New Position: Jernigan Capital (JCAP)

Jernigan Capital (JCAP)
Current Price: $14.25
Shares Outstanding: 6.16 million
Market Cap: $87 million
Current Dividend Yield: 9.8% 

Introductory comments: I typically do not get involved with REITs and other real estate development plays because of the complexity of the financials and numbers as they can be very difficult to follow and understand for non-financial folks like me. However, the opportunity with JCAP is pretty straightforward and the numbers are actually fairly simple to understand. And while JCAP is not a company that is going to provide many multiples of shareholder returns like opportunities with smaller microcaps, the potential does exists for multiples of returns on principal as well as for collecting a very hefty dividend along the way. 

The Company: Jernigan Capital is a commercial real estate finance company (operating as a REIT) that provides financing to private developers, owners, and operators of self-storage facilities. The company offers financing solutions for ground-up construction of self-storage facilities or redevelopment opportunities, as well as for the acquisition of, refinancing of, or recapitalization of self-storage facilities.The company is a bit unique in that it was a start-up company at the time of its IPO in early 2015. Via the IPO, as well as with a concurrent Private Placement, the company raised approximately $112 million.

The Founder and CEO: Dean Jernigan, the founder and CEO of Jernigan Capital, is a veteran within the self-storage industry. In 1984 he founded Storage USA with a single location, which was eventually acquired by Security Capital Group/GE Capital in 2002 for $1.8 Billion. Jernigan then become the CEO of CubeSmart, stepping down in 2013 to found Jernigan Capital. Dean is an owner/operator CEO that you want to invest alongside with. His knowledge of the industry, coupled with his proven success within the industry, should provide JCAP shareholders with a lot of confidence. Dean has been buying shares very frequently on the open market, very aggressively at times. 

Management: In addition to Dean, one reason to get excited about JCAP is John Good, the President/Chief Operating Officer, who was hired by Dean in May 2015. John has been a successful M&A/Corporate Securities attorney for much of his career, with a very heavy focus on REITs. Dean said this about John when he announced him as President/COO:

"John is well known in REIT circles and has been an extremely important part of our team since the formation of the Company," said Dean Jernigan, the Company's chairman and chief executive officer. "He counseled us through structuring our company and execution of our IPO and has very ably served other REITs alongside me. Having John as our president and chief operating officer gives the Company benefit of his outstanding talents and relationships on a full time basis to help take us to the next level. I know I speak for the board, management and shareholders when I say that we could not be more pleased.”

In addition to Good, the company has a lot of talent in it’s front office, including Bill Drummond as CFO, who has has a highly successful career as a public auditor and managing partner at Ernst & Young. Also on the JCAP team is Jack Connell, a long-time associate of Dean’s who worked alongside him at CubeSmart for a number of years. 

The Opportunity: It’s very easy to get lost in the numbers when analyzing a REIT, so I want to keep my analysis of this opportunity as simple as possible. Here are the reasons why I feel the investment opportunity with JCAP is pretty compelling:

  • Dean Jernigan started Jernigan Capital because he strongly feels that the beginning of a 5-7 year development cycle for storage units is upon us. Dean’s reason for this is because of the the backlog within the self-storage industry that has resulted from a lack of commercial funding following the recession.
     
  • Dean and John both have expressed that the opportunity for the company is “exponential” to what they thought it was prior to the company’s IPO. Since their IPO they have closed on 14 development deals, and the company believes in just these 14 deals there is “upwards of $5/share of inherent value” from those deals (more on this later).
     
  • Get this… the company feels that it’s current team of 18 people can handle up to $1 billion in total assets under management, basically suggesting that company expenses will stay relatively flat going forward, and the company can grow up to roughly 10x its current size before needing to add additional personnel. 
     
  • Commercial banks typically will only finance a self-storage development up to 65-70% of the total development cost, whereas Jernigan takes a little more risk and will finance up to 90% of the upfront cost. Commercial lenders will always make such loans full recourse loans, while JCAP’s loans are all non-recourse. In consideration for taking additional risk and for having the industry expertise and contacts that can greatly assist the developers (typical lenders wouldn’t have this expertise/level of contacts), Jernigan has a 49.9% “participation”, or “equity kicker” in each development loan it funds. This is substantial and it is where the hidden value is in Jernigan. In the Q3 2015 conference call, Dean mentioned that each development deal it funds is worth around $2 million in “profit participation” to shareholders. Based on the 14 current development deals on the books, there is $29 million in “profit participation” that will be realized in the coming years. With another seven development deals to be closed in coming months, another $13 million worth in “profit participation” are for the shareholders. So, with 21 total deals closed, total “profit participation” for shareholders is already north of $40 million once these deals, realized when the developer or owner who built the storage facilities monetizes it’s property. Of course, the company will earn interest income on these loans as well, averaging 8-9% until loan maturity. 
     
  • Self-storage developments are extremely attractive to institutional investors and larger REITs after “stabilization” occurs (i.e. high occupancy rate), typically 3 years after a facility opens. As a result, Jernigan negotiates for the first right of refusal in almost all his development deals that would allow Jernigan to buy the facility outright should he choose to do so prior to the facility owner being able to sell to a 3rd party. 
     
  • $25 billion in new storage facilities will need to be created in the USA over the course of the next 5 years if the population grows at the anticipated 1.5% year over year increase. And with more people renting rather than owning, which typically means moving every 3 years instead of 10 years if owning, the demand for self-storage units is strong.
     
  • Shares have dropped significantly since the IPO at $20/share. Given that the company is essentially a "start-up", investors are wanting to see capital deployed and investments made quickly, and the lack of patience has created an opportunity to pick up shares at the current price of $14.25 that provides a yield of almost 10%!
     
  • The company expects significant free cash flow in 2016. Many more details on expected cash flow and guidance will be provided in the next quarterly report/conference call.

Biggest Risk: The biggest risk, in my opinion, is of course the ability of the company to fund deals and grow without having to raise cash via secondaries, thus diluting shareholders. It is the company’s intention to secure a sizable line of credit, and having the line of credit essentially grow as the business grows. I also know that the company is working to raise capital through private investors as well. While I do not view dilution as a risk at this time, things are always subject to change down the road should JCAP have trouble obtaining capital to continue growing. It's also important to keep in mind that Dean and John are significant shareholders as well, so any form of dilution will be avoided in my opinion.

Conclusion: Jernigan Capital is led by a Owner/Operator with significant success within the industry. The company is serving an unfilled niche as commercial banks typically don’t get too excited about funding self-storage development projects because of the lack of immediate occupancy, which is why they will only fund such projects up to 65-70% of the value. Developers will gladly agree to the “profit participation” that Jernigan requires in order to be able to fund their project up to 90% of the cost. 

With $68 million of cash on the balance sheet, no debt, and Jernigan working hard to leverage the business with a line of credit that would responsibly lever the company at appropriate levels, Jernigan Capital is poised for rapid investment growth that will include “profit participation” kickers that will create inherent value for all shareholders. With a huge pipeline of term sheets, loan commitments, and loans currently in underwriting, the future return for JCAP shareholders looks very bright. 

Disclosure: Long shares of JCAP