Burl East, CFA, Chief Executive Officer of American Assets Capital Advisers, was featured in an article by Sarah Max of Barron’s regarding his top-ranked mutual fund.
Burl East, CFA, Chief Executive Officer of American Assets Capital Advisers, speaks on Strategic Investor Radio with Charley Wright. Mr. East discusses AACA’s unique long short strategy focused on companies believed to have monopolistic pricing models, barriers to exit for the tenant, limited new suppliers, and other key indicators.
Burl East, CFA, Chief Executive Officer of American Assets Capital Advisers, was featured in an interview by Kopin Tan of Barron’s. Mr. East talks about AACA’s unique investment strategy and how it seeks to benefit in an aging bull market.
Burl East, CFA, Chief Executive Officer of American Assets Capital Advisers, was interviewed on a special edition of STA Money Hour by Michael Smith and Luke Patterson. Mr. East talks about AACA’s current outlook on real estate in general and where AACA sees value and risks. Mr. East also talks about his current “long-short” real estate securities fund that he subadvises for Altegris Advisors, LLC. If you are interested in real estate as an investment, this interview will be well worth your time.
American Assets Capital Advisers, LLC (“AACA), is proud to announce that the real estate focused 40 Act fund AACA manages was named the Best 40 Act Equity Fund at the 2016 U.S. Hedge Fund Performance Awards. Presented by HFM, a leading publisher dedicated to the hedge fund market, the U.S. Hedge Fund Performance Awards recognize funds that have outperformed their peers over the past 12 months. For more information please see the official press release here.
*A panel of judges comprised of independent industry professionals, appointed by HFM, determined the winners based on a combination of quantitative and qualitative data. For additional information, visit the following link.
Burl East, CFA, Chief Executive Officer of American Assets Capital Advisers, was interviewed by Steve Schaefer of Forbes. Mr. East talks about AACA’s unique investment strategy and how it seeks to benefit from trends like Pokémon GO.
Many people don’t have an investment allocation to real estate investment trusts (“REITs”) because they believe they already have “enough” exposure to “real estate” through ownership of their home. REITs and your home are very different asset classes with very different characteristics. REITs invest primarily in commercial real estate, which is any non-residential property used for commercial profit-making purposes. Your home is an investment in residential real estate, which is a type of property, containing either a single-family or multifamily structure, which is available for occupation and non-business purposes.
Over the past 20 years publicly-traded REITs have returned an annualized 11.23% total return and homes have returned 3.47%, or just a little more than inflation. Over these 20 years, REITs returned more than 7x (740%) while homes didn’t quite double (98%). Publicly-traded REITs have been one of the top performing asset classes and homes have been one of the worst over the past 20 years.
There are many differences between REITs and your home that contribute to this notable difference in performance. The largest contributor is that commercial real estate can generate positive cash flows but the residential home you live in cannot. By living in your home, you are effectively consuming the market rate rent that your home might have procured. If you forgo rent, as you do by living in your home, the return profile changes to be basically little more than an inflation hedge. Performance of real estate follows the following formula: Total Return = price change + rent collected
With your home, 100% of the asset is in one property type and in one geographic market – this is concentration in its purist form, the opposite of diversification. On the other hand, with publicly-traded REITs, investors can choose from dozens of property types (including, but not limited to, specialized real estate sectors such as data centers, cell phone towers, casinos, medical research labs, infrastructure, prisons, ski areas, etc.) across any market in the U.S. and most major markets in the world. The opportunity for diversification in publicly-traded REITs vastly exceeds that of a single home.
Homes are relatively illiquid compared to public REITs that can be traded every day the stock market is open and settle to cash virtually immediately. This is in stark contrast to the home market, which may be illiquid for months, seasons, or even years, and can take months to settle to cash.
Transacting a home is much more costly than transacting in publicly-traded REITs. When you sell a home, the typical transaction cost is more than 6% of the home’s sale price (for perspective, based on data from the last 20 years as shown in the Total Return chart above, this is equal to about five years’ worth of your home’s price appreciation after inflation). In contrast, it costs little more than pocket change to trade shares of a public REIT ($7.95 per trade at Fidelity and $4.95 per trade at Scottrade).
Home ownership is not flexible. The entry price for a home is typically six-figures and you can’t really buy or sell a percentage of a home – it is binary: either you are in all the way or you are completely out. With publicly-traded REITs you can buy almost any amount you wish in single share increments (typically $20-$50/share) on the stock market. With public REITs you can trim, add or change a position in almost any amount on almost any day.
Supply & Demand
Perhaps the single most impactful factor that undermines home price appreciation is the ability of developers to add new product to the market. In our opinion, homes are the type of real estate most likely to be oversupplied because we believe they are the cheapest, smallest, quickest and least complicated real estate product type to build. AACA also believes that whenever the cost to build new homes is below the current market value of existing homes, builders will build new homes, which could create a price ceiling on the appreciation of your home. Additionally, in recessions, construction costs (materials and labor costs) decrease, which makes building new homes less expensive and creates additional new supply. This combination of factors could dampen your home’s price rebound out of a recession relative to public REITs, as shown in the historical graph below.
Let’s look at volatility of publicly-traded REITs and homes. Below is a graph of the past 10 years, which includes the financial crisis. Since public REITs trade on the stock market, the share price of these REITs are subject to fluctuation in the stock market and as such experience volatility. However, we would argue the underlying physical real estate owned by the REITs can’t be much different in volatility than your physical home. The difference is that your home isn’t bought and sold every day and marked to that market price. That being said, in the graph below we see that homes sold off -32.81% and public REITs sold off -58.89% in the financial crisis. However, looking at a longer period of time, homes captured 56% of the downside and 8% of the upside of public REITs over the past 10 years – homes have been asymmetrical to the downside. And public REITs have since gone on to return 105.17% over the past 10 years while homes have returned 8.56% in that same time period.
We believe you should think of your home first and foremost as the place you and your family live and second as an inflation hedge for your invested principal – nothing more than that. You should not think of your home as an investment in real estate (as history shows there has been almost no meaningful return after inflation). Publicly-traded REITs and your home are very different asset classes with very different characteristics.
But what if I rent my home out?
But what if I buy a home and rent it out? That would be good, right? Sure, you will grab the warranted rent (assuming you can find a good renter), but you may also be the one grabbing a plunger to fix the toilet on Christmas Eve when your renter calls. Also, you still need a place to live so you will presumably either be buying or renting a home to live in. Additionally, it is probably unlikely that you can rent one house as efficiently as a public REIT that has professional leasing, revenue optimization software, economies of scale, expert experience, market knowledge and real-time industry data. Lastly, if you want to buy a home and rent it out, there are several publicly-traded REITs that do that.
This is a summary and does not constitute an offer to sell or a solicitation of any offer to buy or sell any securities or to participate in any investment strategy. This material is for information purposes only and its content should not be relied upon in making any investment decisions. The information provided is not a complete analysis of the market, industry, sector, or securities discussed. While the statements reflect the author’s good faith beliefs, assumptions and expectations, they are not intended as research and are not guarantees of future or actual performance. Furthermore, American Assets Capital Advisers, LLC (“AACA”) disclaims any obligation to publicly update or revise any statement to reflect changes in underlying assumptions or factors, or new information, data or methods, future events or other changes. This document may contain forward-looking statements that are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially.
Flush with record levels of cash, many private capital real estate managers are buying up publicly traded real estate investment trusts (“REITs”) to take advantage of the gap between public REITs and private real estate valuations. Historically, commercial real estate in the private market has usually transacted at, or near, fair value (or else the property doesn’t trade), while shares of REITs often trade at a discount or premium to their underlying net asset value (“NAV”) in the public markets. This is because REIT share prices fluctuate in the public stock market while the underlying real estate NAV remains relatively constant (in the same way private real estate’s NAVs do).
Most of the REITs recently acquired by private capital have been trading at a material discount price to NAV in the public market; however, when these discounted REITs are acquired, it is at a price closer to NAV. These REIT acquisitions have been readily agreed to because they can create value for the private capital (who may get institutional-quality real estate relatively quickly, easily, and less expensively) and for the REIT shareholders (who may get a nice return from the substantial share price increase from the pre-deal share price). This activity of private capital buying beat-up REITs can effectively create a put option for the holders of the publicly traded REITs – if the price drops enough, the REIT may be taken out closer to NAV, and certainly at a premium to the discounted pre-deal share price. In addition to creating a price floor for individual REITs, this buying activity can also create a supporting tailwind bid for the entire REIT asset class.
- The current market cap of domestic public REITs is about $1 trillion; the total value of underlying real estate assets is about $1.5 trillion, assuming 33% leverage, which is typical for public REITs.
- As of 6/30/15, private real estate managers had a record $249 billion in unspent capital commitments (this is equal to about 25% of the total public REIT market cap!). Private capital typically employs meaningfully greater levels of leverage than REITs do, which only further increases its REIT-buying power.
- It is generally faster, easier, and less costly for private capital real estate managers to buy public REITs than private real estate.
- Private capital can buy a large REIT portfolio in one bite. For example, Excel Trust was recently acquired by Blackstone for approximately $2 billion. The Excel Trust portfolio included 38 retail shopping center properties across 18 states. If Blackstone had to buy these properties in one-off transactions, they would have had to travel to every property, conduct their own data gathering and due diligence, review and audit financials and every lease contract, and successfully create and close potentially 38 separate deals with 38 different parties. It is much easier, faster and less expensive for Blackstone to buy an institutional quality portfolio, already equipped with GAAP accounting, lease abstracts, financial audits, and publicly available granular property level data, in one fell swoop. Not only are transactional costs less, but it may be getting it at an arguably cheaper price.
- In the past year, a number of REITs have been purchased by private capital, including but not limited to the following list:
- Investors sometimes pose the question, “Why buy the goods when you can buy the store?” In effect, private capital is answering that question by buying discounted REITs instead of individual properties. We expect this trend to continue as long as REITs trade at material discounts to their NAVs and as long as private capital is looking for ways to deploy nearly $250 billion in unspent capital commitments.
This is a summary and does not constitute an offer to sell or a solicitation of any offer to buy or sell any securities or to participate in any investment strategy. This material is for information purposes only and its content should not be relied upon in making any investment decisions.The information provided is not a complete analysis of the market, industry, sector, or securities discussed. While the statements reflect the author’s good faith beliefs, assumptions and expectations, they are not intended as research and are not guarantees of future or actual performance. Furthermore, American Assets Capital Advisers, LLC (“AACA”) disclaims any obligation to publicly update or revise any statement to reflect changes in underlying assumptions or factors, or new information, data or methods, future events or other changes. This document may contain forward-looking statements that are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially.
As real estate securities analysts, most of the things we do have some basis in being knowable. For example, we analyze business plans, visit assets, build models, talk to tenants and reach conclusions about a company’s portfolio, prospects, management and stock valuation. While none of this is completely knowable, it’s partly knowable.
In the last 10 years, however, under the current administration, there has been a very concerning trend of government agencies reaching into the real estate business, often with politically motivated goals. This has introduced an aspect into the business that is less predictable. Some instances are effectively zoning or permitting processes where, if the applicant (usually a company) has followed the rules, they ultimately get building permits or the equivalent thereof. Other instances are not so simple. There are dozens of examples we could talk about, but one in particular raises such concern that it bears discussion.
Some of the portfolios we manage own shares in a company that is developing the Cadiz Valley Water Conservation, Recovery and Storage Project (project description). For readers not in California, the State has an environmental review and vetting system – The California Environmental Quality Act, or CEQA for short. It is the result of decades of legislative efforts; it is costly, complicated, slow-moving and open to the public. It has its failings, but it is an established legal framework under which all the parties to the process operate.
At 30,000 feet, CEQA requires large real estate infrastructure projects to create an Environmental Impact Report (“EIR”) (CEQA process flow chart). For the Cadiz project and many others, these reviews are multi-year and multi-million dollar undertakings. They also provide fodder for the environmental plaintiffs industry, which sues project participants on many approved EIRs. Imagine putting together a 3,000 page review of anything, and environmental lawyers can probably find a potential nit.
What happens in practice is large projects like Cadiz are sponsored by government agencies, in this case the Santa Margarita Water District and the County of San Bernardino, so the defendants in these environmental lawsuits are generally government agencies.
The process is generally something like the following:
- Hire qualified, independent scientists and consultants to establish the project impacts under applicable local and federal law;
- Design or redesign the project to mitigate these environmental impacts;
- Create a 3,000 page document that covers any real, imagined or perceived environmental impact that your project may create;
- Pull this together into a draft copy and publish it for comment for 90 days; during the comment period, hold open meetings for citizens, project participants and other concerned people to address the lead agency (in this case the water district) face-to-face; and
- Collect all the feedback, consider reasonable commentary, incorporate plan design changes to address these reasonable concerns and put out a final copy of the EIR.
A scheduled vote is then held and a branch of the California government approves or rejects the project. This effort, start to finish, is typically two-to-five years, although in many cases it is much longer. In the case of Cadiz the vote was in 2012 and the project was unanimously approved. In the immediate time period after the approval, the environmental legal industry geared up and sued. No matter that a branch of the California government approved it. There were six challenges, all of which were dismissed in an Orange County court in 2014. (Judge Andler’s dismissals)
As expected, the losing plaintiffs appealed, as there is no material cost to do so and part of the effort may be focused on delay. In the Cadiz case, that appeal was heard on March 23rd and we believe the plaintiffs’ appeals will be dismissed.
At a high level, this should concern any right thinking person, as we start with a two-to-five year EIR process and add at least two-to-three years of litigation. So in California, any project of meaningful scale has a six-year approval process. We would imagine that if we had this conversation with Texas Governor Rick Perry, he would say that’s just great and remind us that Toyota is moving from California to Dallas.
Having said all this, at least the process is final, right? You get a certified EIR and off you go. Technically yes, but in the case of the Cadiz project, no. The Bureau of Land Management (“BLM,” a federal agency) is actively working to interfere with a state-approved project.
There are two particularly troubling aspects to this. For a California project like this, CEQA is law, plain and simple. The reason California has CEQA is to provide a slow-moving, open vetting process; not to engender backroom politics by other, including federal, agencies.
To transport water from the CEQA-approved project, the project sponsors (Cadiz and the various water agencies) are proposing to build a pipeline in an existing railroad right-of-way. Of course, the pipeline is covered in detail in the approved EIR. According to members of Congress and the U.S. Senate, the BLM is attempting to reinterpret 140 years of non-controversial railroad right-of-way law initially put in place by Congress in 1875. (1875 act) In short, this law allows railroads to lease space to other commercial users along their right-of-way (typically 100 feet of surface and subsurface on either side of the rail line). Historically, the railroads had the right to do this as long as it did not interfere with rail operations. More recently, the Solicitor General of the Department of the Interior issued a document called the “M 37025 Opinion,” which provides: “A railroad’s authority to undertake or authorize activities within an 1875 Act ROW is limited to those activities that derive from or further a railroad purpose” (M 37025 Opinion). This is the legal standard and allows railroads to lease space to all sorts of commercial users. The example provided in the M 37025 Opinion is MCI’s fiber line, which was clearly built for commercial purposes, but allows as a railroad benefit some of the fiber capacity for the railroad’s use. Cumulatively there are easily more than twenty thousand miles of railroad rights-of-way in the western United States. It is estimated by Congress that there are 3,500 existing utility uses on railroad rights-of-way over federal lands, which Cadiz believes are similar to its proposed pipeline.
So Cadiz, the Arizona and California Railroad, and the Santa Margarita Water District submitted a proposal that had more than a handful of attributes (e.g., water conveyance pipeline, fire suppression system, access road, power line and supported facilities, and a steam-based excursion train) they felt should qualify as “further[ing] a railroad purpose”. In particular, the railroad along this route features crossings constructed of creosote-soaked wooden trestles, which are flammable. Trestle fires are common. Hence, the pipeline is designed with automated fire suppression equipment to assist the railroad in preventing or containing fires.
In our opinion, it is reasonable to conclude that automated fire suppression is preferable to having railroad employees hop in a truck, race miles to the fire and throw sand on it. Yet the BLM argued in their non-binding letter of response that since the traditional method was the throwing of sand, adding automated fire suppression would not “further in part, railroad use.” (BLM letter) The BLM director that made this statement has since left the California office of the BLM.
Congressional reaction has been swift in condemning this (Congress letter to BLM). Nine Congressmembers, both Democrats and Republicans, have co-authored a letter to the BLM Director saying that the ruling is contrary to the M 37025 Opinion. Congressmen Tom McClintock and Tony Cárdenas in particular have met with the head of the BLM in Washington in person to convey the same opinion. Senator Orrin Hatch is also on record as being “deeply disturbed” by the actions of the BLM.
What is particularly troublesome to members of Congress is that the BLM’s action has clouded the title of all existing uses within railroad rights-of-way. The discretion applied by BLM to reject the opinion of the railroad that the Cadiz project furthers railroad purposes means that BLM, not the railroad, will be the arbiter of the question. This diverges from the M 37025 Opinion where the railroad’s opinion formed the basis of the determination that the fiber optic cable was providing a communication railroad benefit.
Consequently, in addition to the initial backlash from the legislative branch as to the Cadiz project, the issue is being subsumed within a larger cause that has enlisted many members of Congress in an effort to explore every available legislative and administrative means to clarify the scope of railroad rights-of-way.
The problem goes beyond the railroads themselves. Hundreds of millions, if not billions of dollars have changed hands in consideration for the use of these rights-of-way. How would the BLM propose to unwind those transactions if the railroads did not have the authority to lease in the first instance? How will projects be financed in the future? The impact of the BLM’s action effectively is that now every potential use of a railroad right-of-way will have to secure sign-off from the BLM before it may be financed to remove the cloud. But now even if the BLM were to sign-off, its decision would be subject to second guessing by parties in the Courts. The issue seems ripe for action by Congress.
The Cadiz project itself has widespread approval, with at least 30 politicians in favor as well as dozens of community leaders (support for project). As far as we can tell, the only current political opposition is from Senator Feinstein (whose office made no comments and asked no questions of either the Santa Margarita Water District or San Bernardino County, the parties reviewing the Project under CEQA). She has recently indicated her opposition was based on her belief that the project would damage the environment. Since the EIR is approved under California law and indicates the opposite, we fail to see how her opposition has any merit.
Ultimately we believe the project will be approved, hence our investment, but this federal process is adding time and has strained our faith in the operation of the federal government.
This is a summary and does not constitute an offer to sell or a solicitation of any offer to buy or sell any securities. Views are as of April 13, 2016 and are subject to change at any time based on market and other conditions. The author’s assessment and opinions of a particular company, security, and/or other information discussed in this article is not intended as research or advice. While the statements reflect the author’s good faith beliefs, assumptions and expectations, they are not guarantees of future or actual performance or results. The securities and companies discussed are for illustrative purposes only and do not represent all of the securities purchased, sold or recommended for advisory clients. The reader should not assume that any securities discussed were or will be profitable. Furthermore, American Assets Capital Advisers, LLC (“AACA”) disclaims any obligation to publicly update or revise any statement, including forward-looking statements, to reflect changes in underlying assumptions or factors, or new information, data or methods, future events or other changes.
This document may contain forward-looking statements that are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially. The following factors, among others, could cause actual results to differ from those implied by the forward-looking statements in this presentation: changes in general economic conditions; political factors; changes in specific markets; legislative/regulatory/policy changes (including, but not limited to, environmental laws/regulations/policies and laws/regulations/policies relating to railroads, rights-of-way, land management, and real estate); and changes in generally accepted accounting principles. While forward-looking statements reflect AACA’s good faith beliefs, assumptions and expectations, they are not guarantees of future or actual performance.
A tale of two stocks and a tale of two investors that, we believe, demonstrate the sometimes illogical nature of perceptions and how those perceptions can drive valuation.
The stocks are BioMed Realty Trust (BMR) and Alexandria Real Estate Equities (ARE). They are the only two public companies currently focused on ownership of lab/life science space in the US. For the last two decades, they have had a duopoly in this real estate sector. Alexandria effectively gave birth to the industry in 1994, and BioMed’s executives (who were former Alexandria executives) later followed suit. For many institutional investors they were interchangeable, although, as one would expect, both companies would be keen to point out differences and advantages. While lab/life science is a niche, it is a relatively sizable one. BioMed, at the time of its purchase by Blackstone in January 2016, was valued at $8 billion and Alexandria is currently valued at about $10 billion.
The two investors in our tale are: the stock market at large and Blackstone; and the crux of the story essentially revolves around valuation perception of these two.
Blackstone purchased BioMed and the deal closed at the end of January this year (the deal was announced October 8, 2015). They paid $23.75/share, which was 103.6% of the last consensus estimate of net asset value (NAV) published by SNL Financial. The characteristics of the companies are duopolistic with a limited supply of new space, cluster markets (all US inventory of this type of space is in six markets), barriers to tenants moving out, and secular demand drivers. So Blackstone’s calculation that it was worthwhile to pay a slight premium for BioMed to enter the business was very logical, in our opinion.
Blackstone is currently among the largest buyers of real estate in the US, and, based on our experience (they purchased Excel Trust, a public shopping center company with whom I served as an independent director), we believe Blackstone is both sophisticated and thoughtful, thinks for the long-term, and is not prone to overreaction.
Flash forward to February 29, 2016 (the time of this writing) from last October when the BioMed deal was announced. As shown in the chart below, the remaining public company, Alexandria, is now trading at 76% of consensus NAV, which is approximately 1.6 standard deviations cheap. The market price of the shares have tracked closer to NAV more than 95% of the time over the last 10 years (the average valuation over the last 10 years—including the Great Recession—is 97% of NAV). Also, if we remove the Great Recession, the shares have never traded this cheaply. So Blackstone thought Biomed was worth 104% of NAV but the stock market thinks Alexandria was worth 76% of NAV. Between the two companies, in our opinion, Alexandria has the better portfolio as evidenced by the fact that Alexandria’s average same-store net operating income growth has been about 33% greater per year than BioMed’s for the past 10 years of reported data (40 quarters Q4-2005 to Q3-2015; the average annual same-store net operating income growth for ARE was 5.39% and BioMed was 4.06%). This makes no sense to us that Alexandria would trade about 28% cheaper than BioMed.
The public markets seem to have become caught up in a hailstorm of short-term, confusing and frequently false data reads. China, the Fed, interest rates, et cetera, have caused a significant disconnect in public market perception. Given the discrepancies between what Blackstone thinks about value and what the market seems to think, we think Blackstone is more likely correct.
ARE Market Price/Estimated NAV per Share
February 28, 2006 – February 29, 2016
In the last 10 years, 95% of the time, shares have traded above Feb 29th’s price to net asset value.
Data prepared by AACA, compiled from SNL Financial
This material is for information purposes only and its content should not be relied upon in making any investment decisions. The information provided is not a complete analysis of the market, industry, sector, or securities discussed. While the statements reflect the author’s good faith beliefs, assumptions and expectations, they are not guarantees of future or actual performance. Furthermore, American Assets Capital Advisers, LLC (“AACA”) disclaims any obligation to publicly update or revise any statement to reflect changes in underlying assumptions or factors, or new information, data or methods, future events or other changes.
The author’s assessment of a particular security is not intended as research. This commentary and the information contained herein is not, and does not constitute, directly or indirectly, a public or retail offer to buy or sell, or a public or retail solicitation of an offer to buy or sell, any fund, units or shares of any fund, security or other instrument, or to participate in any investment strategy. All data in this document, including that used to compile performance, is obtained from sources believed to be reliable but is unaudited and not guaranteed as to accuracy. The performance data cited represents past performance, which does not guarantee future results. The securities discussed are for illustrative purposes only and do not represent all of the securities purchased, sold or recommended for advisory clients. The reader should not assume that any securities discussed were or will be profitable.
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