Consistent and Patient in Global Real Estate Investing
Virtus Duff & Phelps Global Real Estate Securities Fund
Frank J. Haggerty
Author: Ticker Magazine
Last Update: May 16, 7:58 AM EDT
|Real estate investments require patience given the multi-year nature of opportunities, according to Frank Haggerty, portfolio manager of the Virtus Duff & Phelps Global Real Estate Securities Fund. With a consistent approach to security selection, a structured process and an experienced team, the fund focuses on companies with above-average cash flow and dividend growth, superior return on invested capital, growth-supportive balance sheets and reasonable valuations.
“We believe that the value of a real estate security goes beyond the underlying real estate owned by the company, so we focus on companies with strong capital allocation track records and superior returns on invested capital.”
Q: How has the fund evolved since inception?
Duff & Phelps started investing in real estate securities more than 20 years ago and is one of the pioneers in the field. Over time, we expanded our research capabilities outside the U.S. We launched the ex-U.S. strategy in 2007 and the Global Real Estate strategy in 2009.
Our approach to investing in listed real estate securities is based on a global framework. We believe that an allocation to global real estate can tangibly improve an investor’s portfolio by delivering compelling risk-adjusted returns with lower correlation to other investments. Such an allocation provides growth opportunities and the benefit of diversification.
The companies that we select generate their returns primarily from exposure to high-quality, lease-based cash flow with strong dividend growth. The portfolio is inherently diversified across property sectors, while the global orientation provides diversification across a number of countries as well.
Q: Why do you consider REITs to be a good investment opportunity?
The global real estate universe offers large, attractive and growing investment opportunities. The REIT structure was first introduced in the U.S. in 1960, but over time we have seen its adoption throughout the world.
Today, there are about 40 countries with REIT-like legislation. We believe that the opportunity will continue to grow as the securitization of real estate in different countries increases, or as real estate moves from private hands to the public markets.
Q: What are the main characteristics of the REIT structure?
The REIT structure is a corporate wrapper, similar to other corporate wrappers, but with some distinct attributes. These attributes may vary in different countries, but there are universal features, such as the taxation benefits for investors. In the U.S. a company that adopts a REIT structure is a single tax payer, which means that no corporate tax is paid. There is tax only on the distributions from the REIT company itself. To receive that benefit, the companies are required to pay 90% of their taxable income as distributions to the shareholders. Some other features include limitations on the amount of leverage and active earnings associated with development.
Overall, the REIT vehicles are created to provide individual investors with an efficient way to access commercial real estate. As we know, it is difficult for a person to invest directly in real estate assets and to build a diversified portfolio of meaningful scale. In essence, the REIT structure gives investors an efficient way to build a diversified portfolio of quality properties that can provide stable cash flows and dividends.
Q: How do corporations raise capital if they distribute 90% of their income to shareholders?
In the U.S. the distribution requirement refers to the net taxable income. Technically, there is a difference between the operating cash flow and the net taxable income. There is a large non-cash expense, the depreciation expense, which lowers the net taxable income.
The operating cash flow generated from the properties is well in excess of the net taxable income. So, the companies actually have fairly conservative dividend payout ratios. That allows them to retain capital for reinvestments and for maintaining the quality of the properties.
Q: What differentiates you from other funds in the space?
A major differentiator is our consistent approach to defining the investment opportunity set. We primarily seek companies that generate most of their revenue via rent from their owned properties. So we do not invest in homebuilders, commercial merchant builders or real estate companies that depend primarily on management fees.
According to our research, the companies we invest in have historically delivered superior risk-adjusted returns. They offer the characteristics that investors seek when making an allocation to global real estate, such as stable cash flow and dividend growth, low correlation to other asset classes, and some degree of inflation protection.
Another unique feature is our fundamental approach that enables us to identify some of the small and mid-cap opportunities available on an ex-U.S. basis. That has benefited our security selection over time.
The other differentiator is the structure of our team, which is based in Chicago and consists of professionals with deep experience in both private and public real estate markets. In our structure, we have global property sector generalists, so individuals are covering companies across multiple property sectors. This structure has helped our investment and research process by prompting debates around investment ideas.
Q: What core beliefs drive your investment philosophy?
Our investment philosophy is based on four pillars. First, we are bottom-up investors, who rely on a fundamentally-driven investment process. Second, we believe that the value of a real estate security goes beyond the underlying real estate owned by the company, so we focus on companies with strong capital allocation track records and superior returns on invested capital.
Third, we believe that a successful real estate investment strategy requires patience because of the multi-year nature of the value creation opportunities. It is important to identify and invest in the right management teams and businesses at the appropriate point in the economic cycle, but then we must have the patience to allow the opportunity to play out. That belief is reflected in our lower turnover ratio.
Lastly, our core philosophical pillar is being active managers and maintaining that ability. The global real estate investment universe consists primarily of mid and small-cap companies with a handful of large-cap names in the mix. We believe that we should maintain our flexibility to invest, so we’ve committed to a threshold of assets under management. Ultimately, if we reach that threshold, we would close the Fund to new investors.
Overall, the key philosophical aspect is the focus on companies with a strong capital allocation track record, superior corporate governance, a thorough business strategy combined with the appropriate staffing levels, a well-located competitive position in enduring real estate, and a balance sheet that supports the business strategy and the growth of the business over time. Those are the types of companies that we seek to identify, because such companies have outperformed their peers historically.
Q: What are the main steps in your investment process?
We have a fundamentally-driven, five-step investment process, which has been in place for more than 20 years. The first step is identifying the opportunities in the real estate market and the property sectors. We do this by focusing on the interaction between the macro environment, the real estate rental market and the real estate investment market.
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