Ask most REIT analysts and they’ll tell you there are just a few, simple rules most management teams need to follow:
Manage your balance sheet to keep leverage low. Allocate capital correctly, which means wise, prudent acquisitions and dispositions. Get the basics right—operate your properties efficiently. Then, finally, listen to the market.
“The market makes it pretty clear whether or not investors are comfortable with external growth,” says Ryan Burke, a REIT analyst with Newport Beach, Calif.–based Green Street Advisors.
But, apparently, student housing firm Campus Crest Communities (NYSE: CCG) never got the memo. In four short years, the REIT eviscerated all of these rules by piling up leverage, making questionable acquisition and development decisions, botching construction and operations, and baffling analysts with its operating results.
Finally, CEO Ted Rollins and CFO Donnie Bobbit stepped down in early November as the company announced a long overdue “strategic repositioning.” Richard Kahlbaugh, lead independent director, stepped in as executive chairman and interim CEO to direct the Charlotte, N.C.–based firm through its reorg. But the real driver behind the change appears to be Aaron Halfacre, the newly minted chief investment officer, who joined CCG just last August.
To analysts covering the REIT, these changes were long overdue.
“They’ve had a lot of missteps, and, quite frankly, C-suite executives don’t get as many opportunities to make as many mistakes as this management team has,” says Ryan Meliker, managing director of equity research, REITs, and lodging for New York–based MLV & Co. “This was a long time coming. It should have come sooner.”
But to right the ship, the CCG team will have a lot of work to do fixing the firm’s capital allocation, operations, and reputation.
“They’re finally making some of the right decisions,” says Rod Petrik, a real estate research analyst at Baltimore-based Stifel Nicolaus and Co. “We’ll see if it’s too late.”
CCG’s problems began shortly after it went public, in October 2010. In its first quarter as a REIT, CCG’s leaders reported higher capital-expense charges than expected. “That was a big credibility hit for the management team right out of the gate,” Burke says.
The company missed expectations with elevated bad-debt expense, lower-than-expected ancillary revenue, and additional cosmetic capital expenditures.
“This is a situation where you had a management team that has continually had missteps since its IPO, whether it was missing earnings immediately following the IPO to continually disappointing quarters and other unexplainable decisions, like bad-debt expenses,” Meliker says.
In February 2013, CCG acquired a 48 percent equity interest in a student housing portfolio from Copper Beech Townhome Communities, the nation’s fifth-largest student housing operator. The deal gave CCG the right to acquire the remaining 52 percent interest over a period of up to three years at fixed prices. For the initial purchase, CCG paid $230.2 million to acquire equity interests and repay debt in Copper Beech and gave a $31.7 million loan to the existing investors.
The problem was, the acquisition was going to occur in three phases over multiple years. “They funded the first phase,” Meliker says. “That was an accretive transaction. Then, the stock went south for mostly things outside of CCG’s control.”
Those “outside things” included the disappointing lease-up in 2013 by Austin, Texas–based American Campus Communities. Investors suddenly grew wary of student housing, and CCG’s stock took a hit. “If they issued equity, the acquisition was no longer accretive,” Meliker says.
Development was another can of worms. CCG started a high-rise EVO development line, with disastrous results. In Philadelphia, in a joint venture with Brandywine, its EVO leased up at 48 percent. In Montreal, a market where it had never built before, the results were even worse when it converted hotels to student housing.
“They tried to enter the Canadian market in quick fashion,” Burke says. “Montreal is a relatively unproven student housing market where most students prefer traditional apartment living. The two hotels they converted to student housing didn’t fit this bill. Those properties are about 11 percent occupied for the school year.”
Not only did the developments founder, but they made it difficult for the company to operate, as well.
“It’s nowhere near what they were expecting and nowhere near what they underwrote,” Meliker says. “They gradually increased their leverage to fund these.”
Beyond EVO, CCG has had a hard time delivering developments on time and, in some cases, without defects. Some of the reported problems with the firm’s developments include a balcony collapsing at a property in Denton, Texas, and repeated power outages, frozen water pipes, mold and mildew, and faulty appliances at The Grove in Orono, Maine, according to The Bangor Daily News. At a Grove property in Columbia, Mo., apartment doors didn’t shut completely, according to The Columbia Daily Tribune. In fact, almost 50 percent of CCG’s new developments were delivered late, forcing them to make other arrangements for students.
These problems hurt CCG’s resident profile. In the fourth quarter, the REIT saw an increase of about $1.2 million in bad-debt expenses across its same-store properties. The problem: Operating issues had led to a less creditworthy tenant base.
“From an operating perspective, one of the main problems has been bad-debt expense from lower credit–quality tenants,” Burke says. “These are real dollars, they thought—and communicated to the market—they would get. However, they repeatedly came up short because students simply weren’t paying their rent.”
Add all of this together, and you have serious issues. “It has caused a crisis of confidence in the company that stems from the management team,” says Burke.
‘Strip Out the Drama’
After a strategic shift that produced more transparency, investors got a true taste of CCG’s issues with its third quarter 2014 results, when the firm saw a net loss of $130 million. “What caused CCG’s undoing [last] year were the capital allocations made [in 2013],” Halfacre says.
As acting CEO, Kahlbaugh handles initiatives like identifying new board members and senior-level student housing management talent; guiding the leasing and operations teams; and overseeing information technology initiatives.
But some of the really heavy lifting will fall to Halfacre, a veteran of the REIT wars. In addition to managing capital market activities, Halfacre oversees all capital deployment decisions pertaining to acquisitions, dispositions, and new development. Essentially, he’s in charge of fixing the major issues that got CCG in trouble in the first place. But first, he just wants to give investors predictable performance.
“What I’d like to do is strip out the drama,” he says.
So far, the reaction to Halfacre has been positive. “Right now, they are saying a lot of the right things and starting to take steps in the right direction,” Burke says. “The question investors are appropriately asking is, how much of this talk will turn into action?”
Most recently, Halfacre was head of strategic relations at Phoenix-based REIT Cole Real Estate Investments, where he was tasked with capital markets activity and corporate strategy, before the company merged with New York–based American Realty Capital Properties. Before that, he was chief of staff for BlackRock’s global real estate group and even got a different view of the public-company world at Green Street Advisors.
As Halfacre takes steps to right the ship, he couples an analyst’s view on what sets the best REITs apart with the practical background at Cole. He knows fixing CCG won’t be easy and that, after four years of broken promises, analysts and investors have every right to be skeptical.
“It’s a matter of getting things right, in some cases for the first time. This means shutting down the external growth spigot in order to focus internally on operations,” Burke says. “And of utmost importance is fixing the balance sheet. They currently hold the highest leverage in our coverage universe of nearly 90 REITs.”
With the management change, the company announced its intention to acquire the remaining equity interests in 32 properties in the Copper Beech portfolio; discontinue its construction and development business; reduce joint-venture exposure; and sell noncore assets. The Copper Beech transaction is expected to generate about $20 million of incremental net operating income at an incremental purchase cap rate of 7.3 percent based on current share price.
Not everyone is on board with the decision, which costs about $60.3 million in cash, around $140.6 million in debt assumption, and the issuance of nearly 12.4 million operating partnership units.
“Most investors would like to see them eliminate the overhang and move forward,” Meliker said before CCG announced it completed the Copper Beech deal. “Don’t throw good money after bad.” But other moves have been more well received. CCG announced a number of steps, including establishing a lean operating model to capture cost savings; overhauling its financial planning and analysis process to provide better forecasting; and adding experienced independent directors. The final step should allay concerns of analysts who have been critical of the board’s independence and credibility.
Minding the Store
One move that has met with universal applause was the decision to halt all construction and development and market those development pipeline assets.
“We won’t be doing any EVOs for a while,” Halfacre says. “We didn’t do that [development] particularly well. So we solved that problem by getting out of the internal construction and development business.”
CCG is also reducing its joint-venture exposure through select asset dispositions. Halfacre is “actively looking at options” for the best way to move forward with the Montreal assets while working to drive occupancy through leasing and resident life initiatives.
Next year, Halfacre plans to dive deeper into CCG’s portfolio.
“We will do a strategic review of the portfolio and determine which assets are nonstrategic, or noncore to our strategy, and we will look to sell those,” he says.
For the assets CCG keeps, Halfacre wants to improve its operations. In fact, he expects “just getting things right” to be a major growth engine for the company over the next couple of years.
“We can see significant internal growth opportunities just by minding our own store,” Halfacre says. “We can get far greater growth than by doing any single development. Over time, as our share price improves, so will our cost of capital.”
But that won’t happen overnight. “In student housing, in particular, it takes time,” Burke says. “You can’t just turn things around on a dime when you have academic calendars dictating typically yearlong lease terms.”
Halfacre admits there’s a lot of work ahead, but he’s confident CCG can turn itself around.
“We’re not out of the woods,” Halfacre says. “This is the first step of many.”