Relative Values in REITs
Cohen & Steers Real Estate Securities Fund
Author: Ticker Magazine
Last Update: Apr 15, 9:11 AM EDT
|Real estate securities ultimately track the private real estate market, according to Jason Yablon, portfolio manager of the Cohen & Steers Real Estate Securities Fund. With this premise in mind, the portfolio team keeps a steady focus on real estate fundamentals and relies on thorough research of each market and property type, while taking into account the big picture.
ďA key element of the fundamental process is getting the supply-demand dynamics correct. We spend the bulk of our time figuring out the direction of rents and occupancies, because that allows us to estimate the value of each individual company.Ē
Q: Can you give a historical overview of the fund?
Cohen & Steers Real Estate Securities Fund was launched in 1997, but since 2008 the fund has followed a total return oriented strategy. Currently, this is our opportunistic fund, which can invest across all real estate securities, all market caps, and internationally. We also have the ability to use options to enhance total return potential.
Our investment approach relies on a relative value perspective. Our goal is to own high-conviction stocks, diversified by property type and sector, and to generate 200 or 250 basis points of alpha relative to the benchmark. As the original REIT specialists in the sector, we have one of the largest teams focused on real estate securities. We use our accumulated knowledge and long-standing relationships within the industry to aspire to generate alpha in the portfolio.
Q: Why should investors consider real estate as an investment opportunity?
We believe real estate offers several benefits. First, historically, the total returns of the sector over long periods of time have been very effective. Second, REITs offer total return with a healthy component of income and dividend yield. Third, we think investors get the diversification benefit of investing in a property type or a sector that reacts differently from the broader equity market. REITs are not bonds or equities, but they have some of their characteristics, while providing attractive total return opportunity set. So, we believe real estate is a good component of everyoneís portfolio.
Q: What is the role of an active manager in the real estate sector?
We believe that real estate lends itself more to active management than other sectors. Within real estate, the different business models react differently to various economic environments and demographic trends. There can be different supply-demand dynamics in each submarket. Thatís why we believe the nature of the real estate business requires in-depth, bottom-up fundamental analysis, while most investors donít have the resources to do that effectively. As a result, we believe that active management works well in the real estate space.
Q: What are the core beliefs that drive your investment philosophy?
Our guiding philosophy is that real estate securities ultimately track the private or direct real estate market. That means that if we get the fundamentals right, we will be right about the equities, because we believe over time the stocks trade in line with the underlying fundamentals and the asset value growth.
Thatís why we spend a lot of time and effort on the bottom-up fundamentals and the supply-demand dynamic of each market. We formulate our views on the direction of rents and occupancies and, therefore, on the future asset values. That view is the basis of our investment decisions. If we are correct about the direction of the fundamentals at the property level, we will likely be correct on our view of the stock and its ability to create alpha.
The second tenant of our philosophy is that while the companies own real estate, they are still traded in equity wrappers and we believe that creates opportunities for asset management to create alpha. We are focused on finding relative value every day. Obviously, there can be dislocations in equity prices due to market events or current news. For us, these dislocations represent an opportunity to potentially add a stock to the portfolio, if it becomes attractive enough.
Third, we take a broader view of the real estate universe, which includes all income-producing real estate, including data centers and cell phone towers. From our perspective, all the income-oriented real estate is investable and can be evaluated. The different fundamentals might be driven by different sectors or trends and we take advantage of that.
Lastly, we believe that there is a price for everything. We rank the entire universe by value and we typically own the cheapest securities. We wouldnít own great companies with good fundamentals if the stocks are trading expensively. As long as we are confident in the fundamentals, we donít mind owning companies that might be perceived as lower quality, because it depends on the valuation. We screen everything versus our view of value, while taking into account geographic and property-type diversification for the portfolio.
Q: Which areas of the real estate market do you focus on?
We invest in REITS and in securities that are driven by the real estate market. For instance, Hilton spun off its direct ownership in real estate to a REIT, but the company is still driven by the fees it generates from managing hotels. These fees depend on the occupancy and room rent in the hotel business. The development pipeline is developing hotels and new brands to clients around the world and these are real-estate driven trends.
On the other hand, we wouldnít spend a lot of time on a company like Zillow, because it has essentially been just a referral service for brokers. Now it is morphing into buying and flipping homes, but thatís still a small piece of the business. Currently, Zillow is not in our investable universe, but Hilton is, because it is directly tied to the underlying real estate and the income-producing fundamentals. If Zillow converts from an advertising platform and a broker referral business to a company thatís driven by real estate, then we would consider it.
Overall, our investable universe includes anything that is structured as a REIT and anything that is driven by real estate. Gaming companies are also included, because they are often the owners and the operators of the real estate that is integral to their business. Hotel operators and homebuilders are also part of our investable universe, even though they are not REITs. We donít typically own too much homebuilders because we tend to rarely like the businesses, but they are in our universe.
Q: What are the key elements of your investment process?
We employ a bottom-up, fundamentally driven approach to identifying value and we also have a top-down overlay in terms of understanding the economic cycle. We need to have a view of the economy to understand where we are in the cycle and whether we are heading into a recession or growth acceleration, because the different real estate business models respond differently to the changing economic conditions.
For example, we believe the hotel business is extremely economically sensitive. If we are going into a recession, the hotel business EBITDA could dramatically decline versus the EBITDA of other REITs. On the flip side, net lease businesses can provide bond-like returns for decades. So, we need to have a view of job growth and interest rates to build an understanding from an economic standpoint.
A key element of the fundamental process is getting the supply-demand dynamics correct. We spend the bulk of our time figuring out the direction of rents and occupancies, because that allows us to estimate the value of each individual company. We have a very large team, because we need to have people on the ground to visit properties and markets, to figure out the direction of rents and opportunities, and to form a forward-looking view of fundamentals.
For example, we may believe that rent growth in a particular market will be 7% per year for the next five years, based on our different view of the supply-demand dynamics. If the stock market expects growth of only 2% per year, then our view on the value of that company will be higher. The stock would be cheaper to us and we would likely consider owning it in our portfolio. If we are correct about the fundamentals and the rent growth is higher than the market expects, the stock valuation will ultimately reflect that.
We look at the companies on three primary metrics. The first one is the premium or discounted net asset value. In other words, if we sold the companies or their pieces, how much money we would get back. Then we compare that value to the level of the stock price. Basically, we calculate the private market value of real estate. The second metric is the dividend discount model that we use to value the equity as a going-concern. The third metric is the multiple-to-growth rate.
We rank the entire universe on those metrics. Then we populate the portfolio with the companies that rank statistically cheap, while taking into account sector and geographic diversification and the impact of the macro picture on the performance of the difference sectors.
Q: How does you decision-making process work?