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Robert Jaffe Loves This mREIT, Should You?

Force Capital Management, managed by Robert Jaffe, is a mid-sized hedge fund with more than $600 million in assets under management. The average account balance at Force Capital is $86.6 million, which is higher than the New York City hedge fund industry’s average ($68.2M); in short, this means that Jaffe’s fund caters to above-average high net worth individuals.

Force Capital has around two-thirds of its total capital allocated equally between the financials and services sectors, with the remainder split between a bevy of investments. According to his second quarter 13F filing with the SEC, Jaffe held 21 different long positions, with the remainder of his 13F portfolio allocated to an assortment of call and put options. Here’s the definitive list of his 13F portfolio, but we thought it was important to take a deeper look at the fund manager’s top stock pick.

iStar Financial Inc. (NYSE:SFI)

Accounting for 5.3% of Force Capital’s total holdings, iStar Financial is a commercial mortgage REIT, and the top long-only pick in Jaffe’s 13F portfolio. In a post-recessionary environment where commercial real estate has been a far from ideal investment, iStar has had to change its business model rather drastically. Before crisis rocked the housing market, this mREIT primarily handled short term debt for commercial development projects. Now a days, iStar has a more diversified portfolio of assets including: (1) condo and hotel projects, (2) land, (3) leases, (4) direct investments in loan servicing companies, (5) foreclosed real estate, and (6) traditional loans. The company also recently settled a lawsuit with shareholders claiming it had knowingly withheld negative economic data in 2007; the settlement is estimated to be worth $29 million.

In 2012, shares of the mREIT have been a superb investment, generating a 55.0% return. This price appreciation has outpaced the diversified REIT industry’s average (22.7%), and peers like Brookfield Office Properties Inc. (NYSE:BPO) at 4.5%, Boston Properties, Inc. (NYSE:BXP) at 13.0%, Gramercy Capital Corp. (NYSE:GKK) at 20.0%, BRT Realty Trust (NYSE:BRT) at 8.0%, and RAIT Financial Trust (NYSE:RAS) at 11.6%.

Brookfield Office Properties Inc (USA) (NYSE:BPO)

iStar last reported a positive Funds from Operations – a measure of an mREIT’s earnings minus depreciation and property value fluctuations – in 2007. At this time five years ago, its year-end FFO was $819 million, which was larger than that of Brookfield ($240M), Gramercy Capital ($147M), BRT Realty ($47M), and RAIT Financial (-$607M), but below Boston Properties ($1,964M). Over the past half-decade, iStar has seen its financial health deteriorate quite rapidly, and currently sports a trailing twelve month FFO of -$310 million. In fact, the mREIT’s 5-year average annual FFO growth of -27.6% is worse than most of its aforementioned competitors including: Boston Properties (-9.4%), Gramercy Capital (10.5%), BRT Realty (-20.0%), and RAIT Financial (-19.2%). Only Brookfield (-62.0%) has experienced greater declines.

Weak FFO growth indicates that iStar will have trouble initiating a dividend in the future, as the mREIT does not currently offer income-seeking investors any yield. This is in stark contrast to Brookfield (3.43%), Boston Properties (1.95%), and RAIT Financial Trust (6.79%), which each sport solid, but unspectacular dividend yields.

From a valuation standpoint, we must measure how investors are valuing every dollar of iStar’s FFO growth. In most cases, a simple Price-to-FFO ratio is suitable, but since a few of these mREITs have negative FFOs, it’s better to use a growth-focused alternative. Similar to the PEG ratio, the Price-to-FFO Growth ratio indicates how an mREIT’s FFO is valued. When computing this metric, we can see that iStar sports a PFFOG ratio of 8.02, and while this may seem overvalued at first glance, it is actually far below the likes of Brookfield (26.36) and RAIT (59.76). Only Gramercy, with a PFFOG ratio of 6.73, looks more attractive.

Aside from Jaffe, other hedge fund managers that are bullish on iStar Financial include: David Gallo, Ric Dillon, and Edward Lampert. Each member of this trio holds at least 0.3% of their 13F portfolio in the mREIT. The most prominent hedge fund managers with a stake in iStar are Jim Simons, Israel Englander, D.E. Shaw, and Ken Griffin, with Englander holding the largest position in terms of total value, worth $4.5 million.

While iStar Financial has seen its financial health deteriorate post-recession, a new focus on asset diversification, as well as the conclusion of a lengthy lawsuit may create some tailwinds behind this mREIT. While the company has seen its Funds from Operations shrink by double-digits annually over the past few years, it hasn’t been the industry’s biggest loser. Finally, from a valuation standpoint, we can see that iStar’s FFO are not massively overvalued, so there may be further gains in store. For a complete look at the hedge fund industry’s sentiment toward iStar, continue reading here.

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