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This Small Cap REIT Is a Diamond in the Rough

Stocks in this article: LSE O NNN ARCT ARCP

CapLease Trades at Significant Discount to Book Value

CapLease is trading today $5.37 per share -- up almost 63% in just a year -- and the current share price has plenty of more room to grow. The company's discounted cash flow stands at around $305 million -- over 10% less than the companies market cap of $359 million. Amazingly, the current share price seems to assume that the company will return all of its assets to the bank, and might sign up one of two large leases for the balance of the company's history.

In short, that won't happen. The company will increase cash flow both by renewing the leases on many of its larger properties and by continuing to deploy capital from its low cost revolver, thereby significantly adding to future cash flows at no cost to investors.

Why is CapLease trading at a Discount?

CapLease holds about double the amount of leverage as its peer group. (CapLease has around 75% debt to market cap). However, even if CapLease defaults on some of its loans and has to return property to lenders, the debt is nonrecourse and will not affect the other properties in the portfolio.

To make the point more emphatically, even if CapLease loses half of its properties to lenders, considering the company trades almost at cash flow, you still get the other half for free. In short, a default does not affect the company on the REIT level, and the other properties remain safe.

Between now and 2017, CapLease has a slew of major lease expirations coming due. The harshest of this wave will come in 2016 and 2017 when CapLease faces 12% and 13% of the leases, respectively, coming due.

Additionally, in the immediate future, the company has two major leases still up in the air, one with the U.S. government in Bethesda, Md., and the remaining Nestle Holdings lease (mentioned above) in Indiana.

Current management has been in this business for 17 years, and I think it has the knowledge and experience to guide the company through this tough time. In addition, insiders own over three percent of CapLease shares making the "skin in the game" proposition more compelling.

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