American Financial Seeks New Lease on Life

I've long tried to find value in American Financial Realty (NYSE: AFR  ) . The story seems solid. American Financial is the only REIT focused on leasing to financial service companies like Bank of America (NYSE: BAC), State Street (NYSE: STT), and Citigroup (NYSE: C). These are extremely high-credit tenants, and they sign long-term leases (customers need to know where the branches are). In other words, it seems like the lease payments would be money in the bank.

Stuart Little?
First, let me digress into something interesting I noted. American Financial's story hasn't worked out well so far. The company can't seem to get its cash flow up to respectable levels, and the financial statements are somewhat incoherent due to recurring non-recurring items. Lew Ranieri of Liar's Poker fame is the company's chairman. Ranieri is often credited as the founder of the mortgage-backed security and is widely hailed as a financial genius. While reading up on American Financial, I noted that one article pointed out that Ranieri's track record as a corporate steward gives one pause.

Ranieri is also chairman at Computer Associates (NYSE: CA  ) , Capital Lease Funding (NYSE: LSE  ) , and Franklin Bank (Nasdaq: FBTX  ) , and he has served on the board of directors at Reckson Associates.

Of those companies, Computer Associates is still recovering from an accounting scandal, and Reckson Associates was accused of a "takeunder" (management bought part of the company from shareholders, allegedly for less than market value). As for Franklin Bank and Capital Lease Funding, I don't know much about them except that their stock charts are both flat, and Capital Lease Funding and American Financial have to be two of the only REITs that haven't soared in value over the past two years.

Of course, correlation doesn't equal causation. However, if you keep seeing the usual suspects, it may be cause for concern.

Portfolio repositioning
Anyhow, back to the subject at hand, American Financial. The company reported mediocre fourth-quarter and full-year results (see our Fool by Numbers), but management did make some positive noise about its portfolio repositioning plan.

As previously announced, the company reviewed its assets and decided to take a sharp knife to underperforming and non-core assets. In the quarter, $917 million worth of assets were sold, and $575 million more are earmarked for the scalpel. The company ended the quarter with $2.3 billion in net real estate investments (30% less than last year), so you can see it's making some major moves. The sale proceeds are going toward paying down debt, another move shareholders should applaud.

Hopefully, paring down the portfolio can help the company get rid of underperforming property and focus on producing more cash flow. Total occupancy at the end of 2006 was 86.9%, a number that needs to be improved.

In the earnings call, management noted that it basically needs to improve its blocking and tackling: lease out vacancies, renew expiring leases, manage capital expenditures, and leverage operating expenses.

Management noted that of the 911 properties the company plans to keep, 646 are fully triple net leased or 90% occupied -- those properties are healthy and not the problem. Another 46 properties are recently acquired vacant properties, and American Financial is working on leasing them out. The remaining 219 properties are where the problem lies. Out of the 2.3 million in vacant square feet (excluding properties earmarked for sale), these 219 properties account for 2 million vacant square feet, half of which comes from 26 large office buildings in central business district locations.

Are you for real estate?
I know current shareholders may think they're listening to a broken record, but this time the turnaround may have some substance to it. If there's one thing I know, it's that when people make very specific promises to which they will be held accountable, they tend to work very hard to meet those goals. It is very encouraging that management has specifically identified where the problem vacancy areas are, as opposed to making vague promises to improve results (i.e., "We need to... make more money").

Not only that, but management has clearly throttled back and pared down the portfolio, getting rid of problem properties and paying down debt. Although I'm not putting my money where my mouth is (I'm not a shareholder), I do like management's tone in the earnings call, and I think they are earnest about getting cash flow up and increasing shareholder value.

American Financial and Bank of America are Motley Fool Income Investor recommendations. Try any one of our investing services free for 30 days.

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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.

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