67 WALL STREET, New York - December 18, 2012 - The Wall Street Transcript has just published its Best Investment Strategy Interviews of 2012. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.
Topics covered: Investment Strategies - Large Cap Investing - Investing in Emerging Markets - Investing in Energy - Value Investing - Downside Protection With Upside Participation - Macroeconomic Trends
Companies include: Simon Property Group (SPG), Boston Properties (BXP), Vornado Realty (VNO) and many others
In the following excerpt from the Best Investment Strategy Interviews of 2012, an experienced portfolio manager discusses his proprietary valuation methods for REITs:
TWST: Your firm has a proprietary model for evaluating REITs. Would you tell us about it?
Mr. Schaff: What it comes down to is that everything about the equities market is about supply and demand as much as it is about fundamentals. What drives valuation many times is the perception of REIT ownership. In their early history, the REIT law that was applied in the 1980s was about trying to get real estate into retail investors' hands. What it really resulted in, however, was during the S&L crisis a lot of the S&Ls and banks effectively tried to offload the bad assets to mortgage REITs. And so it got tainted by that, and the mortgage REITs, at the end of the day, a lot of them blew up, because they were bad to begin with and they were highly leveraged. Interest rates went up, and valuations cratered, and they were basically caught.
The modern REIT era - where they are mainly equity REITs, they are self-managed, they actually own the underlying assets, they actually lease and manage the properties, different types of properties - started in about 1993. So REITs have been around for a long time, but the modern equity REITs really started around 1993. And the number of REITs that came into the marketplace, and the better managed ones, the ones that have strong management teams, they're shareholder sensitive, they're shareholder activists in some cases.
Milton Cooper of Kimco Realty (KIM) came in, Simon Property Group (SPG), Boston Properties (BXP) , Vornado Realty (VNO), etc. - a lot of the big property owners, they all came in the 1990s and the market expanded quite a bit. When that happened, they were being promoted early on by some of the retail brokers who were selling them on the dividend yields. Most of it's tax-sheltered dividend; they are a single-taxation entity at the shareholder level, which is a huge advantage. They were liquid, which a lot of the private REITs were not. And you could get into shopping centers, you could get into offices, you could get into apartments. It's a lot easier selling an apartment building in Atlanta by selling shares of Post Properties (PPS) than it is by actually selling the property privately, which could take you a year and a half. So there was a lot of incentive.
Since you have a large retail base, a lot of the retail investors basically look at dividends. That's pretty much how they view it, that's how they value it, that's what they want. And so they don't care whether their internal rate of return or capital gain is 15% or 20%, as long as they know they're getting their 6% income. So dividend discount models tend to work and are very effective in representing that valuation.
Then on the other hand, we have private real estate investors. They don't really care how good the management is, they simply want to buy assets on the cheap. They don't mind buying them on Wall Street versus Main Street, but at the end of the day the net asset value, the cap rate, the typical real estate valuation play comes into being, and allows the institutional funds that actually have direct, private real estate funds - a lot of them have opportunistic funds where they say, wherever we can buy the cheapest real estate assets, we'll go. And so there are times when REITs are cheap, and you'll find a lot of these opportunistic funds dipping into securitized commercial real estate.
The third group is the institutional market, institutional equity, hybrid market...
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