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This Small Cap REIT Is a Diamond in the Rough

Tickers in this article: ARCP ARCT NNN O LSE
NEW YORK ( TheStreet) -- CapLease (LSE) is a single-tenant REIT founded around 17 years ago in 1996.

The company has around 49 properties and enjoys a strong stable of high-quality tenants, including Nestle, the U.S. government, TJX Companies (TJX) , Kroger(KR) , Lowe's (LOW) , and Tiffany(TIF) .

Recently, CapLease announced the company entered a build-to-suit arrangement to construct a 311,730-square-foot distribution center for Vitamin Shoppe (VS) in Ashland, Va., at a total cost of $20 million. This new triple-net lease (on 43 acres) will have an average capitalization rate of about 8% over the 15-year lease term.

CapLease has maintained a consistent occupancy level (99.1% as of the second quarter) and the experienced management team has demonstrated skillful risk control as it successfully maintains and retains its free-standing tenants. In addition, CapLease's has one of the lowest funds-from-operations payout levels, 29.55% Q2-12) -- one of the lowest in the triple-net sector.

CapLease: What Difference a Year Makes

A year ago CapLease was trading at around $3.30 per share and several of the company's facilities, leased to Nestle, were subject to becoming dark. The company was exposed to substantial credit risk and considerable leverage, specifically the company's cross-collateralization associated with a portfolio of Nestle-leased properties.

However, since that time, CapLease has finalized the extension of the mortgage debt on the three Nestlé warehouses located in Breinigsville, Pa., Lathrop, Calif., and Fort Wayne, Ind., and these properties are now financed with a $106 million securitized first mortgage note that was scheduled to mature in August 2012.

During the past year, the company obtained a note extension for up to five years, inclusive of all extension options and with the last two years subject to re-tenanting the Fort Wayne property by August 2015.

The note face amount of $106 million and coupon of 6.32% were not modified by the extension, and the only immediate capital required for the extension was $3 million, which was funded into a reserve with the lender for future re-tenanting costs at the Fort Wayne property.

Pursuant to the extension, CapLease agreed that any cash flow shortfalls from the properties after debt service during the extension term will be funded through an approximately $5 million reserve previously deposited with the lender.

With just the Pennsylvania and California properties leased, the $5 million reserve is sufficient to cover expected shortfalls for the full term of the extension. CapLease also agreed to pay substantially all excess cash flows from the properties to reduce the principal amount of the debt. The company is permitted to prepay the loan at any time without payment of a penalty of premium to the lender.

CapLease previously extended the leases on two of the Nestlé properties where the leases were scheduled to mature in December. The extension of the approximately 1 million-square-foot Pennsylvania property is with the existing tenant Nestlé for five years commencing Jan. 1, 2013.