we think."

Because property prices fluctuate with the market, analysts differ in their interpretation of Lexington's portfolio and how its NAV compares to its stock price. Evercore ISI's estimate pegged its current NAV at $14.27 per share and its forward NAV, an estimate of where it will stand in 12 months, at $14.74 per share. 

McGrath, who declined to comment on a potential sale of Lexington, noted that any acquisition deal comes with a host of transaction costs for the buyer that can make a sale price different than the actual NAV. 

KeyBanc Capital Markets, another analyst firm that covers Lexington, pegs its NAV estimate at $16.36 per share, it said in a Nov. 18 report, adding that its stock was trading at a 7% discount on that date. KeyBanc's report said that Lexington has underperformed its industrial REIT peers, and it said it believes that Land & Buildings' involvement increases the likelihood that Lexington will sell. 

"The sale of LXP is the quickest avenue of value maximization," KeyBanc's Craig Mailman wrote in the report. "The release of the shareholder letter, intentional or not, seemingly opened the door for unsolicited bidders to approach the board; substantial capital continues to pursue industrial assets, and we suspect there is a higher probability for a transaction (i.e., 60-70%)."

Litt said he believes Lexington's portfolio could sell on the private market for well above where the REIT is trading on the stock market, given the high demand for industrial real estate and the recent examples of major M&A deals. 

His presentation to investors noted that Equity Commonwealth and Starwood were both "left at the altar" in the bidding war for Monmouth and that there continues to be a deep buyer pool for industrial.

Litt said he believes Lexington's portfolio is more attractive than Monmouth's, which sold at a 4% capitalization rate. KeyBanc's $16.36 per share NAV estimate translates to a 4.25% cap rate, meaning that if Lexington sold for a lower cap rate than that, its price would rise even higher and shareholders would realize more gains. 

“I do believe that there is substantial interest and there would be multiple bidders at valuations well in excess of where the stock’s trading today," he said. "I do believe, for the company, a 4% cap rate is in the cards."