August 26, 2013

CONSUELO MACK: This week on WealthTrack, a top performing mutual fund manager and award winning financial planner explain why they are building up their global real estate holdings. Third Avenue Real Estate Value Fund’s Jason Wolf and Gerstein Fisher’s Gregg Fisher on the opportunities they are finding in real estate around the world are next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack.  American humorist and social commentator Will Rogers once famously quipped: “Buy land, they aren’t making any more of it.”  Americans have taken that advice to heart since the nation’s founding, expanding and homesteading across a continent.

The American dream of owning a home reached its zenith in 2004 when ownership peaked at 69.2% of U.S. households. But even after the biggest real estate and credit boom and bust this country has ever known, home ownership has only slipped to 65% and when asked younger generations of Americans still aspire to own their own homes.

The desire to own real estate, both residential and commercial has also become a worldwide aspiration and the demand for it has never been greater thanks in a large part to rapid urbanization, particularly in the developing world.  According to a recent report on Megatrends affecting institutional real estate, “China estimates 400 million more people will relocate to its cities during the next three decades.” India is expected to add another 250 million to its cities in the next 20 years.  According to a major research report by McKinsey this unprecedented urbanization trend will lift the incomes of people on every continent. Average urban incomes in China and India are roughly three times higher than rural incomes. McKinsey predicts one billion new city dwellers will enter the consuming class by 2025 and could contribute $20 trillion a year to the global economy. A major beneficiary is expected to be the real estate industry as demand for residential and commercial buildings soar, which is where this week’s guests come in. Both are big believers in the investment opportunities in global real estate.


Jason Wolf is co-lead portfolio manager of the Third Avenue Real Estate Value Fund among others. In 2004 he joined the deep- value investment firm founded and still run by investment legend Marty Whitman and initiated their foreign real estate coverage including Third Avenue’s now substantial Hong Kong real estate holdings. Gregg Fisher is the Chief Investment Officer of Gerstein Fisher, an independent investment management and advisory firm he founded in 1993. Gerstein Fisher was named to Barron’s list of top 100 Financial Advisors in 2013. Its Gerstein Fisher Research Center works which works with leading academics recently published a paper on real estate investment trusts and the firm recently launched a mutual fund to invest in global commercial REITs. I began the interview by asking them about our home market, their assessment of the U.S. housing recovery.


JASON WOLF: Well, I don’t think that there’s any doubt that we’ve come off of the bottom within the real estate and particularly in the residential businesses, but the inventory levels have come down. Housing starts have started to come up. A lot of the businesses such as homebuilders have started to lead the charge. The performance in the stocks have been fantastic over the past two years, but now the inputs are starting to move which is the timber companies, the land development companies and whatnot. So there’s different pockets of the United States that have done really, really well, and it has been helped out by the private companies coming in, private equities come in and soaked up some of that foreclosure inventory, and they’re now renting some single-family homes. So I think you’re in the third or fourth inning in the recovery in the housing market, and you have some ways to go.


CONSUELO MACK: Gregg, what’s your take?


GREGG FISHER: Yeah, I would agree. I think you just have to keep an eye on the economy. There’s a lot of history around this. You see economies moving along, and there’s a bit of a momentum effect. Industries come into areas. It could be the technology sector coming into the New York. It could have been the technology sector that came into California. You know, when economies are robust, industries come into areas. They start building. We then need housing for the people that come to work for these companies. Then we need things like movie theaters and bowling alleys and I think…


CONSUELO MACK: Right, this is the Dakotas, for instance, right.


GREGG FISHER: Yeah, absolutely. I think that if the economy continues to move along at some reasonable pace, which seems to be happening, that the odds are that the housing market and the real estate market would continue to do well along with the economy.


CONSUELO MACK: So what’s the situation with the global real estate market?


JASON WOLF: Yeah, well, there’s just been an explosion of publicly traded real estate stocks over the past decade. Right? The securitization of real estate, a lot of private wealthy families have listed their companies on the exchanges from Malaysia to Singapore to Philippines, all across the globe. You’ve got real estate companies, and so there’s a huge opportunity set there.  That also offers us opportunities as value investors, because each market doesn’t move in the same way, and today you’ve got, for example, Germany, a German office company that’s going through a massive distress and a restructuring.


CONSUELO MACK: And which company is that?


JASON WOLF: It’s IVG Corporation, and so you have opportunities there, but as a whole Europe has been doing pretty good from a real estate perspective, and then you have Brazilian homebuilders and commercial companies having a hard time while U.S. real estate companies are doing well. So it’s really becoming uncorrelated, if you will, as far as the way the markets are moving, and it’s very good for stock pickers.


CONSUELO MACK: So what role does a real estate, a real estate investment have in our portfolio?


GREGG FISHER: Well, I think when you think about all the different things investors can invest in, you’ve got stocks. You’ve got bonds. You’ve got real estate and you’ve got natural resources. There aren’t that many other things, but when we look at investors on average in our experience, we find that investors tend to be underexposed to commercial real estate or even real estate in general.  It’s not uncommon for an investor to own their home or maybe a second home, but as a percentage of their net worth, commercial real estate tends to be tiny. It’s particularly tiny if not even not existent when we ask U.S. investors particularly what exposure they have to foreign real estate markets. So if you’re just wanting to add an asset class to your portfolio that has a reasonable expected long-term return that adds a diversification benefit to the portfolio, global real estate seems to be something that most investors don’t already own that would, in fact, qualify in that regard.


CONSUELO MACK: So Jason, let me pick up on that, because you work, of course, for the legendary Marty Whitman at the Third Avenue Funds, and you actually, when you joined the firm in 2004, you introduced Third Avenue to the concept of global real estate, of foreign real estate. And so from your vantage point as a deep value investor, what’s the appeal of global commercial real estate?


JASON WOLF: Well, look. As I was underwriting the businesses, it’s one thing that we look at in the real estate market is that you try to find trends, big trends that could potentially really create a lot of long-term wealth for businesses, and three are urbanization, rising middle class and consumer consumption. And when you put that together in some of the areas of the world, it looks like the long-term wealth creation available to buy publicly traded securities of high-quality assets that are really well-financed are there, and so that’s where we went in heavy in Asian markets.


CONSUELO MACK: Well, I was going to say, so Hong Kong you’ve got some major holdings in Hong Kong, for instance.


JASON WOLF: That’s right.


CONSUELO MACK: The Third Avenue Real Estate Value Fund.


JASON WOLF: Right and, you know, we own Cheung Kong Holdings which is the flagship conglomerate of Li Ka-shing, and this is a business that is much more than a Hong Kong real estate company. Its exposures are all over the world. It’s the largest port operator in the world through Hutchison Whampoa. It’s the largest retailer, health and beauty retailer in the world as well as a large developer in a number of other businesses, but trades at 10 times last 12 months’ earnings and 80% of book value and has a fantastic balance sheet. So when you look at the long-term growth potential of the business, we feel really good about maybe a business that can grow 10% a year.


CONSUELO MACK: So real estate investment trusts and, Gregg, you recently launched a fund that invests in commercial real estate investment trusts. Real estate investment trusts, as an asset class, have been incredibly popular in the last several years because they are high-yield vehicles. What’s your view of REITs right now as an investment?


GREGG FISHER: Well, again I would approach this from an asset allocation point of view in that I don’t think investors should think of REITs for income. I think they should think about REITs in the context of a total portfolio and total return and think about what percentage of your portfolio do you already have in this asset class, should it be there and how to fit it in. That said, I also believe that investors should be thinking of REITs as part of their stock market allocation. I’ve seen investors where they think of this as an alternative to a bond, and REITs are not bonds. I would look at them the way I would stock market investments in terms of their risk and return characteristics, but they are a little bit different. A large component of REIT returns is the ordinary income, and we think that …


CONSUELO MACK: Ninety percent of the income revenues are basically distributed to shareholders by law because they don’t pay taxes.  Right.


GREGG FISHER: That has to happen in most cases, so at any rate, we think investors should typically own these things inside tax deferred retirements accounts because the tax attributes of these things could be quite negative.  So for the majority of investors that are putting this into their portfolio, if there’s a way to do it inside a tax deferred account, it takes that handicap away from REITs that they would have.


CONSUELO MACK: Because they’re taxed at ordinary income.


GREGG FISHER: That’s exactly right.


CONSUELO MACK: But the concept of treat them as stocks, you know, a lot of people are treating them just they’re income vehicles, but they don’t have the characteristics of income vehicles?


GREGG FISHER: Yeah, I mean, if you look at the price volatility of REITs or the standard deviation, and you compare them to the stock market over a long period of time, they look very similar. They move around a little bit differently, but for the most part you’re picking up a lot of the stock market volatility, The stock market returns, the returns on REITs and equities have been very similar over a long period of time. So I think investors should think of these things the way they would think of stocks as to when they should buy them and also how much of them they should own.


CONSUELO MACK: So Jason, how are you looking at REITs? And I know that at the Third Avenue Real Estate Value Fund that you’ve made a transition more to real estate operating companies. So talk to us about the changes that you’ve made and how you view REITs at this point.


JASON WOLF: Yeah, look, we’ve been involved in the real estate public markets for 15 years now with our fund, and it’s been heavily influenced by Marty Whitman’s philosophy of owning companies that are super well-financed, that don’t need access to capital on a regular basis, and REITs just don’t fit that bill. Today…


CONSUELO MACK: And because, just to explain for our viewers why they need constant access to capital.


JASON WOLF: Well, because of the dividend obligation companies have to pay out the majority of their cash flow to their investor base, and so as they pay out the shareholders their dividend income, they aren’t allowed to redeploy that capital into their business.  So it becomes a very sensitive issue, and it makes the financial crisis highlight some of the issues these companies have, which is the lack of growth prospects without being able to go to the equity markets and without being able to get access to the debt markets.  And what’s gone on over the recent four-year period is the cost of capital for these companies has been driven way down, as stock prices have lifted and interest rates have come down, so it’s been an unprecedented period of access to capital for the REITs, so it’s been pretty much a best time that they’ve ever had as far as that’s concerned.


CONSUELO MACK: With interest rates, it appears, going to start to rise, is it going to be possibly the worst of all worlds for REITs, or it’s not going to be as easy for REITs to raise cash in the debt market?


JASON WOLF: Yeah, well, I would just rephrase it to real estate companies. I mean, rising interest rate environment doesn’t have to be bad to all real estate companies, and we wrote a letter in January describing how we’re tilting our portfolio to protect our capital in a potentially rising rate environment. I think when you look out five years, which is what we typically do in our analysis on a fundamental basis, it’s hard to figure out how rates won’t be higher, and I hope they are, because that means the economy is better. Right? You don’t want the shock that Gregg mentioned earlier in rates rising, and the way I think you do that is to avoid passive income, meaning real estate investment trusts that don’t create a lot of long-term value. I think you got to maintain a portfolio that is cheap on a net asset value basis, so I have a margin of safety within the businesses that you own with catalysts involved to unlock the value, and then I think you have to have companies that have pricing power.


CONSUELO MACK: And so the theory of owning real estate operating companies, the for-instances are … so are these developers? Are these hotels?


JASON WOLF: Yeah, yeah, absolutely. They’re mainly involved in the development process or land development process, companies that don’t necessarily generate a lot of cash flow today, but they generate it over time through the stabilization of development properties. A perfect example is Forest City Enterprise, right, the largest holding in our fund, and it’s a Cleveland-based company that’s been around for a long time. 1960 it was listed, and basically they use their income-producing portfolio, quality assets in gateway cities, to develop into urban areas large complicated long-term projects like the Atlantic Yards in Brooklyn, and so they’ve done this for a very long period of time and it’s successful of redeploying capital within the business.


CONSUELO MACK: So Gregg, REITs, you’ve got a REIT fund now, so listening to the issues that Jason has with REITs, so what’s your response to that?


GREGG FISHER: Well, I think the point Jason made earlier about, you know, interest rates and so on, we did some research recently at Gerstein Fisher along with Professor Titman who’s a co-portfolio manager with me on our fund, and what we showed was we analyzed REITs across all countries, and we took a look at the effect that leverage had in REITs through a full market cycle. So I think if I’m an investor who’s contemplating REITs in my portfolio, I either have them, thinking about adding them, and I’m concerned about interest rates, I’d looking to have exposure to REITs that had less leverage than the overall marketplace and also the kind of leverage like long-term debt might be better than short-term debt. In our research we showed that leverage magnified the losses of the REIT market during the financial crisis, and that makes sense. Leverage definitely does…


CONSUELO MACK: Absolutely.


GREGG FISHER: … magnify risk, but interestingly, normally leverage would magnify the up side of assets, but in the REIT marketplace, because of the way these REITs are capitalized and the way they had to actually sell equity to raise money to buy properties during the decline, what we found was that the more levered REITs declined more on the way down and didn’t recover fully on the way up. So our thinking is at a minimum to reduce risk and we think possibly without reducing return, we would look at the REIT markets and the REITs that have less leverage than the others.


CONSUELO MACK: So there’s the quality argument as well, that the higher quality…


GREGG FISHER: It’s a value characteristic, but it’s particularly interesting now with the threat of rising interest rates.


CONSUELO MACK: And the global piece to this, because again, you’re focusing on global commercial real estate investment trusts. So again, why global as opposed to the U.S.?  Do you think the U.S. REIT market, for instance, is overvalued at this point after the big run up?


GREGG FISHER: You know, at our firm, we tend to take the view that markets do a good job pricing risk. So whether a market’s over or undervalued is a difficult task, but I do think we’ve been hearing about urbanization and the growing middle class and everything going on around the globe. The idea of having all of your money in any one country in any asset class I think just never made sense, and it particularly doesn’t make sense with the REIT market.  What’s changed with real estate, though, you know, our firm uses quantitative methods to manage assets, and five or six years ago, what we’re doing today wasn’t even really possible. The idea that we can sit behind a computer in our office and analyze real estate characteristics globally within seconds, the amount of data that exists from demographic patterns to agricultural yields to travel issues, it’s really unbelievable how much information we now have available. These markets have become far more liquid, far more accessible, and it’s much easier for an investor to have exposure in these things in a way that we can all feel comfortable than it was just a few short years ago.


CONSUELO MACK: And would you agree with that, how the Internet has basically changed everything?


JASON WOLF: Yeah, and the transparency of the companies internationally has changed dramatically. I mean, there’s copying what the United States REITs do which is comprehensive disclosures of their portfolios, and the data explosion is real, and so you can really underwrite businesses on a bottom up fundamental basis like we do, using all of the tools of the Internet in a very robust way.


CONSUELO MACK: So Jason, talk to us about a couple of the other companies that you are as a deep value investor that you’re invested in at Third Avenue and that you’re excited about.


JASON WOLF: Well, I think everybody today in the United States should have exposure to the housing recovery, and one of the businesses within our portfolio is Weyerhaeuser.  It’s a very easy business to understand. It’s super well-financed, trades at a large discount to net asset value.




JASON WOLF: Yeah, right. It’s a timber company. They own seven million acres of timberland in the United States with three other businesses that most investors put very little value on but are going to become very valuable, and that’s a homebuilding operation, a wood products company and a cellular fiber business, and when you put it all together, we think the stock trades at about a 20% discount to net asset value. It offers a three percent dividend yield today that’s going to grow with the recovery in the housing markets, particularly housing starts which is the first input into the housing business.


CONSUELO MACK: Is there a REIT that you’re particularly… I mean, a particular investment that you are excited about as well?

GREGG FISHER: The things that we’re doing at our firm are we’re looking at various forms of risk factors such as leverage which we discussed earlier or value characteristics or even smaller REITs versus the larger ones. So our portfolio tends to have market-like exposure with tilts to and away from these risks that we want our clients to have exposure to, smaller REITs, less levered REITs. We certainly are looking at value characteristics to make sure we’re buying ones that we think are fairly valued relative to the market, and another thing that we look at is momentum. What we know about security prices over long periods of time is they tend to move in directions a little longer than sometimes they should.


CONSUELO MACK: Even with high-frequency trading? I mean, that has not changed?


GREGG FISHER: That has not changed. We are still seeing it, and actually we see it happening more even in the REIT market than any other asset class. What we see is that REITs that have actually grown in value more than their peers seem to continue to grow in value more than their peers a little longer than perhaps the fundamental should.  So we do expose our portfolio a little more highly to momentum than perhaps the market would or some other managers may.


CONSUELO MACK: So this is probably exactly the opposite approach than what you’d take, Jason?


JASON WOLF: I was about to say I think it’s exactly the opposite of.  I mean, we’re highly concentrated. We’re value investors. We’re bottom up stock pickers, if you will, that focus on extreme attention on the balance sheets of companies and trying to figure out what the growth prospects of the assets within each company is as well as really doing a management assessment and figure out their long-term track record and how they are then as operators and as capital allocators and try to buy those businesses at a significant discount to what we think they’re worth today.


CONSUELO MACK: So this is really an asset class versus an individual security approach. What percentage do you think that we all should have in a global real estate investment trust?


GREGG FISHER: I think that a default position might be for an investor to have somewhere between three and ten percent of their portfolio in a global REIT strategy.


CONSUELO MACK: Which would include U.S. REITs as well.


GREGG FISHER: Absolutely, both U.S. and non U.S. REITs. This would depend upon their other exposures, the homes they own, the real estate they may own elsewhere, but without that being considered, three to ten percent is probably a decent place to start.  None of us know exactly how much the real estate values across the globe really are worth, because the majority of the real estate markets are appraisal-based.  Maybe we think it’s something like 30 trillion, but none of us actually know. What we do know, though, is that the public real estate markets, which we have a market price on, is a tiny fraction of that. The potential for the global real estate market to grow, to become a larger percentage of worldwide real estate is really significant, but back to your question on asset allocation. I think if you take that similar view, a three to ten percent allocation is a good place to start.


CONSUELO MACK: And one last question on this line for you, Jason, is, so would you agree as far as looking as a deep value investor at all the different kinds of companies that you could invest in, that global real estate is a place that you see tremendous potential as well?


JASON WOLF: I do. I just would do it, frankly, a little bit differently. Right?




JASON WOLF: Because there’s markets that I think are extremely overvalued, and there’s other markets that are offering very, very good pricing today such as Brazil and India. There’s areas of the world that, if you’re opportunistic and you use a fundamental bottom up strategy, you can really put together a portfolio that should significantly outperform over a long period of time and give you the best chance of success.


CONSUELO MACK: Right, in real estate.


JASON WOLF: In real estate.


CONSUELO MACK: So interesting. All right, final question for each of you, One Investment for long-term diversified portfolio. What would yours be?


GREGG FISHER: I would say global real estate, what we’re talking about today. I think the majority of investors that we come across have very little, if any, exposure to this. So I would look for something different than we already own, and I do think that the global real estate market is a very robust place for people to be looking out over the next decade or two.




JASON WOLF: I think it’s Forest City Enterprises, our largest holding in the fund. It’s a fantastic real estate operating company here in the United States.  It owns real estate in the gateway markets. It’s involved in some complicated developments that tend to be very profitable over a long period of time.


CONSUELO MACK: All right, we’ll leave it there. Thank you both so much for joining us and talking about global real estate, a fascinating topic for us.  We appreciate.


JASON WOLF: Thank you, Consuelo.


GREGG FISHER: Thank you.


CONSUELO MACK: At the conclusion of every WealthTrack we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: Consider adding some international real estate to your portfolio. This week’s guests Jason Wolf and Gregg Fisher made some compelling arguments about the value, appreciation and diversification opportunities that selective overseas real estate investments offer. The fact that Wolf was able to convince his boss, deep value investing legend Marty Whitman to invest in overseas real estate speaks volumes. Their fund, Third Avenue Real Estate Value is considered to be one of the best in class.


Another best in class but with an emphasis on growth is run out of investment legend Ron Baron’s shop. It is the Baron Real Estate Fund, launched by portfolio manager Jeffrey Kolitch more than three years ago and ranked number one last year and in the top percentiles since inception.

If you have missed any of our past Great Investor or Financial Thought Leader guests you can find them on our website wealthtrack.com as well as access exclusive interviews and research in our WealthTrack Extra Feature. Thank you so much for joining us! Have a great weekend and make the week ahead a profitable and a productive one.







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