In May my Special Situations portfolio set up a synthetic long position on the pre-split NorthStar Realty Finance (NYSE:NRF). I'm back today to announce another acquisition -- the post-split shares of NorthStar Realty Finance, a REIT yielding a very high dividend that should drive the stock price higher.
Why buy the REIT?
NorthStar also split off NorthStar Asset Management (NYSE:NSAM), the more attractive business of the two. This latter company is a high-growth, low-capital business, and I think it could double in the next couple years as its fees from running the REIT and other businesses explodes upward. Why not buy more of that?
The major reason is that the options position already gives me huge exposure to this segment. And it's a high-multiple stock, which could drop if the market drops. So I'm not buying more largely for reasons of portfolio management.
In contrast, I think the REIT offers significant upside and lower downside through its high dividend. Pre-split, NorthStar was paying out about 90% of its funds from operations as a dividend. With management expecting FFO to clock in at $1.58-$1.70 this year, that would put the dividend around $1.50 at the same payout rate. So at today's prices, you're receiving nearly a 9% yield. That's much too high.
If you figure a 6.5% yield is normalized and that the REIT can grow income at 3%-4% annually, that implies a total yearly return of better than 10%. That's still attractive. So a 6.5% yield would put the stock at $23 per share and you get 9% a year while you wait. Add it all up, and I think shareholders could get up to 50% upside over the coming year.
Foolish bottom line
So my Special Situations portfolio is putting $3,000 -- about 4% of its capital -- into NorthStar Realty Finance. If the stock lingers around today's prices, I expect to buy more.
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Jim Royal owns shares of NorthStar Realty Finance. Jim Royal has the following options: long January 2016 $17 calls on NorthStar Realty Finance. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.