My Investment Strategy: Find Tenants Who Stay Put

After a career of nearly three decades investing in commercial real estate, it is my opinion that the sector performs best when these conditions exist: tenants are reluctant to leave because they have few options; developers have limited options to add new supply; and tenants’ demand for space is growing, requiring more real estate. Who are my dream tenants?

Before I identify them, let me back up. I invest in commercial real estate via real estate securities, which includes Real Estate Investment Trusts (REITs)1 and C-Corporations2.  Most of these companies typically specialize in one property type, giving investors the chance to invest in “pure plays” of property types they otherwise may not have investment access to, such as shopping malls, cell-tower networks, data centers, casinos or ski areas. Specialization requires that the people who put these securities together become experts in the underlying properties.

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1) A REIT (real estate investment trust) is a type of real estate company that mainly owns and operates income-producing real estate; some engage in financing real estate. Most REITs trade on major exchanges.

2) A C-Corporation generally refers to any corporation that is public and for-profit, unless the corporation elects the option to treat the corporation as a flow-through entity.

REITs vs. Your Home

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.

Transaction Costs

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[1] and $4.95 per trade at Scottrade[2]).


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.


Final Thoughts

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.



The Wave of Private Capital Behind Public REITs

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[1]; the total value of underlying real estate assets is about $1.5 trillion, assuming 33% leverage, which is typical for public REITs[2].
  • As of 6/30/15, private real estate managers had a record $249 billion[3] 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. 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.





A Tale of Two Stocks

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 appear to be the only two 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.


Source: SNL Financial


The opinions expressed reflect the views of American Assets Capital Advisers, LLC’s (“AACA”) and not the views of Altegris. 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, 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.

Buy the (P/NAV) Dip

Burl East is a very experienced participant in and student of the real estate industry. As CEO of American Asset Capital Advisers (AACA), he is the sub-adviser for the Altegris long/short real estate strategy, of which REITs are an important part. He has recently written a blog for the AACA website on REITs and how they have historically traded relative to actual net asset values. Burl spends a lot of time looking at individual real estate companies, many of which are REITs, running long only separately managed accounts and, for us, looking at both sides of the markets—long and short—for opportunities. He makes an interesting case about the historical patterns of REIT stock performance relative to net asset values. Worth paying attention. —Jack Rivkin

Net asset value (“NAV”) is one of the core valuation metrics for real estate investment trusts (“REITs”). The metric aims to determine the inherent value of a REIT by assigning approximate liquidation values to the underlying real estate. To do so, investors must derive a series of go forward expectations such as net operating income (NOI) and cap rate assumptions to estimate a current market value of the underlying real estate.

As one may expect, general bouts of market volatility allow for share prices of publically traded REITs to deviate from their underlying net asset value. Thus, REIT shares typically trade at either a premium or discount price to net assets value (“P/NAV”). Generally, whenever REITs are trading at an elevated premium P/NAV, we expect lower go forward rates of return; and whenever REITs are trading at a deep discount P/NAV, we expect go forward rates of return to be higher. Fluctuations in P/NAV can create opportunity when REITs are trading at a premium to consider reducing positions or consider incorporating hedges, particularly in those REITs that are poorly positioned in their respective markets. Additionally, as evidenced by the recent pick up in announced REIT M&A activity, P/NAV discounts can grant opportunity to a variety of external buyers. These opportunistic buyers can generate a profit by selling off individual assets in the private market at an amount greater than the price they paid for the company in the public market. Hence, all else being equal, we believe it to be prudent to invest in REITs when they are trading at a discount P/NAV.

The SNL US Equity REIT Index (“REIT Index”) P/NAV has historically been somewhat mean-reverting with share price trading within a band of the underlying NAV. Looking at the “post-financial crisis” time period (trailing five years, 4/30/10 to 3/31/15), the mean P/NAV of the REIT index over this period was a 6.3% premium. As of the most recent month end (9/30/15), The REIT index was trading at an 8.5% discount to NAV (about 14.8% below the REIT index’s mean P/NAV for the trailing 5-year period studied).

In the study time period, when the REIT Index was trading at a discount P/NAV, the forward six-month returns of the REIT Index were positive 100% of the time. When the REIT index was trading at a premium P/NAV, the forward six-month returns of the REIT Index were positive 73% of the time during the study time period. Negative forward six-month returns of the REIT Index during that period only occurred when the REIT Index had been trading at a premium P/NAV.


As of the most recent month end (9/30/15), the REIT Index was trading at an 8.5% discount P/NAV, which we believe may suggest a positive forward six-month return.


This is a summary and does not constitute an offer to sell or a solicitation of any offer to buy or sell any securities. The performance data featured in this document represents past performance, which is no guarantee of future results. Views are as of the dates indicated and are subject to change at any time based on market and other conditions. All data in this document, including that used to compile performance, is obtained from sources believed to be reliable but is not guaranteed. Data is unaudited.

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; changes in specific real estate markets; legislative/regulatory changes (including changes to laws governing the taxation of real estate); and changes in generally accepted accounting principles, including policies and guidelines applicable to real estate funds. While forward-looking statements reflect American Assets Capital Advisers, LLC’s (“AACA”) good faith beliefs, assumptions and expectations, they are not guarantees of future or actual performance. Furthermore, AACA disclaims any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, or new information, data or methods, future events or other changes.

The SNL US Equity REIT Index. The SNL US Equity REIT Index (“REIT Index”) is an index comprised of all the publically traded US equity REITs and is considered to be generally representative of the US real estate market as a whole. Results for the REIT Index include dividends and the reinvestment of all income and are presented gross of fees. At times, the volatility of your investment may be greater than the volatility of the REIT Index. Unlike the REIT Index, your investment may be actively managed.


“The Internet of Everything”

How to make money when your refrigerator orders milk

The U.S. Department of Transportation (DOT) wants cars to talk to nearby cars to aid in safety and maybe target traffic congestion.  According to DOT, there are more than 255 million registered vehicles in the U.S.[i] – that’s a lot!  Meanwhile, in the air, a single Boeing Dreamliner tracking its flight creates enough data (40TB[ii]) per hour to fill about 57,000 CDs[iii].  On my wrist, my Nike Fuel Band talks to both my phone and laptop, and every piece of information that’s remotely relevant gets measured, transmitted and stored.  In my kitchen, my smart refrigerator complains to my microwave that the embedded music system never plays Perry Como, because it’s fixated on Katy Perry.

As a real estate investor, my company AACA is drawn to stocks of companies that possess certain characteristics.  We look for businesses that operate in sectors that have few competitors, where the real estate they own is in markets with very high barriers to entry, where the tenants have practical, locational, or physical issues that prevent them from moving, and lastly where the tenants or users are experiencing strong secular growth.  In our opinion, data centers and cell phone tower operators fit the bill for these characteristics. I’m going to be speaking about this and more in an upcoming webinar on August 27th. I welcome you to attend (Register here).


What are data centers?

Data centers are giant high-tech facilities used to house computer systems and associated components such as telecommunications and data storage.  They are ultra-secure buildings outfitted with redundant systems including power-supplies, security and communication systems, environmental controls, blast and EMP (electro-magnetic pulse) protection.  These buildings use as much electricity as a small town.  Perhaps you have seen data centers in the movies.  Any good action hero – like Tom Cruise in Mission Impossible – invariably needs to retrieve a secret data file from one of these impossibly-complex-weapons-grade facilities at some point in the plot.

But in our opinion, “the Internet of Everything” is a massive secular demand driver for these companies.  The possibilities are nearly endless. Some are trivial, such as my Nike Fuel Band or my refrigerator telling me I am out of soy milk (don’t even ask) and some are crucial, like medical devices chatting with one another to update the health status of a nursing home population or hospital.  Soon wearable computing is likely to be as ubiquitous as cell phones are today and the sheer amount of data these items will gather, store, share and access boggles the mind.


Accelerated demand for data storage

Perhaps you have heard the saying that 90%[iv] of the world’s data was created in the past 2 years.  Activities that previously were non-data producing, like hailing a cab (UBER) and dating (eHarmony), are now at the center of the digital revolution.  All this data has to be stored somewhere and the demand is growing.  Morgan Stanley says the number of devices connected to the internet will exceed 75 billion[v] by the year 2020 – that’s about 10 connected devices per person for every man, woman, and child.  We believe this is a long-term trend that may make for a good long-term investment.

If you take this to its logical conclusion, huge quantities of currently inert non-connected items will start connecting, talking, communicating, and eating up bandwidth.  As more and more people connect and create data, all these products will need to store data in the cloud, housed physically in data centers and will need to transmit that information via cell phone towers and other wireless networks. Cisco’s expectation for wireless bandwidth is that global mobile traffic will grow almost 10 fold between 2014 and 2019[vi]. We like this.


Development yields vs. traditional real estate

Data center real estate investment trusts (REITs) develop and operate the buildings that house the cloud which can potentially generate compelling profits.  Due in part to the surging demand and lack of supply (these buildings are very difficult – nearly impossible – to build), data center returns and development yields have been different than the returns of more generic real estate sectors.

While growth in this sector is in some way a blinding glimpse of the obvious, we don’t think it’s actually baked into the numbers.  Each time available bandwidth has increased, previously unimagined applications pop up to absorb that bandwidth and store that information.  No one would have predicted 5 years ago that kids would have Facebook’s mobile app open on a smartphone 24 hours a day running in the background.

There is a lot of research that needs to go into understanding the sector, which represents a small part of real estate overall.  We are seeing an overwhelming secular demand in data centers and cell phone towers, and continue to actively manage our exposure to the sector.  If you’ve ever wondered how to allocate real estate in your portfolio, you can download our recent whitepaper (here) on real estate in Modern Portfolio Theory.


To hear more from Burl East, Register here for the webinar on August 27th, 2015.


[i] Source: U.S. Bureau of Transportation Statistics

[ii] Source: Cisco

[iii] assumes 700MB size CDs (40TB/700MB = 57,143)

[iv] Source Science Daily

[v] Source Morgan Stanley

[vi] Source: Cisco